CHAPTER 11: INVESTMENT PLANNING

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CHAPTER 11INVESTMENT PLANNING
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The Objectives Rewards Of Investing

• Investingusually considered a long-term
  activity. Future values and returns expected to
  increase through time.
• Speculatingusually considered a short-term
  activity. Future values and returns highly
  uncertain.
• Adequate insurance coverage and emergency funds
  should be in place before starting to invest.

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How Can You Get Started Investing?

• Accumulate money by regularly allocating a
  portion of your earnings for investingPAY
  YOURSELF FIRST!
• Take advantage of automatic investment and
  dividend reinvestment programs.
• While saving, learn as much as possible about
  investments and "play" trade.

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Coming Up With the Capital

• Determine your financial objective.
• How much money will it take?
• Do you have a lump sum to invest now, or will you
  systematically save toward your goal?
• Your investment plan provides direction in
  helping you attain your goal!

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What Are Your Investment Objectives?

• Supplement current income appropriate for
  retired persons.
• Save for major expenditures such as college
  education, down payment on a home, or starting a
  business.

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• Save for retirementto live comfortably in your
  "golden years."

• Shelter income from taxesto preserve more of
  your earnings.

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Different Ways to Invest

• 1. Common Stock
• 2. Bonds
• 3. Preferreds and Convertibles
• 4. Mutual Funds
• 5. Real Estate
• 6. Commodities, Financial Futures, and Options

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1. Common Stock

• Represents a share of ownership in a company.
• Greater potential returns, but at a higher level
  of risk.
• 2. Bonds
• Represent the debt of a company.
• Provide current income.
• Lower level of risk than stocks, but with lower
  expected returns as well.
• Bond valuations inversely related to changes in
  prevailing interest rates.

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3. Preferred Stock

• An equity security that behaves like
  debtprovides current income and possible price
  appreciation.
• However, company has no legal obligation to
  declare dividends.
• Convertible Bonds
• Usually offer lower interest rates than regular
  bonds, but
• Can be converted into common stock.
• Risk that common stock will not do well and
  investor simply gets lower return.

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4. Mutual Funds

• Collection of professionally managed securities
  offered by an investment company.
• Returns and level of risk depend on
  characteristics of underlying portfolio.
• 5. Real Estate
• Can invest directly or through buying shares of a
  REIT.
• Estimating risk and expected return can be
  difficult. Investors must be aware of economic
  cycles.

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6. Commodities and Futures

• Originally designed for agricultural producers to
  manage price risks participants are now mostly
  speculators.
• Traders enter contracts to buy or sell a certain
  physical or financial item at a future date.
• Options
• Contract which conveys the right, but not the
  obligation, to buy (call) or sell (put) the
  underlying asset at a specific price on or before
  the expiration date.
• Learn more at www.cme.com.

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Securities Markets

• Place (not always physical) where financial
  instruments are traded.
• Capital marketwhere long-term securities (those
  with maturities greater than 1 year) are traded.
• Money marketwhere low-risk, short-term
  securities (those with maturities less than 1
  year) are traded.

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• Primary marketfor new issues which are available
  for the very first time. The issuing company gets
  the proceeds.

• Secondary marketfor trading previously issued
  securities. Trading is done between investors
  issuing company gets nothing.

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• Organized securities exchanges

• Secondary markets for trading listed securities.
  
• Physical marketplaces, such as the NYSE, AMEX,
  and regional exchanges.
• Utilize brokers to facilitate trading between
  buyers and sellers.
• Handle transactions of larger, well-known
  companies' securities.

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• Over-the-counter market

• Secondary market where securities are traded via
  a telecommunications network.
• Investors trade directly with securities dealers.
• Larger, actively traded issues make up NASDAQ,
  while smaller, thinly traded issues are listed on
  "pink sheets."

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• Foreign securities markets

• Organized securities exchanges exist in more than
  100 countries worldwide.
• Found in major industrialized nations such as
  Japan, Great Britain, Germany and Canada.
• Also found in developing markets around the globe.

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Regulating the Securities Markets

• Federal and state laws regulate the sale of
  securities.
• Purpose is to provide for adequate and accurate
  disclosure of financial information.
• Securities and Exchange Commission (SEC) is the
  agency in charge of administering federal
  securities laws.

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Market Trends

• Bull marketgenerally rising securities prices
  for an extended period of time.
• Reflects investor optimism.
• Associated with favorable economy.
• Bear marketgenerally falling securities prices
  for an extended period of time.
• Reflects investor pessimism.
• Associated with economic downturn.

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Making TransactionsIn the Securities Markets

• Stockbrokers purchase and sell securities for
  investors.
• Select from full-service, discount, or online
  broker, depending on your needs.
• Consider brokerage fees when making securities
  transactions.

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Investor Protection

• Securities Investor Protection Corp. protects
  customer accounts against financial failure of
  brokerage firm.
• SIPC insures accounts up to 500,000 (brokerage
  firms often purchase even greater amounts of
  coverage).
• Guarantees securities or cash held by broker will
  be replaced (does not guarantee dollar value of
  securities!).

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Executing Trades

• Investor must first establish account with
  broker.
• Trades can be executed by phone, at the brokerage
  firm, or online.
• Odd lots (less than 100 shares) may incur extra
  fee. Round lots (multiples of 100) do not.
• Market orders generally take less than a minute!

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Investor places the order with the broker.
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Investor places the order with the broker.
Broker transmits order to the market via
tele- communications equipment.
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Investor places the order with the broker.
Broker transmits order to the market via
tele- communications equipment.
Order is filled at the market by other buyers and
sellers.
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Investor places the order with the broker.
Broker transmits order to the market via
tele- communications equipment.
Order is filled at the market by other buyers and
sellers.
Execution of the order is confirmed to the broker.
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Investor places the order with the broker.
Broker transmits order to the market via
tele- communications equipment.
Broker confirms order fulfillment. Investor has 3
days to settle account.
Order is filled at the market by other buyers and
sellers.
Execution of the order is confirmed to the broker.
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Types of Orders

• Market ordertrade now at best available price.
• Limit ordertrade when a specified price or
  better is reached investor is seeking
  opportunity.
• Stop-loss ordersell if price drops to certain
  price investor is seeking to limit losses.

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Margin Trading

• Allows investor to purchase securities on credit
  by borrowing part of purchase price from broker.

Increases gains when returns are positive.
Increases losses when returns are negative.
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Example of Margin Trade with Profit(See Exhibit
11.3 in text)

• Transaction w/out w/margin
• Initial investment (100 shares _at_ 50)
• Amount invested 5,000 2,500
• Amount borrowed 0 2,500
• Total purchase 5,000 5,000
• Price INCREASES (100 shares _at_ 70)
• Gross proceeds 7,000 7,000
• Less interest (9) 0 225
• Net proceeds 7,000 6,775
• Net profit 2,000 1,775

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Example of Margin Trade with Loss

• Transaction w/out w/margin
• Initial investment (100 shares _at_ 50)
• Amount invested 5,000 2,500
• Amount borrowed 0 2,500
• Total purchase 5,000 5,000
• Price DECREASES (100 shares _at_ 30)
• Gross proceeds 3,000 3,000
• Less interest (9) 0 225
• Net proceeds 3,000 2,775
• Net loss (2,000) (2,225)

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Margin Trade Returns

• Return Profit (loss) ? Amount Invested
• w/out w/margin
• Price Increase 2,000 1,775 5,000 2,500
• Return 40 71
• Price Decrease (2,000)
  (2,225) 5,000 2,500
• Return (40) (89)

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Short Selling

• Allows investor to sell securities borrowed from
  the broker or broker's accounts.
• Before period is over, investor must replace the
  borrowed securities.

Investor profits if securitys price has declined.
Investor loses if securitys price has increased.
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• Example of Short Sale
• (See p. 459 in text)
• Investor wishes to short 100 shares of ABW now
  selling at 52.50/share.
• Broker sells borrowed shares for investor
• 100 x 52.50 5,250 proceeds

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Scenario A Price of security drops to
40/share investor repurchases

• Costs 100 x 40 4000 to replace shares.
• Investor receives
• 5250 4000 1250 profit!!

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Scenario B Price of security rises to 60/share
investor repurchases

• Costs 100 x 60 6000 to replace shares.
• Investor receives
• 5250 6000 (750) loss!!

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• To profit from short selling
• Not only must the price of the security fall,
  but it must do so within the given time period.
• Double jeopardy!

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Becoming an Informed Investor

• Types of Information to Follow
• Economic developments and current events
• Alternative investment vehicles
• Current interest rates and price quotations
• Personal investment strategies

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Available Investment Information

• Annual Reports
• Financial Press
• (WSJ and financial magazines)
• Brokerage Reports
• Advisory Services
• Investment Advisors
• On-Line Sources

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Online Investing

• Online services
• Educational material
• Investment tools
• Investment planning

• Research and screening
• Portfolio tracking
• Day trading

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Using the Internet Wisely

• Do your own research.
• Realize that frequent trades mean higher
  transaction costs.
• Dont believe everything you read.
• Avoid online scams!

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Questions to Ask

• Is the stock registered?
• Who is making the sales pitch?
• Is it too good to be true?

Refer to SEC Web site www.sec.gov (Search on
investment scams.)
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Managing Your Investment Holdings

• Build a diversified portfolio of securities based
  upon your goals and personal situation.
• Allocate your assets according to your
  objectives.
• Track your investments and rebalance your
  portfolio as your needs change.

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THE END!