INVESTING

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INVESTING THE STOCK MARKETS

• Chapter 11

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Investing Free Enterprise

• Investing is essential to the free enterprise
  system.
• It promotes economic growth and contributes to a
  nations wealth. HOW?
• People deposit money into a savings account and
  the bank lends this money to businesses.
• Businesses can then increase production, which
  leads to expansion and growth.

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Financial Systems

• Financial systems are established in an economy
  so investments can take place.
• When people save money they are really loaning it
  to other people.
• Savers receive a document, such as a passbook or
  a bond certificate, that confirms their purchase
  or deposit.
• These documents represent the claims, or
  financial assets, of the borrower.

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Financial Intermediaries

• Financial intermediaries, including banks and
  other financial institutions, accept funds from
  savers to make loans to investors.

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Sharing RISKS

• Dealing with financial intermediaries
• offers three advantages
• Sharing risk
• Providing information
• Providing liquidity
• Sharing risk
• Dont put all your eggs in one basket!
• Diversification allows you to spread out your
  investments so that you dont put all of your
  money into one single investment.
• Sharing risk helps ward against losing everything
  on a bad investment.

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TYPES OF RISK

• Investors must weigh the risks of investment
  against the potential rate of return on their
  investment.
• How does diversification lessen the risks
  described in the chart?

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Return and riskThe higher the risk, the higher
the potential return!

• The safer the investment, the lower the return.
• Whenever people evaluate their potential
  investments, they must balance the risks involved
  with the rewards they expect to gain.
• Some investments, like CDs, are very safe since
  they are govt- insured
• Investing in a new business is far riskier, but
  if its a success, the return could be very big.

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INVESTMENT ALTERNATIVES

• BONDS a way to save and earn interest
• Businesses and governments borrow through
  issuing of bonds
• A bond is an IOU
• Investor loans to corporation/government,
  holds bond until maturity date, then gets paid
  back at par value
• Just like any loan, the borrower pays interest
  the coupon rate - to the lender usually via a
  coupon every 6 months
• U.S. savings bonds paid differently all at end.
• Bond ratings Standard Poors, Moodys
• Higher the bond rating, the lower the interest
  rate it will pay
• Risk? Liquidity? Return?

Corporate Bonds
U.S. Savings Bonds
Municipal Bonds
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INVESTMENT ALTERNATIVES

• Certificates of Deposit (CDs)
• Loans from investors to banks
• Investors can choose maturity date
• Usually 6 months, two years, three years, etc.
• Can deposit as little as 100
• Severe penalties for early withdrawal
• Risk? Liquidity? Return?
• IRAs Individual Retirement Accounts
• Way to save for retirement
• Set aside 3000/year no taxes on this income so
  puts off paying taxes until worker is retired (
  then in a lower tax bracket)
• High penalties if cashed in early
• Risk? Liquidity? Return?

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INVESTMENT ALTERNATIVES

• A professionally managed type of collective
  investment scheme that pools money from many
  investors to buy securities (stocks, bonds, etc.)
• Have a staff of analysts
• Investors like them because
• Gives them a diversified portfolio
• Experts are keeping up with the investments
• They pay dividends
• Slow to change in value
• Risk? Liquidity? Return?

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WHAT ARE YOU REALLY GETTING WHEN YOU BUY A STOCK?

• Part ownership but no real control
• A certain amount of risk
• Faith in the financial reporting
• Fairly liquid investment
• Only a paper value until
• sold

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What to look for when picking stocks

• Company information
• News articles
• Numbers dividends charts price/volume trends
• Analyst reports
• Annual/quarterly reports
• Insider buying/selling

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• COMMON STOCK
• Most widely held type of stock
• Confers voting rights 1 share 1 vote
• May attend company annual meeting
• May raise concerns to Board of Directors
• May receive dividends
• Last in line for assets in a bankruptcy

TYPES OF STOCK

• PREFERRED STOCK
• Bought like any stock
• Dividends, if any, go to preferred shareholders
  first and are guaranteed
• Generally has no voting rights
• Ahead of common stock for liquidated assets in
  bankruptcy

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WALL STREET ...

• Refers in general to the markets in the U.S. for
  stock trading
• It is where financial trading began in colonial
  America.
• It is home to our oldest stock exchange, the New
  York Stock Exchange

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WHAT IS AN EXCHANGE?

• It simply refers to the meeting place - physical
  or virtual - for buyers and sellers of stocks
  bonds (a/k/a securities)
• In a stock exchange, representatives of buyers
  sellers meet to trade on behalf of their
  customers.
• These exchanges function as auction markets.

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MAJOR U.S. STOCK EXCHANGES

• New York Stock Exchange - NYSE
• is the oldest largest in U.S.
• is located at 11 Wall Street, NY, NY
• Blue Chip stocks listed here
• American Stock Exchange - AMEX
• younger companies are listed here
• lots of energy companies listed
• located in NY also -- just a few blocks from NYSE

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The Trading Floor of the New York Stock Exchange
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How is this exchange different?
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• NASDAQ - National Association of Securities
  Dealers Automated Quotations
• is an electronic market -- no floor trading /
  phone computer only
• is our second largest market
• is based in Washington, D.C.
• Primary focus -technology stocks

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Securities Exchange Commission

• The SEC
• Government agency responsible for overseeing the
  stock market
• Established after the 1929 Crash
• Function is to make sure investors are informed
  to help prevent cheating in stock transactions
• Prospectus required before stock purchases

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THE DOW

• Is the Dow Jones Industrial Average
• Takes the average of 30 stocks to determine
  whether the market traded up or down for the day
  (compared to a previous average)
• Serves as a thermometer gives a quick reading
  of the markets temperature

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• It is compiled daily by Dow Jones Company
  (owner of the Wall Street Journal)

• Investors use the Dow to compare the performance
  of their stocks
• Dow was originally 12 stocks. The only stock in
  the original 12 Dow stocks that is in the 30 Dow
  stocks today is GE

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The 30 Stocks of the Dow Jones Industrial Average
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THE IMPACT OF 9-11 ON THE DOW
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Whats the difference between a Bull and a Bear
Market?
Bull market prices climbing over an extended
period of time
Bear market prices falling over an extended
period of time
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Other Ways of Making Money in the Market
Margin buying you believe a stock will rise
Buying with borrowed money
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Buying on margin works like this

• You could buy stock with only a 10 down payment
  (1,000 shares, 10/share total cost of 10,000
  but you just put 10/1,000 down)
• You borrow the remaining 90 (9,000) from the
  stockbroker
• Then, when the price goes up (20/share for ex.,
  you sell it (20,000) pay off broker (9,000)
  and keep the remaining profit (11,000)
• BUT, when stock values start going down,
  everybody tries to sell prices keep plummeting
• Broker then sells off your stock (for ex., at 5
  per share- 5,000) gets less than what you owe
  him
• Now you have no stock, and still owe 4,000 on
  your loan to the broker?
• So what type of market do you need if you want
  to use margin buying?

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Other Ways of Making Money in the Market
Short selling you believe a stock price will
fall
Selling with borrowed stock Borrow stock, not
, then sell to cover the stock you borrowed.
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Short selling works like this

• You borrow stock from the broker (1000 shares)
  this is what you have to return to him1000
  shares
• You sell the borrowed stock for ex., at 10 per
  share and you are expecting the stock value to
  continue to go down (you now have 10,000)
• When the prices do go down (lets say to 5 per
  share), you now cover your stock loan and buy
  1000 shares to repay the stock to the broker
• You made a 5,000 profit off stock you never
  owned!
• BUT, when stock prices start going up, you have a
  problem?
• If you had to buy back the stock at 12 for
  example, your cost would be 12,000 and you would
  be 2,000 down on this transaction

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Should you diversify your stocks?
How lucky do you feel?
Had been dubbed Americas Most Innovative
Company but in 2001 it died out in a bankruptcy
wrapped up in accounting fraud, criminal charges,
and the destruction of employee investments and
retirement savings.
TIP Do diversify your portfolio! Buy different
stocks so that losses in one can be balanced by
gains elsewhere.
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SAVING COMPOUND INTEREST

• THE TIME VALUE OF MONEY HAS A SIGNIFICANT IMPACT
  ON SAVINGS INVESTMENT GROWTH
• The more time you have to invest,
• The more money you have to invest,
• the higher the rate of interest you can earn
• EQUALS A GREATER RETURN ON YOUR

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• REMEMBER THE RETURN IS THE AMOUNT EARNED ON
  ONES SAVINGS/INVESTMENTS

• COMPOUNDING provides even more incentive to
  invest early.
• COMPOUND INTEREST the earned on your original
  deposit AND the interest payments you have
  received on that deposit in the past

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The Rule of 72

• An easy rule to determine how much your savings
  or investments can grow with compound interest.
• Just divide the interest rate into 72. The result
  tells you how long it will take for your money to
  double without further savings.
• For example, you have 10,000, which is earning
  6 interest (after tax). 72 divided by 6 12.
• Every 12 years your 10,000 will double, so
• After 12 years you have 20,000
• After 24 years you have 40,000
• After 36 years you have 80,000

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Do I Have A Deal for You!

• You go in for a summer job interview. The boss
  offers to pay you 50 a day for a 5-day, 10-week
  position
• OR
• You can earn only one cent on the first day but
  have your daily wage doubled every additional day
  you work.
• Which option would you take?
• Option A you would earn 2,500 if you work all
  50 days
• Option B if you took this offer and worked only
  HALF the summer, you would earn 167,772.16by
  the 30th day you would have over 5,000,000!!!

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The Time Value of
The

• DOES IT REALLY MATTER WHEN YOU START SAVING?
• Jim and Mary are both 22. They both want to save
  1000 a year for retirement.
• Mary starts saving at age 22 and saves for 20
  years, until she is 42. Mary then quits and
  leaves her savings to compound.
• Jim starts 10 years later at 32 and saves for 33
  years until age 65.
• Both earn 4 on their savings every year.
• Who do you think has more money at age 65?

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• Mary has built a fund of 76,327 at age 65.
• At age 65, Jims fund is 68,855,
• Jim put more money into his savings but because
  Mary started early and gave her savings more time
  to compound, Jim was not able to catch up.

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More on the time value .The sooner you start to
save, the greater the benefit of compound
interest!

• In this example, two different individuals--Darryl
  and Cheryl, each 22 years old--have an extra
  2,000 a year to invest or spend as they choose.
  Darryl opens an Individual Retirement Account
  (IRA) to start saving. Cheryl chooses to spend
  her 2,000.
• In this example, Darryl's IRA earns 12 per year.
  Darryl saves 2,000 per year for 6 years, then
  never puts another cent into his IRA. Darryl's
  total investment is 12,000.
• Cheryl spends her 2,000 per year for six years.
  At age 28, she starts investing 2,000 per year
  until she is 65 years old (37 years). Cheryl's
  total investment is 74,000 . Cheryl earns the
  same 12 interest per year that Darryl does.
• Because she lost some of the time value of
  money, Cheryl had to invest an extra 31 years
  an extra 62,000 to get to the same stage by
  retirement age.

Age Darryl Cheryl
22 2,240 0
23 4,509 0
24 7,050 0
25 9,896 0
26 13,083 0
27 16,653 0
28 18,652 2,240
29 20,890 4,509
30 23,397 7,050
35 41,233 25,130
40 72,667 56,993
45 128,064 113,147
50 225,692 212,598
55 397,746 386,516
60 700,965 693,879
65 1,235,339 1,235,557