Introduction to Investments

1
Introduction to Investments
Spring 2012, BUS-123 Introduction to
Investments Frank Paiano Paco Professor,
Business, Professional Technical Studies
Welcome, Everyone!
2
First A Perspective
It is a gloomy moment in history. Never has the
future seemed so dark and incalculable. The
United States is beset with racial, industrial
and commercial chaos, drifting we know not where.
Of our troubles, no one can see the end.
Harpers Magazine, 1847
3
CHAPTERS 1, 3, Lecture Notes
A Brief History of Risk and Return (Chapter
1) Security Types (Chapter 3) Time Horizon
Short-term Investments (Lecture)
What I have tried to do here is create what I
believe should be the contents of the first
chapter of an Introduction to Investments
Securities textbook.
In investing money, the amount of interest you
want should depend upon on whether you want to
eat well or sleep well -- J. Kenfield Morley
4
What is an Investment?

• An investment is any vehicle into which resources
  can be placed with the expectation that it will
  generate positive income, or that its value will
  be preserved or increased, or both
• Investment returns (a.k.a. investment rewards)
• Income interest, dividends, rent
• a.k.a. cash flows
• Increased value / Decreased value
• a.k.a. capital gains, capital appreciation
  (Yippee!)
• a.k.a. capital losses (Boo! Hiss!)

Investments come in all shapes, flavors and sizes
5
Types of Investments

• Securities
• Investments that represent debt or ownership or
  the legal right to acquire or sell an ownership
  interest
• (a.k.a. financial investments)
• Property
• Real property (land, buildings) and personal
  property (precious metals, autos, art,
  collectibles, etc.)
• (a.k.a. real estate, hard assets, tangible
  assets, commodities)
• Personal
• Examples Education and Training, Travel
• College is often the best investment a person
  will ever make Why?

This class concentrates on securities
6
Types of Investments
(continued)

• Primary Assets
• Debt
• Funds lent in exchange for interest income and
  the promised repayment of the loan at a given
  future date
• Examples Bonds, Short-term investments (savings
  accts, etc.)
• Equity
• Ownership in a business or a property
• Examples Stocks (corporations), Partnerships,
  Sole Proprietorships, Real Estate, Real Estate
  Investment Trusts
• Derivative Assets
• Securities that derive their value from an
  underlying security or asset normally highly
  speculative
• Examples Options, Futures

Some in the industry do not classify derivatives
as investments
7
Types of Investments
(continued)

• Direct Investments
• Your name is on the investment and you control
  the investment can buy or sell as you wish
• Examples Real Estate, Stocks, Bonds
• Indirect Investments
• Someone else is in control of the investment
• You have limited control, or more likely, no
  control over the underlying investment
• Examples Mutual Funds, REIT, Limited Partnership

You can buy or sell your shares in the mutual
fund, REIT, or limited partnership, but you do
not control the underlying investments
8
Types of Investments
(continued)

• Domestic Investments
• Based inside the United States
• International Investments (a.k.a. Foreign)
• Based outside the United States
• Be careful of this subtle distinction
• International (a.k.a. Foreign) ? Global

Global Domestic and International
The world is a very small place these days
economically. Sixty-five percent (by value) of
the parts in the Ford Mustang come from the U.S.
and Canada. Ninety percent of the parts in the
Toyota Sienna which is built in Indiana come
from the U.S. and Canada. Which is the more
American car? (Forbes)
9
Types of Investments
Domestic or Foreign?
(continued)
Fox Network Seagrams Bayer Aspirin Vaseline Frisk
ies Motel 6 Union Bank Volvo Saab
Foreign

• Budweiser
• Shell Oil
• Ben Jerrys
• Farmers Ins
• Arco
• Gerber
• Carnation
• Cup-a-Soup

Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Foreign
Domestic
Foreign
Foreign
Domestic or Foreign?
10
Types of Investments
Global Investing
(continued)
Average annual return from 1973 to 2009
Which country had the best average annual return
over the past quarter century?
Top 18 countries according to per capita income
(alphabetical order)
The return of the stock markets in the developed
world has been 9.2.
11
Types of Investments
(continued)

• Short-term Investments
• Up to a 1 year
• Intermediate-term Investments
• 2 to 5 years
• Long-term Investments
• 5 or more years

These are general guidelines used throughout the
industry

• I disagree with the general guidelines. Here are
  mine
• Short-term 1 to 2 years
• Intermediate 3 to 5, maybe even 6 or even 7
  years
• Long-term 7 years or longer (10 to 30 years)

Before you make an investment, you must know your
time horizon!
12
Types of Investments
(continued)

• Liquid Investments
• Easily and quickly converted into cash
• There is a ready market to purchase the
  investment and change of ownership happens
  quickly
• Examples Stocks, Bonds, Mutual Funds, REITs
• Illiquid Investments
• May be difficult to convert into cash
• Market for investment is small or change of
  ownership happens slowly or both
• Examples Real Estate, Partnerships, Collectibles

13
Risk the Risk/Return Spectrum

• Risk is the chance that actual investment returns
  will differ from the expected returns
• What is the typical definition of risk?
• The possibility of suffering harm or loss
  danger
• In general, the higher the expectation of
  investment returns, the higher the risk level
• The Risk / Return Spectrum
• Low-risk 3 to 5
• Moderate-risk 5 to 8
• High-risk 8 to 12
• Speculative-risk Greater than 12
• Speculation is often not considered investing
• (I certainly do not consider it investing)

These are my guidelines
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Lets Try Some Examples

• What type of investment is
• Bank of America passbook savings account
• Nestles Foods, Inc.
• Southwestern College Propositions AA R Bonds
• Duplex in Spring Valley (rent one, live in other)
• Qualcomm Corporation
• Loan to Uncle Harry

Short, Inter, or Long Term?
Low, Moderate, or High Risk?
Security or Property?
Domestic or Foreign?
Debt or Equity?
Direct or Indirect?
Liquid or Illiquid?
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Measuring Investment Return

• Return is straight-forward to measure
• Total Dollar Return
• The return on an investment measured in dollars
  that accounts for all cash flows and capital
  gains or losses
• Total Percent Return
• The return on an investment measured as a
  percentage that accounts for all cash flows and
  capital gains or losses

Measures of return allow us to compare investment
alternatives
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Measuring Investment Risk

• Risk is difficult to measure
• There are many ways, all of them are imperfect
• One popular measure is standard deviation
• Standard Deviation
• Measures the volatility of an investment
• In any given year, there is about a ? chance that
  the return of an investment will be within one
  standard deviation of the historical average
  return (average return plus or minus one standard
  deviation)
• The higher the standard deviation, the more
  volatile the investment
• The greater the variance from the norm

We will investigate standard deviation in detail
later in this chapter
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Investments Overview

• Equity Securities a.k.a. Common Stocks
• Fixed-Income Securities a.k.a. Bonds
• Short-term Investments a.k.a. Cash
• Mutual Funds a.k.a. Investment Companies
• Hybrid Securities Preferred Stocks,
  Convertible Securities
• Others Real Estate, Physical Assets
• Derivatives Options, Futures

Let us look at each in more detail
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Investments Overview
Chapters 5 through 8, 17
(continued)

• Equity Securities a.k.a. Common Stocks
• Represents ownership in a corporation
• Investors receive
• Dividends optional payments to shareholders
• Capital Gains shares increase in value
• Limited Liability
• Moderate-risk to high-risk to speculative-risk
• Volatility euphemism for I lost a whole
  lotta money!
• Historically best returns over time
• 8 to 12 (I normally tell people 8 to 10)
• Should be considered a long-term investment

2008 Definition Stocks are equity investment
instruments designed to lose value.
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Investments Overview
Chapters 9 10, 18 through 20
(continued)

• Fixed-Income Securities a.k.a. Bonds
• Long-term loans to
• Corporations (Corporate bonds)
• State and local governments (Municipal bonds)
• Federal government (Treasury bonds)
• Bond investors lend their money to the bond
  issuers (corporation, state or local
  municipality, Treasury)
• The bond investors then receive interest and a
  promise that the loan will be repaid when due
• Historically much less riskier than stocks but
• Also less reward 4-6 (govt/mun) to 6-8 (corp)
• Good intermediate-term / long-term investment

2008 Definition Bonds are fixed-rate investment
instruments designed to lose value.
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Investments Overview
Lecture Notes, Chapters 3, 19
(continued)

• Short-term Investments
• a.k.a. Cash Short-term vehicles
• Normally up to 1 year (1 to 3 years)
• Usually guaranteed (or pretty darned close)
• Liquid (many let you simply write a check!)
• Very low risk of losing principal
• Hence, very low reward
• 2 to 5 over time (currently less than 1)
• A place to park your money
• Also used for holding an emergency fund

2008 Definition Short-term investments are
instruments designed to accept what remains of
investors money after they have given up on
stocks and bonds.
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Investments Overview
Lecture Notes, Chapters 3, 19
(continued)

• Short-term Investments Examples
• Deposit accounts at financial institutions
• Passbook savings accounts at banks, share
  accounts at credit unions
• Series EE or I savings bonds
• U.S. Treasury bills (T-bills)
• Certificates of Deposit (CDs)
• Money market accounts
• Money market mutual funds
• Commercial paper (Corporate IOUs)
• Bankers acceptance notes (Bank IOUs)

More about short-term investments later in this
presentation
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Investments Overview
Chapter 4
(continued)

• Mutual Funds
• a.k.a. Investment companies
• A company that pools investors money and invests
  in a diversified portfolio of securities
• Investors get
• Diversification
• Mutual fund can purchase hundreds of securities
• Professional money management
• Very popular form of investment
• Range from low-risk to speculative-risk

2008 Definition Yeah, them too.
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Investments Overview
(continued)

• STOCKS BONDS CASH

Balanced mutual funds
Stock mutual funds
Bond mutual funds
Money market mutual funds
a mutual fund a.k.a. investment company
Professional Money Management Diversification
Approximately 50 of American households own
mutual funds. Or used to
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Investments Overview
Chapters 3 and 18
(continued)

• Hybrid Investments
• Preferred Stock
• Represents ownership in corporation, but
• Dividends are not considered optional
• Convertible Securities
• A bond or preferred stock that can be converted
  into common stock
• Hybrid investments are designed to offer the
  stability of fixed-income investments (bonds)
  with the opportunity for capital growth of equity
  investments (stocks)

Some in the industry categorize these with
stocks, some categorize them with bonds
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Investments Overview
Lecture Notes
(continued)

• Other Popular Investment Vehicles
• Real estate
• Examples residential, commercial, raw land, Real
  Estate Investment Trusts (REITs)
• Tangible assets
• Examples precious metals, jewels, art,
  collectibles
• Tax-advantaged investments
• Examples oil and gas limited partnerships,
  low-income housing projects

If there is sufficient time and interest, we will
look at some or all of these, especially real
estate and tangible assets. By the way, none of
these were spared in 2008, either.
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Investments (???) Overview
Chapters 14 and 15
(continued)

• Derivative Assets
• Speculative securities that derive their value
  from an underlying security or asset
• Options a.k.a. Options Contracts
• Calls and puts
• Futures a.k.a. Futures Contracts
• Commodities
• Stock indexes
• Many in the financial world (myself included) do
  not categorize these as investments

The derivative speculators did not feel so all
alone in 2008. Usually, they are the only ones
who are proud to have only lost 30.
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Our Emphases in this Course

• Equities a.k.a. Stocks
• You are an owner
• Fixed-Income Securities a.k.a. Bonds
• You are a loaner
• Short-term Securities a.k.a. Cash
• Your principal is safe (often guaranteed)
• Mutual Funds a.k.a. Investment Companies
• Your investments are managed on your behalf

For the vast majority of investors, these are the
most popular and most important financial
investment options
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Investments What are ___?

• Investment companies that pool investors' money
  and invest in a diversified portfolio of
  securities. Investors get diversification and
  professional money management.
• short-term securities
• common stocks
• bonds
• mutual funds

The correct answer is (D). Investment company is
the legal term mutual fund is the popular term.
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Investments What are ___?

• Represent ownership in a corporation. Investors
  receive dividends and capital gains (or capital
  losses).
• hybrid securities
• common stocks
• bonds
• short-term securities

The correct answer is (B). When people use the
term stocks, they are talking about common
stocks.
30
Investments What are ___?

• Investments with very little risk, and
  correspondingly, very little return. Often used
  as a place to "park your money" or for an
  emergency fund of 3 to 6 months income.
• hybrid securities
• common stocks
• bonds
• short-term securities

The correct answer is (D). Low risk, low return.
31
Investments What are ___?

• Fixed-income securities that represent loans to
  corporations, municipalities (state local
  governments agencies), and the Federal
  government. Investors receive interest and a
  promise to repay the loan.
• hybrid securities
• common stocks
• bonds
• short-term securities

The correct answer is (C). Bonds are
fixed-income investments.
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Investments What are ___?

• Securities designed to offer the stability of
  fixed-income investments with the opportunity for
  capital growth of equity investments. Examples
  include preferred stock and convertible bonds.
• derivatives
• common stocks
• bonds
• hybrid securities

The correct answer is (D). The best (?) of both
worlds.
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Investments What are ___?

• Speculative securities that derive their value
  from an underlying security or asset. Examples
  include options contracts and futures contracts.
• derivatives
• hybrid securities
• bonds
• short-term securities

The correct answer is (A). You can make a lot of
money you can lose a lot of money.
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What are Reasonable Expectations?

• What are reasonable long-term expectations of
  returns from the following investments?
• stocks
• bonds
• short-term securities
• mutual funds
• hybrid securities
• derivatives

8 - 12
4 - 8
2 - 5
?
?
?
Now, let us look at investment returns and risks
in detail
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Investment Return Revisited

• Over the long term, equities (stocks) have
  produced the best returns
• Equities Stocks
• 8 to 12 (I usually tell people 8 to 10)
• Fixed-income Securities Bonds
• Treasury Municipal Bonds 4 to 6
• Corporate Bonds 6 to 8
• Short-term Investments Cash
• 2 to 5
• Mutual funds will more or less (often less)
  reflect the underlying assets that they invest in

36
Growth of 1 Investment
1925 2009
37
Growth of 1 Investment
1801 2009
38
Investment Risk Revisited

• It is no accident that stocks and bonds have
  produced better returns than short-term
  investments (a.k.a. cash)
• Otherwise, why would investors assume the higher
  risks of stocks and bonds? Why wouldnt they
  just assume the
• Risk-free Rate of Return
• The return on guaranteed short-term investments
• Specifically, the return on U. S. Treasury Bills
• Risk Premium
• The reward for bearing risk the extra return on
  a risky asset over the risk-free rate of return

39
Investment Risk Premiums
40
Investment Risk Revisited
(continued)

• Risk versus Reward Risk versus Return
• Investment return is very straight-forward
• How much did you start with and how much did you
  end with? That is your return!
• But measuring how much risk you took to receive
  that return is much more difficult
• Each year, the investment community measures the
  average annual return and the amount of variance
  from the average return
• Using statistics, the resulting measures of risk
  are called variance and standard deviation

41
Investment Risk Revisited
(continued)

• Variance and Standard Deviation
• We will leave the calculations for your
  statistics class
• Suffice to say the higher the variance and
  standard deviation, the riskier the investment
• i.e. The higher the variance and standard
  deviation, the more the investment return will
  deviate from the average annual return

?
?
?
?
?
?
?
?
?
?
?
?
These are just fancy, schmancy terms for, You
Can Lose Yer Money!
42
Distribution of Annual Returns on Common Stocks
1926 to 2011
Does this distribution resemble anything you are
familiar with?
43
The Normal Distribution The Bell curve
Investment returns over time tend to mirror a
normal distribution
44
Historical Returns, Standard Deviations, and
Frequency Distributions 1926-2009
The greater the standard deviation, the wider the
distribution of returns and the riskier the
investment
45
Another View of Risk versus Return
Average Annual Return versus Annual Return
Standard Deviation
46
A Global View of Risk versus Return
Now we can complete the global picture regarding
risk versus return. Who had the best
risk-adjusted return?
Sweden may have had the best average annual
return, but you had to accept almost 60 more
risk to get that return.
The standard deviation of the developing world
was 15.2 with a 9.2 average annual return.
47
So, Does Youse Gots It Yet?

• Youse Wants High Returns?
• Youse Gonna Gets High Risk!
• Youse Gonna Lose Some Money, Maybe Alls Yer
  Money!
• Ifn Anybodies Tells Youse Different,
• Dere Lying!

So when (not if) you see an advertisement for a
12 Safe Rate of Return, you will know that the
chances of losing your money are pretty high.
When you see claims such as 300 or even 3000
(and you will if you are involved in investing
for any length of time), sit on your hands and
grab your wallet! P.S. By the way, they are also
breaking the law. Examples Wade Cook,
WizeTrade, Day Trading Coach, Optionetics, etc.
48
But Isnt Somebody Doing It?

• Yes, it is true
• Some people make tremendous rates of return
• But those people are not Investors
• They are Traders (a.k.a. Speculators)
• Being a Trader can be very profitable
• But it is also very stressful and very perilous
• And you are up against the best in the world

Story John Gutfreund versus John
Meriweather John Bogle http//www.forbes.com/2009
/01/09/intelligentinvestingbogle.html
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So What is a Realistic Rate of Return For Me?

• After you have taken this course, you will have a
  strong knowledge of the most popular types of
  investments
• Stocks, Bonds, Cash, Mutual Funds, etc.
• You will also know what levels of returns and
  what levels of risks you should reasonably expect
  to receive
• And if you are a patient, long-term investor, I
  believe it is realistic to expect 8 to 10
• I am certainly working on it myself!

Of course, as we will reiterate time and time
again, there are no guarantees!
50
But Is 9 or 10 Good Enough?

• It turns out the answer to this question is,
  YES!
• If you start early
• If you are patient and consistent
• If you do not get cocky or greedy
• If you do not chase after every Next Big Thing
  that comes along
• And most importantly, you dont PANIC when the
  market swoons!
• As it inevitably will do from time to time
• The trick is to take advantage of the Time Value
  of Money
• a.k.a. Compound Annual Return

51
The Time Value of Money

• The amount to which a sum you invest now will
  increase based on a specified rate of return and
  time period
• Calculating amounts into the future is called
  compounding a.k.a. the future value of money
• Future value can be computed for a single amount
  a.k.a. a lump sum or principal
• Future value can also be determined for a series
  of deposits a.k.a. stream of investments,
  annuity

We will also learn how to move from the future
back to the present (a.k.a. discounting, the
present value of money) when we learn how to
assign valuations to stocks and bonds
52
The Time Value of Money
(continued)

• Let us do some future value exercises

One last comment on risk versus return
53
Psst! Here is One of Paianos Secret TipsAvoid
Large Losses!

• Where would you put 100?

Year 1 Year 2 Investment A 85
-50 Investment B 10 9
92.50 120
185 110
Now, before we embark on the process of
identifying and familiarizing ourselves with the
longer-term, higher-yielding investments, let us
learn how and where to park our money using
short-term investments.
54
Uh, Wait a Sec. One More Time

• The greater the variance and standard deviation
  of the average annual returns of an investment,
  ______________.
• the greater the risk (a.k.a. the more volatile)
• the lesser the risk (a.k.a. the less volatile)
• there is no correlation (a.k.a. no relationship)
• standard what? (I always hated statistics)

The correct answer is (A). Dont you dare get
this one wrong on the exam!
55
Short-term Investments

• Review
• a.k.a. Cash Short-term vehicles
• Normally up to 1 year (1 to 3 years)
• Usually guaranteed (or pretty darn close)
• Liquid
• Very low risk of losing principal
• Hence, very low reward
• 2 to 5 over time
• A place to park your money
• Also used for holding an emergency fund

56
Interest on Short-term Investments

• Stated rate of interest
• Most common form of interest
• Example Nominal rate on a savings account
• Discount basis
• Method of earning interest on a security by
  purchasing it at a price below its redemption
  value the difference is the interest earned
• The interest accrues on the investment
• Treasury bills, corporate paper
• Example Purchase a security now for 4,800 that
  will be redeemed for 5,000 in nine months.
  Interest would be 200.

57
Risks of Short-term Investments

• Risk of default (a.k.a. capital losses)
• None or almost none
• Your principal is safe, often guaranteed
• Risk of losing purchasing power
• High! Short-term investments barely keep up with
  inflation
• Risk of lost opportunity cost
• High! Unless your time horizon is very short,
  there are several investment alternatives, almost
  all of which will give you a better rate of return

Repeat after me There is no such thing as a
risk-free investment.
58
Types of Short-term Investments

• Deposit accounts
• Passbook savings account
• Share account at credit unions
• Negotiable Order of Withdrawal (NOW) account
• Checking accounts that pay interest
• Money Market Deposit Account (MMDA)
• Limited check writing privileges

Deposit accounts are offered by banks and credit
unions. They are often called demand accounts
since the funds are available upon demand. They
provide the highest level of liquidity and are
usually guaranteed up to 100,000 (currently
250,000) by the government or a government
agency.
59
Types of Short-term Investments
(continued)

• Series EE Savings Bonds
• Discount method of payment
• a.k.a. Accrual-type security
• Example 100 bond cost 50
• Do not pay income tax on interest until redeemed
• Free from state and local income taxes
• Free from federal income taxes if used for higher
  education
• Popular gift for newborns

60
Types of Short-term Investments
(continued)

• Series HH Savings Bonds
• Issued at face value and pay interest twice a
  year
• Being phased out can no longer purchase
• Series I Savings Bonds
• Also issued at face value
• Inflation indexed!
• Guaranteed to outpace inflation (but not by much)
• Pay accrued interest at bonds maturity of 30
  years
• Again, free from taxes if used for higher
  education
• Maximum purchase of 30,000 per year

The Series I bonds are becoming more popular with
those concerned about inflation
61
Types of Short-term Investments
(continued)

• Treasury Bills
• Obligations of the United States Treasury
• Sold at a discount, redeemed at face value
• Varying short-term maturities
• Typically one-, three- and six-month maturities
• Generally regarded as the safest of all
  investments a.k.a. risk-free return
• Used as the benchmark for all other investments
• Free from state and local income tax
• Can be purchased directly from the Treasury
• www.treasurydirect.gov

62
Types of Short-term Investments
(continued)

• Certificates of Deposit (a.k.a. CDs)
• Savings instruments in which funds must remain on
  deposit for a specified period
• Periods range from 7 days to several years
• Penalty for early withdrawal
• Insured to same 100,000 per investor
• (Again, currently 250,000)
• Brokered CDs
• Sold by brokerage firms normally offer higher
  yields
• Can be sold prior to maturity without incurring a
  penalty

Careful! CDs will usually rollover automatically
if you do not redeem them. You can specify that
your CD proceeds be automatically rolled into
your checking or savings account.
63
Types of Short-term Investments
(continued)

• Commercial Paper
• Short-term, unsecured promissory notes (IOUs)
  issued by corporations with very high credit
  standings
• 90-day, 180-day and 270-day maturities
• Maximum maturity is 270 days
• By keeping the maturity less than one year,
  commercial paper does not need to be registered
  with the Securities and Exchange Commission
• Usually sold in multiples of 100,000
• Hence, commercial paper is usually purchased by
  institutional investors (exp money market mutual
  funds)

64
Types of Short-term Investments
(continued)

• Bankers Acceptance Notes
• Short-term, low-risk investment vehicles arising
  from bank guarantees of business transactions
• Sold at a discount from their face value and
  generally provide yields slightly below those of
  CDs and commercial paper
• Typically 30-day to 90-day maturities
• As with commercial paper, usually the minimum
  denomination is 100,000

65
Types of Short-term Investments
(continued)

• Money Market Mutual Funds
• A mutual fund that pools the capital of a large
  number of investors and uses it to invest
  exclusively in short-term securities
• Virtually all brokerage firms and mutual fund
  companies offer them
• Money Market Mutual Funds are not guaranteed
• Unlike Money Market Deposit Accounts from a bank
  or credit union
• Still considered virtually risk-free
• If there is ever a default, other companies step
  in and bail out the investors (with blessing from
  govt)
• Virtually all offer check-writing privileges and
  direct transfer to and from checking accounts

66
Choice of Short-term Investments

• So, which short-term investment is for me?
• Commercial paper and bankers acceptance notes
  are usually only suitable for institutional
  investors
• Savings bonds make cute gifts for newborns
• Many investors purchase Treasury bills directly
  from the Treasury (www.treasurydirect.gov)
• Certificates of Deposit are okay for those that
  are sure that they will not need the money until
  maturity
• Money Market Mutual Funds and Deposit Accounts
  are the preferred choice by most investors
• Especially since every bank, credit union,
  brokerage firm and mutual fund company offers
  them
• But most non-investors still use a passbook
  savings account from a bank (they have not taken
  this course yet)

67
The Emergency Fund Debate

• Should you have an Emergency Fund?
• Many financial experts recommend that households
  create an emergency fund of three, six or even
  nine months of income

I simply do not agree with the concept of an
emergency fund of three to nine months of living
expenses. As long as you have access to cash
(via a line of credit, for example) there is no
good reason to keep 10,000 to 25,000 or more in
a savings account earning 2. Instead, use the
money to pay down high interest debt, especially
credit card debt. P.S. You are adequately
insured, right?
Exceptions salespeople, the self-employed, and
those who get laid off often
68
Short-term Investments What are _?

• A mutual fund that pools the capital of a large
  number of investors and uses it to invest
  exclusively in short-term securities.
• commercial paper
• money market mutual funds
• passbook savings accounts
• Certificates of Deposit (CDs)

The correct answer is (B). Money market mutual
funds and their counterparts at banks and credit
unions have rates close to CDs without the early
withdrawal penalty.
69
Short-term Investments What are _?

• Savings instruments in which funds must remain
  on deposit for a specified period. There is
  normally a penalty for early withdrawal.
• commercial paper
• money market mutual funds
• passbook savings accounts
• Certificates of Deposit (CDs)

The correct answer is (D). If interest rates are
going down, you can lock in a good rate. But you
better hope you do not need the money until the
CD matures!
70
Short-term Investments What are _?

• Short-term, unsecured promissory notes (IOUs)
  issued by corporations with very high credit
  standing, normally sold in 100,000
  denominations.
• commercial paper
• money market mutual funds
• passbook savings accounts
• Certificates of Deposit (CDs)

The correct answer is (A). Commercial paper and
their cousins, bankers acceptance notes, are
normally only purchased by institutional
investors such as money market mutual funds.
71
Short-term Investments What are _?

• A guaranteed demand account at a bank or credit
  union that normally pays little interest but will
  often be offered with a toaster or waffle iron
  which makes it all worthwhile.
• commercial paper
• money market mutual funds
• passbook savings accounts
• Certificates of Deposit (CDs)

The correct answer is (C). No comment.
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CHAPTERS 1, 3, Lecture Notes
A Brief History of Risk and Return (Chapter
1) Security Types (Chapter 3) Time Horizon
Short-term Investments (Lecture)
Coming Up Next Chapter 4, Mutual Funds