Chapter 14: Investing in Stocks and Bonds

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Chapter 14 Investing in Stocks and Bonds
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Objectives

• Describe stocks and bonds and how they are used
  by corporations and investors.
• Define everyday terms in the language of stock
  investing.
• Classify stock according to their basic
  descriptive categories.

3
Objectives

• Describe the major characteristics of bonds.
• Differentiate among the four general types of
  bonds.

4
Objectives

• Describe what the investor should consider before
  investing in bonds, particularly the current
  yield and yield to maturity.
• List the advantages and disadvantages of
  investing in bonds.

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Stocks and Bonds and How They are Used

• Common stock
• Preferred stock
• Bonds

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Investing in Stocks

• Why do corporations issue common stock?
• Equity financing
• To raise money to start, expand or help pay for
  ongoing business expenses
• They dont have to repay the money
• Dividends are not mandatory
• Stockholders have voting rights-proxy

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Why Do Investors Purchase Stock?

• Income from dividends
• Dollar appreciationof stock value (averaged 10
  since 1926).
• Increased value from stock splits

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Percentage of People in Different Age Groups That
Own Stocks
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Income from Dividends

• Dividends can be paid in
• Cash
• Additional stock
• Company products
• Who is entitled to the dividends?
• Record Date
• Ex-dividend Date

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Dollar Appreciation of Stock Value

• 100 shares of common stock purchases January 5,
  2007 and were sold January 5,2010 total
  dividends of 4.97 per share for the four years.

Cost when purchased 100 shares _at_57 5,700 Plus
commission 35 Total investment
5,735 Return when sold 100 shares _at_71
7,100 Minus commission -35 Total return
7,065
Transaction summary Total return
7,065 Minus total investment
- 5,735 Profit from stock sale
1,330 Plus dividends
497 Total return from the
transaction 1,827
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Stock Split

• 21
• 31
• 32
• Firms management usually has a theoretical stock
  price range for the firms stock.

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Common vs. Preferred Stock

• Common stock
• get dividends depending on profit the company
  makes
• Preferred stock
• receive cash dividends before common stock
  holders
• pre-determined dividend rate
• most preferred stock is callable

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Features of Preferred Stock

• Cumulative preferred stock
• unpaid cash dividends accumulate and are paid
  before cash dividends to common stock holders
• Conversion feature
• can be traded for shares of common stock

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Characteristics of Common Stock
Blue Chip Cyclical Defensive Growth Income Large
Cap Mid Cap Small Cap Micro Cap Penny Stock
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Language of Stock Investing

• Earnings per share (EPS)
• After tax earnings divided by the number of
  outstanding shares of common stock.
• Price/earnings ratio (P/E ratio)
• Price of a share of stock divided by the
  corporations EPS.
• Dividend payout ratio
• Annual dividend amount divided by EPS

Historical information
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Language of Stock Investing

• Price/Earnings to Growth Ratio A Look to the
  Future
• Step 1 Determine the projected change
• Step 2 Use the PEG formula
• PEG Price earnings ratio divided by annual EPS
  growth.

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Language of Stock Investing

• Look at book value of one share
• net worth of company divided by the number of
  outstanding shares
• if a share costs more than the book value the
  company may be overextended or it may have a lot
  of money in research and development

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Buying and Selling Stocks

• Primary market
• Initial Public Offering (IPO)
• Secondary market
• Security Exchange
• New York Stock Exchange
• Regional Exchange
• Over the Counter Market
• Nasdaq

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Brokerage Firms

• Full Service
• Discount
• Online

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Completing Stock Transactions

• Market Order
• Limit Order
• Stop Order
• Day Order, Week Order, Month Order or Good Until
  Canceled (GTC) Order

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Long-Term Investment Strategies

• But-and-Hold
• Dollar Cost Averaging
• Direct Investment
• Dividend Reinvestment Plan (DRIP)

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Short-Term Techniques

• Day Trading
• Buying on Margin
• Selling Short
• Trading in Options

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Make a Decision toSell Stocks

• 1. Stock reaches target price.
• 2. Favorable development temporarily push up
  price.
• 3. Good profits unlikely to continue.
• 4. Stock lags behind others in industry group.
• 5. Company profits begin to fall short of
  projections.
• 6. Industry/company prospects are deteriorating.
• 7. Losses are moderate.
• 8. Stocks price/earnings ratio appears too high.

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Language of Bond Investing

• Registered and bearer
• Callable
• Warrants
• Convertibility

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Language of Bond Investing

• Indenture
• Face value, coupon rate, maturity date
• Secured and unsecured
• Senior and subordinated

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Types of Bonds

• Corporate bonds
• U.S. government securities
• Treasury bills, notes, and bonds
• Federal agency issues
• Municipal Bonds

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Considerations Before Investing in Bonds

• Susceptibility to certain risks
• Credit
• Callability
• Inflation
• Interest rate

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Considerations Before Investing in Bonds

• Premiums and discounts
• Current yield
• Yield to maturity
• Tax-equivalent yields
• When to sell

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Formula 14.2
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Formula 14.3
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Advantages of Investing in Bonds

• Pay higher interest rates than savings
• Offer safe return of principle
• Have less volatility than stocks
• Offer regular income
• Require smaller initial investment

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Disadvantages of Investing in Bonds

• No hedge against inflation
• Can be quite volatile
• Compounding is almost impossible
• Subject to investors tax rate
• Poor marketability