1. PFIN 4 Investing in Stocks and Bonds 12 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. GITMAN/ JOEHNK/ BILLINGSLEY

2. 2 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1Describe various types of risk to which investors are exposed, as well as the sources of return 2Know how to search for an acceptable investment on the basis of risk, total return, and yield 3Discuss the merits of investing in common stock and be able to distinguish among the different types of stocks LEARNING OUTCOMES PFIN4 | CH12

3. 3 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 4Become familiar with the various measures of performance and how to use them in placing a value on stocks 5Describe the basic issue characteristics of bonds as well as how these securities are used as investment vehicles 6Distinguish between the different types of bonds, gain an understanding of how bond prices behave, and know how to compute different measures of yield LEARNING OUTCOMES (continued) PFIN4 | CH12

4. Risks of Investing 4 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Variability associated with a firm’s cash flows and with its ability to meet its operating expenses Business Associated with mix of debt and equity financing used by the issuing firm and ability to meet its financial obligations Financial Associated with the price volatility of a security Market PFIN4 | CH12

5. Risks of Investing 5 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Results from possible changes in price levels Purchasing power Results from changing market interest rates Interest rate Risk associated with the inability to liquidate an investment at a reasonably price Liquidity Unexpected event leading to a sudden and sizeable change in the value of an investment Event PFIN4 | CH12

6. Returns from Investing 6 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Current income - Received with some degree of regularity over a year Capital gains - Reflected as an increase in the market value of an investment vehicle Earning interest on interest PFIN4 | CH12

7. Exhibit 12.2 7 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. MKTG4 | CH1 The Risk-Return Relationship

8. Components of a Good Investment 8 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Future return Approximate yield Provides a measure of the fully compounded rate of return from an investment Desired rate of return: Minimum rate of return earned in compensation for the amount of risk assumed PFIN4 | CH12

9. Exhibit 12.3 9 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. MKTG4 | CH12 Performance of Dow Jones Industrial Average and NASDAQ Composite, 2004 through 2014 Source: Morningstar 2013.

10. Investing in Common Stock 10 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Issuers of common stock Issued by any corporation in any line of business Voting rights - For each share of stock held holders receive one vote Proxy: Written statement used to assign a stockholder’s voting rights to another person Basic tax considerations Common stocks provide income in the form of dividends and/or capital gains PFIN4 | CH12

11. Dividends 11 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Paid by firms to their common stock holders in cash and/or additional stock Dividend yield: Percentage return provided by the dividends Stock dividends New shares of stock distributed to existing stock holders as a supplement for cash dividends PFIN4 | CH12

12. Key Measures of Performance 12 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Book value: Amount of stockholder’s equity in a firm Net profit margin: Relates a firm’s net profits to its sales Return on equity (ROE): Captures the firm’s overall profitability PFIN4 | CH12

13. Key Measures of Performance 13 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Earnings per share (EPS): Return earned by each share of common stock Price/earnings (P/E) ratio: Measure of investors’ confidence in a given security Beta: Index of the price volatility for a share of common stock PFIN4 | CH12

14. Types of Common Stock 14 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Provides an continuous stream of dividends and long-term growth prospects Blue-chip Earnings and/or market price have increased over time at a above average rate Growth Represents the technology sector of the market Tech PFIN4 | CH12

15. Types of Common Stock 15 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Offers dividend payments that can be expected to increase over time Income Purchased with a hope that its price per share will increase Speculative Price movements tend to parallel the various stages in the business cycle Cyclical Price movements are contrary to movements in the business cycle Defensive PFIN4 | CH12

16. Reasons for Investing in Common Stock 16 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Using the stock as a warehouse of value Accumulating capital Providing source of income PFIN4 | CH12

17. Stock Ownership 17 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Advantages Potential returns Actively traded and are highly liquid form of investment Available market and company information Disadvantages Risk Problem of timing purchases and sales Uncertainty of dividends PFIN4 | CH12

18. Making the Investment Decision 18 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Putting a value on stock Timing the investments Being sure to gain earnings Dividend Reinvestment Plan (DRP): Allowing stockholders to take their cash dividends in the form of more shares of the firm's stock PFIN4 | CH12

19. Types of Bonds 19 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Coupon: Defines the annual interest income paid to bondholder by the issuer Types of issues Mortgage bond: Secured by a claim on real assets Equipment trust certificates: Secured by certain types of equipment PFIN4 | CH12

20. Basic Issue Characteristics of Bonds 20 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Debentures: Unsecured bond issued on the general credit of the firm Sinking fund: Specifies the annual repayment schedule to be used in paying off the issue Call feature: Allows the issuer to retire the security prior to maturity PFIN4 | CH12

21. Bond Market 21 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Treasury bond Issued and backed by the full faith and credit of the U.S. government Treasury inflation-indexed bond (TIPS): Principal payments adjusted to provide protection against inflation Agency bond Obligation of a political subdivision of the U.S. government PFIN4 | CH12

22. Bond Market 22 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Mortgage-backed securities Claim on the cash flows generated by mortgage loans Municipal bonds: Issued by state or local governments Serial obligations: Issue broken down into a series of smaller bonds with own maturity date and coupon rate PFIN4 | CH12

23. Bond Market 23 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Revenue bonds: Serviced from the income generated by a specific project General obligation bonds: Backed by the full faith and credit of the issuing municipality Corporate bonds: Issued by a corporation PFIN4 | CH12

24. Bond Market 24 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Convertible bonds Conversion privilege: Stipulates the conditions of the conversion feature Conversion ratio: Specifies the number of shares of common stock into which a convertible bond can be converted PFIN4 | CH12

25. Bond Market 25 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Conversion value: Measure of what a convertible issue would trade for if it were priced to sell based on its stock value Conversion premiums: Difference between a convertible security’s market price and its conversion value PFIN4 | CH12

26. Exhibit 12.2 26 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. MKTG4 | CH12 Moody’s and Standard & Poor’s Bond Ratings

27. Pricing a Bond 27 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. PFIN4 | CH12 All bonds are priced as a percentage of par Priced in decimals in the corporate and municipal market Accrued interest: Amount of interest earned since the last coupon payment date by the bond holder/seller Clean Price: Quoted price of a bond minus accrued interest Dirty Price: Quoted price of a bond plus accrued interest

28. Bond Prices and Yields 28 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. PFIN4 | CH12 Bond price depends on its: Coupon Maturity Movement of market interest rates Premium bond: Market value is higher than par Discount bond: Market value is lower than par

29. Bond Prices and Yields 29 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. PFIN4 | CH12 Current yield Amount of current income a bond provides relative to its market price Yield to maturity Fully compounded rate of return that bond would yield if held to maturity

30. 30 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Business risk Financial risk Market risk Purchasing power risk Fixed income securities Interest rate risk Liquidity risk Event risk Risk-free rate of return Desired rate of return Residual owners KEY TERMS Proxy Dividend yield Stock dividends Book value Net profit margin Return on equity (ROE) Earnings per share (EPS) Price/earnings (P/E) ratio PFIN4 | CH12

31. 31 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Beta Blue-chip stock Growth stock Tech stock Income stock Speculative stock Cyclical stock Defensive stock Large-cap stock Mid-cap stock Small-cap stock KEY TERMS Dividend reinvestment plan (DRP) Coupon Mortgage bond Equipment trust certificate Debenture Sinking fund Call feature Treasury bond Treasury inflation- indexed bond (TIPS) PFIN4 | CH12

32. 32 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Agency bond Mortgage-backed securities Municipal bond Serial obligation Revenue bond General obligation bond Corporate bond Conversion privilege Conversion ratio KEY TERMS Conversion value Conversion premium Junk bond Accrued interest Clean price Dirty (full) price Premium bond Discount bond Current yield Yield to maturity PFIN4 | CH12

33. 33 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. SUMMARY Investors are exposed to business, financial, market, purchasing power, interest rate, liquidity, and event risks Sources of return - Current income, capital gains, and interest An investment is acceptable only if it is expected to generate a rate of return meets one’s desired rate of return Types of stock Blue-chip, growth, tech, income, speculative, cyclical, defensive, and market-cap PFIN4 | CH12

34. 34 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. SUMMARY Measures of performance Book-value, net-profit margin, ROE, EPS, P/E ratio, and beta Bonds are referred to as fixed-income securities as the debt service obligations of the issuer are fixed Types of bonds Treasury, agency, mortgage-backed, municipal, corporate, and convertible PFIN4 | CH12