1. Chapter 14 Investment Alternatives and Trading Fixed-Income Securities You are a LENDER to the issuer of the security Your return is a fixed amount of income over a fixed amount of time (interest payments on bonds) –Motivation for buying is INCOME –All mature to a fixed amount –Lenders have rights if borrower defaults

2. Chapter 14 Investment Alternatives and Trading All fixed-income securities eventually mature for fixed amount –The maturity amount is called the par value or face value –This amount is fixed regardless of what the security sold for prior to maturity

3. Chapter 14 Investment Alternatives and Trading Types of Fixed-Income Securities Money market instruments -- Mature within a year Bonds -- Mature anywhere from two to twenty years or even longer

4. Chapter 14 Investment Alternatives and Trading Money Market Instruments –A discount security sold for less than its face value –When security matures, lender receives full face value –Lender’s return based on the difference between the price paid and the face value –Little or no default risk

5. Chapter 14 Investment Alternatives and Trading Bonds A fixed-income security with maturity date when issued greater than one year –Bonds are NOT discounted securities –Most bonds pay regular, fixed amount of interest twice a year –Interest is calculated as a percentage of the face value called the coupon rate (simple interest)

6. Chapter 14 Investment Alternatives and Trading Bonds--Callable Feature Most bonds are “callable” –This means issuer can buy back the bonds from investors –Bonds are re-purchased prior to maturity date and at pre-specified prices –Likely to be recalled when interest rates are low or falling

7. Chapter 14 Investment Alternatives and Trading Differences Between Bonds and Money Market Instruments Length of Maturity How Returns Are Earned Callable Feature Safety (Ratings)

8. Chapter 14 Investment Alternatives and Trading Treasury Notes and Bonds –Issued by the U.S. Treasury –Both have fixed coupon rates –Both have face values of $1,000 to $5,000 T-Notes have much shorter maturities than T-Bonds T-Bonds are callable starting five years from date of maturity; T-Notes aren’t

9. Chapter 14 Investment Alternatives and Trading Municipal Bonds Issued by state and local governmental units: Two types:  General obligation Backed by full faith and credit of issuing state General tax revenues can be used to pay bondholders

10. Chapter 14 Investment Alternatives and Trading Municipal Bonds  Revenue Issued to pay for a project like a new road Only revenues generated from the project are used to repay bondholder  Tax status –Exempt from federal income tax –NOT exempt from state income tax

11. Chapter 14 Investment Alternatives and Trading Bond Ratings Ratings range from AAA (best) to D (in default) Bond with rating of B or above considered investment grade (fairly low risk of default)

12. Chapter 14 Investment Alternatives and Trading Corporate Bonds è Issued by U.S. and foreign corporations to Finance expansions Finance acquisitions è Interest is subject to federal, state taxes

13. Chapter 14 Investment Alternatives and Trading Bond Pricing Depending on the interest rate used to discount future cash payments, a bond may sell for Face value Less than face value The interest rate used is called the bond’s “yield to maturity”

14. Chapter 14 Investment Alternatives and Trading Stock Investing –People invest in stock In the hope that the price of the stock will increase with company profit growth For the quarterly cash payments (dividends) which they may receive –Return on stock based on both price appreciation and income (dividends)

15. Chapter 14 Investment Alternatives and Trading Types of Stocks –Blue Chip –Income –Growth –Speculative –Cyclical –Defensive

16. Chapter 14 Investment Alternatives and Trading Valuing Common Stock Two common questions which investors ask:  How much am I willing to pay for this stock?  At what price should I sell?

17. Chapter 14 Investment Alternatives and Trading Criteria in Valuing Common Stock Current level of earnings Current level of dividends Expected growth rate of earnings and dividends Uncertainty about the growth rate in earnings and dividends Level of interest rates

18. Chapter 14 Investment Alternatives and Trading Finding Information About Stocks Investor advisory services (like Standard & Poor’s) given in-depth analysis of stock. Their reports cover: Summary of company’s business Financial performance (for prior 5-10 yrs.) Prospects for the future (general business forecasts) Assessment of the stock

19. Chapter 14 Investment Alternatives and Trading Measures of Financial Strength  Return on Equity  Earnings per Share  Price/Earnings Ratio  Beta

20. Chapter 14 Investment Alternatives and Trading Real Estate –Home ownership may not be as good an investment as it has been in the past –Returns from real estate have lagged behind stocks and bonds on occasion (not this year)

21. Chapter 14 Investment Alternatives and Trading Exotic Investments: Options Gives owner the right to buy or sell stock at a fixed price over a fixed period of time Depending on what happens to stock, an option can go up or down in value Investor does NOT have to exercise the option, but will still be charged a fee

22. Chapter 14 Investment Alternatives and Trading Options Example –If investor owns option to purchase a certain stock at $40/share: Option is VALUABLE if the price rises to $55/share Option has LITTLE VALUE if price falls to $35/share

23. Chapter 14 Investment Alternatives and Trading Exotic Investments: Futures –A real contract between two parties that calls for future delivery of some asset at a set price –Contracts can be on: Agricultural commodities Precious metals Petroleum products Currencies

24. Chapter 14 Investment Alternatives and Trading Exotic Investments: Real assets and collectibles –Includes gold, silver, diamonds, great works of art –All of returns come from price appreciation –Considerably more risky than investing in stocks, bonds, or real estate

25. Chapter 14 Investment Alternatives and Trading Characteristics of Efficient Markets çSufficient information determining underlying supply and demand Is available to all participants Is available at about the same time çTrading takes place in full view of all market participants

26. Chapter 14 Investment Alternatives and Trading Characteristics of Efficient Markets çOne can buy or sell At a price close to that of the most recent, similar trade, assuming there is no new information çTransactions costs as a percentage of the security being bought or sold are low

27. Chapter 14 Investment Alternatives and Trading Characteristics of Efficient Markets çAll participants have equal access to market No investor can execute buy or sell orders faster than any other investor (No Arbitrage Opport.) çPrices adjust quickly to new public information. This information is available –To all participants –At about the same time

28. Chapter 14 Investment Alternatives and Trading Types of Financial Markets ¶ Primary market A market where investors buy newly issued securities The issuer ( perhaps a corporation) receives the proceeds from the security sale –Example: Someone buys a T-bill from the U.S. Treasury or Shares of a Corporation in an IPO from the company.

29. Chapter 14 Investment Alternatives and Trading Types of Financial Markets · Secondary financial market A market where trading between investors involves previously issued securities The original issuer is not directly affected by these transactions –Example: The New York Stock Exchange

30. Chapter 14 Investment Alternatives and Trading New York Stock Exchange  The oldest stock market in the U.S.  More than 2,500 stocks traded Represent most of the largest, best-known corporations in America  Stocks traded have a total market value over $5 trillion  Companies must apply for listing to trade on NYSE

31. Chapter 14 Investment Alternatives and Trading The NASDAQ Stock Market Largest, best-organized over-the-counter market for stocks in the U.S. More than 5,000 stock issues trade on this market Companies tend to be smaller and less well- known than those in the NYSE

32. Chapter 14 Investment Alternatives and Trading The NASDAQ Stock Market –Trading takes place through the network; Buyers and sellers never see each other –Buy and sell orders executed electronically –Maintains at least two market makers Similar to specialists in NYSE Buy and sell from their inventories to maintain orderly market

33. Chapter 14 Investment Alternatives and Trading Selecting a Brokerage Firm –You must determine if you want a Full-service firm Discount firm

34. Chapter 14 Investment Alternatives and Trading Full-Service Firms Offer investment advice and recommendations Have access to reports written by analysts within the firm Have lists of recommended securities Assign specific brokers who are paid on commission to each client

35. Chapter 14 Investment Alternatives and Trading Discount Firms Provide mainly execution order and record- keeping services Also provide investment information from independent sources Many brokers may deal with one client Brokers work on salary instead of commission

36. Chapter 14 Investment Alternatives and Trading Types of Orders: Market  The most common type of order  Instructs broker to obtain the best possible price for you  Highest if you are selling  Lowest if you are buying  Most market orders are filled within one to two minutes

37. Chapter 14 Investment Alternatives and Trading Types of Orders: Limit Establishes a limit to the price at which you will buy or sell  A ceiling if you are buying  A floor if you are selling Can be valid for one day, one week, one month, or until it is canceled

38. Chapter 14 Investment Alternatives and Trading Reasons for Good Investment Record Keeping –Tax Purposes –Performance Tracking