Stock Terminology (continued) Investors make money in stocks in two ways: –Dividends Companies may make payment to shareholders as part of the profits. Different types of companies have different dividend policies, which may change over time –Capital Gains (CG) Investors purchase shares in companies with the expectation that the price of the shares will increase. This increase in share value is a capital gain 4

Stock Terminology (continued) General Classifications of Common Stock –Blue-chip stocks Stocks of the largest and best managed firms. This is not a specific list, but changes over time –Growth stocks Companies which are growing faster than average and which generally reinvest dividends. They generally have higher PE and PB ratios than the market as a whole –Value stocks Companies which are less expensive compared to the market. They generally have lower PE and PB ratios than the market as a whole 5

Stock Terminology (continued) Income stocks –Companies which pay dividends regularly Cyclical stocks –Companies whose share prices move up and down with the state of the economy Defensive stocks –Companies whose share prices move opposite to the state of the economy 6

D. Why Stocks Fluctuate in Value? Why do stocks change in value? –There are many different reasons why stocks fluctuate in value. A few of the more common reasons are due to changes in: Interest rates Perceived risk of the company Expected company earnings, dividends, and cash flow Supply and demand Investor sentiment and the market 8

Why Stocks Fluctuate in Value (continued) Interest rates –Investors require a certain “expected return” or discount rate to invest in stocks. A major component of this discount rate is interest rates As interest rates decrease, shareholder’s discount rate also decreases (which is tied to interest rates), and future earnings are discounted by this lower rate, increasing the value of the firm As interest rates increase, shareholders require a higher discount rate, with all future earnings discounted at this higher rate, reducing the value of the firm 10

Why Stocks Fluctuate in Value (continued) Perceived Risk of the Company –There is an inverse relationship between perceived risk of the firm and price As the perceived riskiness of a firm decreases, investors are willing to pay more for the company stock, resulting in an increase in stock price As the perceived riskiness of a firm increases, investors are willing to pay less for the stock, resulting in a decrease in stock price 12

Why Stocks Fluctuate in Value (continued) Expected Earnings, dividends, and cash flow –As earnings, dividends, and cash flow per share increase beyond what was expected, generally investors are willing to pay more for the stock, and the stock price increases –As earnings, dividends, and cash flow per share decreases beyond what was expected by the market, investors are less willing to pay for the stock, and hence the stock price declines 14

Why Stocks Fluctuate in Value (continued) Supply and demand –Stock prices may rise or fall based on supply and demand for their shares If a large shareholder needs to sell shares of a stock to meet cash needs, supply increases and the price is likely to decline Likewise, if a large investor gets new money into their account, and decides to increase their holding in the stock, the price of that stock will likely rise as the investor must pay a higher price to encourage others to sell the stock 16

Why Stocks Fluctuate in Value (continued) Investor sentiment and the market –Stock prices may rise or fall based on general investor sentiment and how the overall market is performing If investors are generally positive on stocks, and the market is performing well, investors will likely bid up the price of all stocks If investors sentiment is negative, and the market is performing poorly, investors will likely reduce their willingness to purchase the stock, resulting in a lower stock price 18

B. Major Types of Mutual Funds What are the major types of Mutual funds? –The types of mutual funds generally follow the major asset classes Money market, stock, and bond mutual funds –Others specialty funds Index funds Exchange Traded Funds (ETFs) Balanced funds Asset allocation funds Life-cycle funds Hedge funds

Types of Mutual Funds (continued) Money market mutual funds –Money market mutual funds are funds which invest the majority of their assets in short-term liquid financial instruments such as commercial paper and government treasury bills Their goal is to obtain a higher return, after fees and expenses, than traditional bank savings or checking accounts

Types of Mutual Funds (continued) Stock mutual funds –Stock mutual funds are funds which invest a majority of their assets in common stocks of listed companies –These funds generally have a specific objective, i.e. “large-cap,” “small-cap”, “value,” “growth,”, etc. which relates to the types of stocks the mutual fund invests in Their goal is either to outperform their relative benchmarks or to have a consistently high total return

Types of Mutual Funds (continued) Bond mutual funds –Bond mutual funds are funds which invest a majority of their assets in bonds of specific types of companies or institutions –These funds generally have a specific objective, i.e. “corporate,” “government”, “municipals,” “growth,”, etc. which relates to the types of bonds the mutual fund invests in –In addition, most have a specific maturity objective as well, which relates to the average maturity of the bonds in the mutual fund’s portfolio Their goal is to generally outperform their relative benchmarks

Types of Mutual Funds (continued) Index funds (822 as of 3/3/2010 – Morningstar) –Index funds are mutual funds designed to match the returns of a specific index or benchmark –Index funds can track many different benchmarks, including the S&P500 (Large-cap stocks), Russell 5000 (small- cap stocks), MSCI EAFE (international stocks), Lehman Aggregate (corporate bonds), DJ REIT (Real estate investment trusts), etc. –Index funds are tax efficient since they do little in buying and selling of securities Their goal is to match the return of their relative benchmarks

Types of Mutual Funds (continued) Balanced funds –Balanced funds are mutual funds which purchases both stocks and bonds generally in a specific percentage or relationship, i.e. 60% stocks and 40% bonds. –Their benefit is that they perform the asset allocation, stock selection, and rebalancing decision for the investor in the fund. Their goal is to exceed the return of their percentage-weighted relative benchmarks

Types of Mutual Funds (continued) Asset allocation funds –Asset allocation funds are mutual funds which rotate among stocks, bonds, and cash –Asset allocation funds invest the fund’s assets in the asset classes expected to perform the best over the coming period of time Their goal is to exceed the return of their percentage-weighted relative benchmarks after costs and fees

Types of Mutual Funds (continued) Life-cycle funds –Life cycle funds are funds which change their allocation between stocks and bonds depending on the age of the investor –As an investor ages, life cycle funds reduce their allocation to stocks and increase their allocation to bonds, more consistent with the goals and objectives of an older investor –These funds seek to perform the asset allocation decision normally done by the investor and to reduce transaction costs as well Their goal is to exceed the return of their percentage-weighted relative benchmarks after costs and fees