Personal Finance SIXTH EDITION Chapter 15 Investing in Stocks

Chapter Objectives 15.1 Identify the functions of stock exchanges 15.2 Describe how to interpret stock quotations 15.3 Explain how to execute the purchase and sale of stocks 15.4 Explain how to analyze a stock 15.5 Explain how investing in stocks fits within your financial plan

Stock Exchanges (1 of 4) Stock exchanges: facilities that allow investors to purchase or sell existing stocks New York Stock Exchange Most popular organized exchange in U.S. Floor traders: traders at a stock exchange who execute trades to fulfill orders placed by other investors

Stock Exchanges (2 of 4) Other stock exchanges Specialists: traders who help to make a market in one or more stocks by taking the position opposite of orders placed by clients A typical stock transaction on the NYSE is submitted through a brokerage firm and executed by a specialist Other stock exchanges American Stock Exchange Other regional exchanges in large U.S. cities

Stock Exchanges (3 of 4) Over-the-counter (OTC) market: an electronic communications network that allows investors to buy or sell securities Market makers: traders who execute trades on the OTC market and earn commissions in the form of a bid-ask spread Less stringent listing requirements than for NYSE

Stock Exchanges (4 of 4) Electronic Communication Networks (ECN): computer systems that match up desired purchases and sales of stocks Allow for after-hours trading No person needed to perform the exchange

Stock Quotations (1 of 2) Price quotations readily available from the Internet, stock brokers or financial newspapers Provide information about the price of each stock over the previous day or a recent period

Stock Quotations (2 of 2) EXHIBIT 15.1 Example of a Daily Stock Quotation 52-Week Hi Lo Stock (Div.) Yield (%) PE Vol. (100s) Close Net Change 62.10 49.40 Zugle ($1.00) 14 9000 50.00 +.27

Purchasing and Selling Stocks (1 of 7) Selecting a broker Analyst recommendations May be overly optimistic Must disclose ownership of stocks they recommend Individual broker skills Information available on the Internet

Purchasing and Selling Stocks (2 of 7) Brokerage commissions Discount brokerage firm: a brokerage firm that executes your desired transactions but does not offer investment advice Full-service brokerage firm: a brokerage firm that offers investment advice and executes transactions

Financial Planning Online (1 of 5) Go to the finance section of Yahoo.com Click “Get Quotes” after typing the symbol of a stock in which you are interested This site gives analyst recommendations about a stock that you specify

Purchasing and Selling Stocks (3 of 7) Placing an order Name of the stock Ticker symbol: the abbreviated term that is used to identify a stock for trading purposes Buy or Sell—specify what you want to do Number of shares Round lot: shares bought or sold in multiples of 100 Odd lot: less than 100 shares of stock

Purchasing and Selling Stocks (4 of 7) Market order or limit order Market order: an order to buy or sell a stock at its prevailing market price Limit order: an order to buy or sell a stock only if the price is within the limits that you specify Stop orders Stop order: an order to execute a transaction when the stock price reaches a specified level; a special form of limit order

Purchasing and Selling Stocks (5 of 7) Stop orders Buy stop order: an order for a brokerage firm to buy a stock when the price rises to a specified level Sell stop order: an order for a brokerage firm to sell a stock when the price falls to a specified level Placing on order online Low commission

Financial Planning Online (2 of 5) Go to http://www.etrade.com This Web site provides information that you can use when making investment decisions. It also illustrates how you can trade stocks online, which typically reduces your transaction costs.

Purchasing and Selling Stocks (6 of 7) Buying stock on margin On margin: purchasing a stock with a portion of the funds borrowed from a brokerage firm Federal Reserve limits margin to 50 percent Margin call: a request from a brokerage firm for the investor to increase the cash in the account in order to bring the margin back up to the minimum level

Purchasing and Selling Stocks (7 of 7) Short selling stock Short selling (shorting): a process by which investors sell a stock that they do not own Borrow stock from another investor and will have to return it Investor hopefully sells high and buys low (in that order)

Analyzing Stocks (1 of 11) Technical analysis: the valuation of stocks based on historical price patterns Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions

Analyzing Stocks (2 of 11) Analyzing a firm’s financial condition Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time

Analyzing Stocks (3 of 11)

Analyzing Stocks (4 of 11) Analyzing economic conditions Accounting fraud In the early 2000s many firms used fraudulent financial statements Enron and WorldCom are the most prominent examples Motivation for fraud Manager compensation Analyzing economic conditions Economic growth: a measure of growth in a country’s economy over a particular period

Analyzing Stocks (5 of 11) Gross domestic product (GDP): the total market value of all products and services produced in a country Fiscal policy: the means by which the U.S. government imposes taxes on individuals and corporations and by which it spends its money Impact of international economies One country’s strong economy can improve another’s and the opposite is also true

Analyzing Stocks (6 of 11) Interest rates Stocks perform better when interest rates are low Some stocks are more sensitive to interest rates than others The Federal Reserve uses monetary policy to influence interest rates Monetary policy – policy established by the Federal Reserve to adjust the supply of funds in the financial system in order to influence interest rates

Analyzing Stocks (7 of 11) Inflation: the increase in the general level of prices of products and services over a specified period Consumer price index (CPI): a measure of inflation that represents prices of consumer products such as groceries, household products, housing and gasoline Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products, such as coal, lumber, and metals

Analyzing Stocks (8 of 11) EXHIBIT 15.3 Sources of Economic Information Published Sources Federal Reserve Bulletin: provides data on economic conditions, including interest rates, unemployment rates, inflation rates, and the money supply. Federal Reserve District Bank publications: provide information on national and regional economic conditions. Survey of Current Business: provides data on various indicators of economic activity, including national income, production levels, and employment levels. Online Sources Bloomberg (http://www.bloomberg.com): provides reports on interest rates, other economic conditions, and news announcements about various economic indicators. Federal Reserve Meeting Information is also available online at http://www.federalreserve.gov. Federal Reserve District Bank publications are also online at http://www.frbsf.org. Federal Reserve System (http://www.federalreserve.gov): provides detailed statistics on economic conditions. St. Louis Federal Reserve District (http://www.stlouisfed.org): provides updated information about U.S. economic conditions. Survey of Current Business is also online at http://www.bea.gov. Yahoo! Finance: provides information and news about economic conditions.

Financial Planning Online (3 of 5) Go to http://www.oecd.org Click on: OECD Economic Outlook This Web site provides information about economic conditions that can affect the values of investments.

Analyzing Stocks (9 of 11) Industry conditions Stock prices susceptible to industry conditions Industry indicators Integrating your analyses Analyzing the firm, the economy and the industry allows assessment of future performance

Analyzing Stocks (10 of 11)

Analyzing Stocks (11 of 11) Limitations of stock analysis Difficulty in forecasting future conditions Favorable attributes are reflected in the stock price

Financial Planning Online (4 of 5) Go to http://www.bloomberg.com Click on: Market Data This Web site provides a summary of recent stock performance.

Financial Planning Online (5 of 5) Go to the finance section of Yahoo.com This Web site provides recent quotations of indexes that can be used as benchmarks when assessing your investment portfolio’s performance. Click on “Charts” to review historical movements in any specific index

How Stock Investment Methods Fit Within Your Financial Plan (1 of 3) Key decisions about investing in common stock for your financial plan are: Should you consider buying stock? What methods should you use for investing in stocks?

How Stock Investment Methods Fit Within Your Financial Plan (2 of 3) EXHIBIT 15.5 How Stock Investment Methods Fit Within Stephanie Spratt’s Financial Plan GOALS FOR INVESTING IN STOCK 1. Determine if I could benefit from investing more money in common stock. 2. If I consider investing in stocks, determine how to execute stock transactions. ANALYSIS Type of Brokerage Firm Full-service Guidance on stock selection; higher commissions charged on transactions. Discount No guidance on stock selection; lower commissions charged on transactions. Type of Order When Purchasing Stock Market Order A buy order is executed at the market price. Limit Order A buy order is only executed if the price is at or below a price that I may specify. Buy Stop Order A buy order is executed if the price rises to a price that I may specify. Whether to Borrow Pay with Cash Need cash to pay for the entire investment. My return will be equal to the return on the stock itself. Buying on Margin Can make investment with less money (by borrowing a portion of the funds needed). My return will be larger than the return on the stock itself. My return (whether it is a gain or loss) is more pronounced if I borrow to buy the stock, which increases the risk of my investment.

How Stock Investment Methods Fit Within Your Financial Plan (3 of 3) EXHIBIT 15.5 How Stock Investment Methods Fit Within Stephanie Spratt’s Financial Plan DECISION In the future when I invest in stocks, I will use a discount broker instead of a full- service broker because I prefer to make my own investment decisions and the commissions charged by a discount broker are low. I will use only limit orders to buy stocks, so that I can set the maximum price that I am willing to pay. I will only invest in a stock if I have sufficient funds to cover the entire investment because it is a less risky method of executing a stock transaction. Buying on margin magnifies the return (whether positive or negative) on the stock, and causes the investment to be more risky than I desire.