Chapter 14 Methods of Investing © 2010 Pearson Education, Inc. All rights reserved

Why Invest? Investment is something that you acquire with the goal of making money You should save a cash reserve that is placed in liquid investments These include checking accounts, certificates of deposit (CDs) , and savings accounts This is money that you should use for emergencies or unexpected expenses Explain that before investing, you should make sure your emergency fund is in place and in highly liquid accounts. © 2010 Pearson Education, Inc. All rights reserved

Investing in Stocks Stocks are certificates that represent pieces of ownership in a company If a company has issued 100 shares of stock that represents the entire ownership of the firm, then each share of stock would be equivalent to 1 percent of the firm’s value Companies, such as Apple, have issued millions of shares Stock ownership also carries voting rights Explain that if the company is successful, you share in the rewards by your stock increasing in value and likewise, if the company performs poorly your stock value will suffer. Explain that for a company like Apple that has issued millions of shares, each of these share represents a much smaller fraction of the firms' ownership © 2010 Pearson Education, Inc. All rights reserved

Stock Exchanges Initial public offering (IPO) is when a company chooses to “go public” and has the first sale of stock The IPO occurs in what is called the primary market Companies issue and sell stock as a way to raise money for business operations, expansion, and other needs. This initial sale is when the company receives money (shares) Later, the shares may be bought and sold by many different investors Explain that those later transactions involving those same shares of stock do not provide the company with any more money © 2010 Pearson Education, Inc. All rights reserved

The Behavior of Investors Shareholders are the people who own stock in the company Dividends are the distribution of profits Many companies distribute a portion of their profits to shareholders Companies pay dividends in cash, or sometimes, in additional stock Dividends are another way some stockholders make money in the stock market © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Jennifer bought 900 shares of stock for $45 a share in a company’s IPO. Not counting commissions, what was her dollar return if she sold the stock two weeks later for $56 a share? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: 900 x $45 = $40,500 that Jennifer paid for the stock. She sold the stock for $56 x 900 = $50,400. Her return is the difference or $50,400 - $40,500 = $9,900 © 2010 Pearson Education, Inc. All rights reserved

Example of a Stock Transaction Brokerage is a firm that provides you access to the stock markets full service brokerage firms provide advice and execute your trades Commission is a fee for carrying out a transaction Buying or selling stocks will require you to open an account at a brokerage. You can open an account at one of many full service brokerage firms Such firms offer a high level of service and charge customers a commission Do research when deciding what brokerage to use. Make sure it fits your needs. © 2010 Pearson Education, Inc. All rights reserved

Example of a Stock Transaction Discount brokerage offers a reduced level of service, lower costs, and often the ability to make your trades yourself online Some investors decide to go with a discount brokerage Examples of discount brokerages are Scottrade and E*TRADE Take a look at figure 14.3 to see a flowchart outlining the process of selling a stock © 2010 Pearson Education, Inc. All rights reserved

Figure 14.3 © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Evelyn paid $32 a share and later received $38 a share. What percentage return did Evelyn make on the stock? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: ($38 - $32)/32 = .1875 or 18.75 percent. Keep in mind this return is not an annualized return and may be good or bad depending on how long Evelyn held the stock © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Laine paid $65 a share and later received $72 a share. What percentage return did Laine make on the stock? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: ($72- $65)/65= .1077 or 10.77%. Keep in mind this return is not an annualized return and may be good or bad depending on how long Evelyn held the stock © 2010 Pearson Education, Inc. All rights reserved

Investing in Bonds Many investors place some of their money in bonds Companies, nonprofit organizations, and government agencies issue bonds as a way of taking a loan Investors buy the bonds, effectively lending money to the bond issuer In return, the investor earns interest A bond is a promissory note, or a promise to repay a certain amount of money at some point in the future Explain that bonds are a loan an individual makes to a company or government entity in return for interest payments. When investing in bonds, you get to be the bank loaning others money. You receive interest payments until the time the loan is due in full. © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Each bond has a face value and a stated rate of interest This will be paid annually to the bondholder until the bond expires Bonds have maturity dates ranging from five to thirty years Look at figure 14.4 for a flowchart of the bonds process Maturity date the date when the bond expires (matures) Face value is the bond’s maturity value that is printed on the front of the bond Coupon rate is the bond’s interest rate © 2010 Pearson Education, Inc. All rights reserved

Figure 14.4 © 2010 Pearson Education, Inc. All rights reserved

How Bonds Work Bonds offer investors more than one way to make money Coupon payments are the regular interest payments Bonds offer investors more than one way to make money Bondholders can look to trade their bonds at a value higher than their face value A bond’s value moves up and down due to a number of factors Explain the types of factors that will cause a bond’s value to move up or down. such as interest rate changes or changes in investors’ beliefs in the bond issuer’s ability to repay a bond © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Kenneth held a bond for five years that had an 8.5 percent coupon rate and a $1,000 face value. How much did Kenneth receive in interest from the bond? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: $1,000 x .085 = $85 per year x 5 years = $425 © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Kate held a bond for 3years that had a 7% coupon rate and a $5,000 face value. How much did Kate receive in interest from the bond? © 2010 Pearson Education, Inc. All rights reserved

Math for Personal Finance Solution: $5,000 x .07 = $350 per year x 3 years = $1050 © 2010 Pearson Education, Inc. All rights reserved

Types of Bonds Investors can choose from several types of bonds These include: Treasury bonds Municipal bonds Federal agency bonds Corporate bonds © 2010 Pearson Education, Inc. All rights reserved