Chapter 14: Investing in Stocks and Bonds Garman/Forgue Personal Finance Ninth Edition PPT slide program prepared by Amy Forgue and Ray Forgue.

Copyright ©Houghton Mifflin Company. All rights reserved Learning Objectives 1.Explain how stocks and bonds are used as investments. 2.Classify common stocks according to their major characteristics. 3.Describe fundamental and numerical ways to evaluate stock values.

Copyright ©Houghton Mifflin Company. All rights reserved Learning Objectives 4.Determine whether an investment’s potential rate of return is sufficient. 5.Use the Internet to evaluate common stocks in which to invest. 6.Summarize how stocks are bought and sold. 7.Describe how to invest in bonds.

Copyright ©Houghton Mifflin Company. All rights reserved The Role of Stocks and Bonds in Investments Corporation Public Corporation Startup Capital

Copyright ©Houghton Mifflin Company. All rights reserved Common Stock Stocks Cash Dividends Market Price Shareholder (or Stockholder)

Copyright ©Houghton Mifflin Company. All rights reserved Common Stock Residual Claim Limited Liability Board of Directors Management

Copyright ©Houghton Mifflin Company. All rights reserved Preferred Stock Cumulative Preferred Stock Noncumulative Preferred Stock Convertible Preferred Stock

Copyright ©Houghton Mifflin Company. All rights reserved Bonds Principal Maturity Date

Copyright ©Houghton Mifflin Company. All rights reserved Dividends and Splits How do stock dividends and stock splits work?

Copyright ©Houghton Mifflin Company. All rights reserved The Major Characteristics of Common Stocks Match your investment choices using P/E ratio and Beta. Price/Earnings (or P/E) Ratio –Trailing P/E Ratio –Projected P/E (or Forward P/E) Ratio –Earnings Yield

Copyright ©Houghton Mifflin Company. All rights reserved The Major Characteristics of Common Stocks Use Beta to Compare a Stock to Similar Investments –Beta (or Beta Value or Beta Coefficient): Measure of stock volatility.

Copyright ©Houghton Mifflin Company. All rights reserved The Major Characteristics of Common Stocks Income Stocks Growth Stocks –Well-known growth stocks –Lesser-known growth stocks Value Stocks

Copyright ©Houghton Mifflin Company. All rights reserved The Major Characteristics of Common Stocks Value Stocks Speculative Stocks Tech Stocks Blue-Chip Stocks Large-cap, Mid-cap, Small-cap, and Microcap Stocks

Copyright ©Houghton Mifflin Company. All rights reserved The Major Characteristics of Common Stocks Most stocks are cyclical and some are countercyclical. –Cyclical stock –Countercyclical (or defensive) stock

Copyright ©Houghton Mifflin Company. All rights reserved How to Evaluate Stock Values Use fundamental analysis to evaluate stocks. –Fundamental Analysis –Technical Analysis Corporate earnings are most important.

Copyright ©Houghton Mifflin Company. All rights reserved How to Evaluate Stock Values Earnings per share Price/Sales ratio

Copyright ©Houghton Mifflin Company. All rights reserved Numerical Measures to Evaluate Stock Prices Cash Dividends Dividends Per Share Dividend Payout Ratio Dividend Yield Book Value Book Value Per Share Price-to-Book Ratio

Copyright ©Houghton Mifflin Company. All rights reserved About Employee Stock Options An employee stock options is a gift, like a bonus, from an employer to an employee that allows that allows employees to benefit from the appreciation of their employer’s stock without putting any money down.

Copyright ©Houghton Mifflin Company. All rights reserved Calculating a Stock’s Potential Rate of Return Alpha Statistic Use beta to estimate the risk of the investment. Estimate the market risk (or systematic risk). Calculate your required rate of return.

Copyright ©Houghton Mifflin Company. All rights reserved Calculate the Stock’s Potential Rate of Return Add up projected income and price appreciation. –Potential Rate of Return –Approximate Compound Yield (or ACY) Compare the required rate of return with the potential rate of return on the investment.

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Begin by setting criteria for your stock investments. Basic investment information: –Fool.com –kiplinger.com/personalfinance/ –money.cnn.com/pf/indes.html –finance.yahoo.com/marketupdate?u

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Stock-Screening Tools: –Screen.yahoo.com/stocks.html –screen.morningstar.com Security analysts’ research reports Corporate news –Annual reports, 10-K reports, prospectus

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Stock research firms The two most popular firms that offer stock advisory research services: –Morningstar –Value Line

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Economic data Stock market data (Securities market index) –Dow Jones Industrial Average –Standard & Poor’s 500 Index –NASDAQ Composite Index –Russell 3000 Index –Wilshire 5000 Index

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Securities exchanges (stock markets) –Securities Exchange (or Stock Market) –Over-The-Counter (or OTC) Marketplace –NASDAQ

Copyright ©Houghton Mifflin Company. All rights reserved How To Use the Internet to Evaluate and Select Stocks Use portfolio tracking to monitor your investments: –E*Trade: us.etrade.com/e/t/home –MSN Money: moneycentral.msn.com –Morningstar: morningstar.com –InvestorGuide.com

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Stockbroker (or Account Executive) Security’s street name

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Discount, online, and full-service (or general) brokers –Many of these use a cash account.

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Broker commissions and fees –Round Lots –Odd Lot –Differential: The odd-lot portion of the transaction.

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks How to order stock transactions: –The process of trading stocks involves a floor broker and a specialist. –Securities prices are either matched or negotiated. Negotiated price: bid Price, ask price, spread

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Types of stock orders (executing an order): –Market order –Limit order –Stop order (or stop-loss order) –Time limits: fill-or-kill order, day order, open (or good-till-canceled [GTC]) order

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Margin buying and selling short are risky trading techniques. Margin trading is buying stocks on credit (using a margin account). –Margin buying –Margin rate

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Buying on margin can increase returns. Buying on margin can also increase losses. A margin call makes matters even worse.

Copyright ©Houghton Mifflin Company. All rights reserved Buying and Selling Stocks Selling short is selling stock borrowed from your broker. –Buying long –Selling short

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Investment-Grade Bonds Par (or Face) Value Speculative Grade (or Junk) Bonds Default Rate

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Corporate, U.S. government, and municipal bonds –Bond rating –Default (or Credit) risk U.S. government bills, notes, and bonds

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Treasury bills (t-bills), notes, and bonds –Discount yield, I-bonds –TIPS (or Treasury Inflation-Protected Securities) –U.S. Government savings bonds –Series EE savings bonds

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Federal agency debt issues Municipal Government Bonds (or Munis) Tax-Free (or Tax-Exempt) Bonds

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Unique characteristics of bond investing: –Coupon rate (or coupon, coupon yield, or stated interest rate) –Serial or sinking fund –Secured bond or unsecured bond (debenture)

Copyright ©Houghton Mifflin Company. All rights reserved Investing In Bonds Unique characteristics of bond investing: –Registered and issued –Book entry –Callable (call option)

Copyright ©Houghton Mifflin Company. All rights reserved Evaluating Bond Prices and Returns Interest rate risk results in variable value. –Market interest rates –Interest rate risk –Fixed yield –Premium

Copyright ©Houghton Mifflin Company. All rights reserved Evaluating Bond Prices and Returns Premiums and discounts Current yield Yield to maturity

Copyright ©Houghton Mifflin Company. All rights reserved Six Decisions for Bond Investors Decide on credit quality. Decide on maturity. Determine the after-tax return. Select the highest yield to maturity. Consider selling. Think about investing in bond mutual funds.

Copyright ©Houghton Mifflin Company. All rights reserved The Top 3 Financial Missteps of Investing in Stocks and Bonds People slip up in investing in stocks and bonds when they do the following: 1. Seek to invest in just one stock that promises to make them a lot of money. 2. Neglect to carefully research investment choices. 3. Hold onto a lousy investment too long instead of cutting losses by selling it.

Copyright ©Houghton Mifflin Company. All rights reserved Good Money Habits in Investing in Stocks and Bonds Include stocks and bond or mutual funds that own stocks and bonds in your investment portfolio. Use fundamental analysis to determine a company’s basic value before investing in a stock.

Copyright ©Houghton Mifflin Company. All rights reserved Good Money Habits in Investing in Stocks and Bonds Resist putting money into so-called hot stocks. Invest part of the conservative portion of your portfolio in TIPS to beat inflation. Use zero-coupon bonds to help fund a child’s education and your retirement.