STOCKS, BONDS, AND MUTUAL FUNDS Chapter Twenty-one Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

1. Read, calculate, and explain stock quotations. 2. Calculate dividends of preferred and common stocks; calculate return on investment. LU21-1: Stocks LEARNING UNIT OBJECTIVES LU 21-2: Bonds 1. Read, calculate, and explain bond quotations. 2. Compare bond yields to bond premiums and discounts Explain and calculate net asset and mutual fund commissions. 2. Read and explain mutual fund quotations. LU 21-3: Mutual Funds LU 21-4: Distribution of Profits and Losses in a Partnership 1. Calculate distribution of profits (losses) using five methods.

Stock – shares of ownership in a company Common stock – stock that allows owners to have voting rights STOCKS Preferred stock – does not allow voting rights, but gives preference over common stockholders in dividends 21-3 Dividends – payments to shareholders from profit

STOCKS Dividends in arrears - payments owed to cumulative preferred shareholders Stockholders Elect Board of Directors Elect Officers of Corporation 21-4 Cumulative preferred stock – entitles its owners to a specific amount of dividends in 1 year

HOW ARE STOCKS TRADED? Stockbrokers – People who buy and sell stock on the floor of the exchanges; they charge a commission for trading stocks Stock exchanges – an orderly trading place for stock 21-5

STOCK QUOTATIONS IN NEWSPAPERS 21-6

Closing price per share of stock Annual earnings per share Earnings per share = Closing price Price/Earnings ratio STOCK QUOTATION CALCULATIONS Annual dividend per share $1.21 Today’s closing price per share $39.09 *Earnings per share are not listed on the stock quote. Stock yield ==3.1%= PE ratio = $39.09 $2.30 = 17= 21-7 = $ = $2.30

DIVIDENDS ON PREFERRED AND COMMON STOCKS The stock records of Jason Corporation show the following: Preferred stock issued: 20,000 shares. In 2014, Jason paid no dividends. Preferred stock cumulative at $.80 per share.In 2015, Jason paid $512,000 in dividends. Common stock issued: 400,000 shares Dividends paid0 Preferred stockholders Paid: 0 Owe: 20,000 x $.80 = $16,000 Common Stockholders Dividends paid $512,000 Paid for ,000 Paid for ,000 $ 32,000 Total dividend $512,000 Paid preferred for ‘14 & ’ ,000 To Common $480,000 $480,000 = $1.20 per share 400,000 shares 21-8

CALCULATING RETURN ON INVESTMENT Suppose you bought 200 shares of General Mills stock at $39.09 and sold them 1 year later at $ With a 1% commission rate buying and selling the stock and a current $1.21 dividend per share in effect, what was your return on investment? Bought 200 shares at $39.09 = $7, Commission at 1% = Total cost $7, Sold 200 shares at $41.10 = $8,220 Commission at 1% = Total receipt $8, Total cost -7, Net Gain $ Dividends (200 x $1.21) Total Gain $ $ $7, % rate of return 21-9

BONDS Bonds represent a promise from the company to pay the face amount to the bond owner at a future date, along with interest payments at a stated rate. When you own a stock, you own a share of a company. When you own a bond, you are lending the company money – similar to how banks lend money

BOND QUOTATIONS IN NEWSPAPERS Bonds are usually in denominations of $1,000 (the face amount). The newspaper states bond prices in percents of face amount, not in dollar amounts. This is the same as 99.50%.

BOND QUOTATIONS IN NEWSPAPERS The interest on the Aflac bond is 4%. The company pays the interest semiannually. The bond matures in The total interest for the year is $40 (.04 x $1,000). Yearly interest = Face value of bond x Stated yearly interest rate $40.00 = $1,000 x

BOND QUOTATIONS IN NEWSPAPERS = 4.02% Yearly interest: Cost of bond: (.04 x $1,000) (.9950 x $1,000) = $40.00 $ = This is the same as 99.50%.

CALCULATING BOND YIELDS Jim Smith bought 5 bonds of Aflac at the closing price of Jim’s total cost excluding commission is: (Remember that in dollars 99.50% is $995.) Bond yield = Total annual interest of bond Total current cost of bond at closing Example: 5 x $995 = $4,975

CALCULATING BOND YIELDS $200 $ 4975 = 4.02% What is Jim’s interest? No matter what Jim pays for the bonds, he will still receive interest of $40 per bond (.04 x $1,000). Jim bought the bonds at $995 each, resulting in bond yield of 4.02%. Let’s calculate Jim’s yield to the nearest tenth percent: (5 bonds x $40 interest per bond per year)

WHY INVESTORS CHOOSE MUTUAL FUNDS Diversification Liquidity Low fund expenses Access to foreign markets Professional management 21-16

NET ASSET VALUE NAV = Current market value of fund’s investment -- Current liabilities Number of shares outstanding Net asset value (NAV) – the dollar value of one mutual fund share Mutual fund – a portfolio of stocks and/or bonds 21-17

COMMISSIONS WHEN BUYING MUTUAL FUNDS ClassificationCommission chargeOffer price to buy No-load (NL) fundNo sales chargeNAV (Buy directly from investment company) Low-load (LL) fund3% or lessNAV + commission % (Buy directly from investment company or from a broker) Load fund8 ½% or less NAV + commission % (Buy from a broker) 21-18

HOW TO READ MUTUAL FUND QUOTATIONS FUND Net YTD3-Yr. NAME NAV Chg % Ret % Ret. Grln P The $13.82 figure is the NAV plus the sales commission. The fund has decreased $.06 from the NAV quotation of the previous day. The fund has a 8.9% return this year (January through May 27). This assumes reinvestments of all distributions. Sales charges are not reflected

MUTUAL FUNDS Bonnie and Pat Meyer are in their retirement years. They just received $250,000 after taxes from the sale of their vacation home and decided to invest the money in a bond mutual fund. They chose a no-load mutual fund that yields 4.5%. How much will they receive each year? How much would they need to invest if they needed to earn $15,000 per year? Step 1: I = PRT = $250,000 x.045 x 1 = $11,250 Step 2: P = I/RT = $15,000/(.045 X 1) = $333, If Bonnie and Pat invest $250,000, they will receive $11,250 in interest each year. If they need to earn $15,000 in interest each year, they must invest an additional $83,333.33: $333, $250,000 = $83,333.33

DISTRIBUTION OF PROFITS AND LOSSES IN A PARTNERSHIP Partnerships are businesses owned by two or more individuals. Profits may be distributed many ways. We will discuss five options: 1.Equal Share 2.Ratio 3.Original Investment 4.Salary and Investment 5.Interest on Investments and Ratio

DISTRIBUTION BY EQUAL SHARE Example: Suppose a three-partner law firm generated $72,500 in profit the first year. Calculate the distribution based on equal share. $72,500 3 = $24, Profits (losses) are divided equally among the partners.

DISTRIBUTION BY RATIO Profits (losses) are distributed based on a prearranged ratio. Example: Suppose a three-partner law firm generated $72,500 in profit the first year and the partners agree to a 1:2:3 profit distribution. A 1:2:3 ratio says profits (losses) will be distributed into = 6 equal shares. Now we can determine each ratio and calculate each distribution. Partner 1: = 1616 x $72,500 = $12, Partner 2: = 2626 x $72,500 = $24, = Partner 3: = 3636 x $72,500 = $36, =

DISTRIBUTION BY ORIGINAL INVESTMENT The fraction of the total investment each partner invested is used to determine the share of profit (loss). Example: Again, we assume a three-partner law firm generated $72,500 in profit in a year. Partner 1 originally invested $40,000, Partner 2 invested $110,000, and Partner 3 invested $150,000. First we calculate the fraction of total investment each partner made and then we can calculate each distribution. Total invested: $40,000 + $110,000 + $150,000 = $300,000 Partner 1: $40,000 $300,000 x $72,500 = $9, Partner 2:$110,000 $300,000 x $72,500 = $26, Partner 3:$150,000 $300,000 x $72,500 = $36,250

DISTRIBUTION BY SALARY AND INVESTMENT In this distribution, the fraction of the total investment each partner invested is used to determine the share of profit (loss) minus (plus) any salaries paid. Example: Again, we assume a three-partner law firm generated $72,500 in profit in a year. Partner 1 originally invested $40,000, Partner 2 invested $110,000, and Partner 3 invested $150,000. Because Partner 3 operated the business, she earned a $50,000 annual salary. As before, we first determine the ratio of each partner’s investment and then calculate the distributions. Total invested: $40,000 + $110,000 + $150,000 = $300,000 Profit minus salaries paid: $72,500 - $50,000 = $22,500

DISTRIBUTION BY SALARY AND INVESTMENT Example: Again, we assume a three-partner law firm generated $72,500 in profit in a year. Partner 1 originally invested $40,000, Partner 2 invested $110,000, and Partner 3 invested $150,000. Because Partner 3 operated the business, she earned a $50,000 annual salary. As before, we first determine the ratio of each partner’s investment and then calculate the distributions. Total invested: $40,000 + $110,000 + $150,000 = $300,000 Profit minus salaries paid: $72,500 - $50,000 = $22,500 Partner 1: $40,000 $300,000 X $22,500 = $3,000 Partner 2:$110,000 $300,000 X $22,500 = $8,250 Partner 3: $150,000 $300,000 X $22,500 = $11,250 + $50,000 = $61,250

DISTRIBUTION BY INTEREST ON INVESTMENTS AND RATIO Distribution, profits (losses) are distributed by a prearranged ratio after return on investments have been satisfied. Again, we will use the same information we used previously: a three-partner law firm with $72,500 profit, where Partner 3 receives a 7% return on her $150,000 investment. Partner 3’s return on investment: $150,000 x.07 = $10,500 Amount available for distribution: $72,500 - $10,500 = $62,000 We know from our earlier example that a 1:2:3 ratio says profits (losses) will be divided into 6 equal shares. We can now determine each ratio and calculate each distribution. Partner 1: 1616 x $62,000 = $10, Partner 2: 2626 x $62,000 = $20, = Partner 3: 3636 x $62,000 = $31,000 + $10,500 = $41, =