1. Chapter 14 Methods of Investing © 2010 Pearson Education, Inc.
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2. 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.
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3. 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
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4. 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
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5. 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
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6. 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?
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7. 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
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8. 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.
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9. 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
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10. Figure 14.3
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11. Math for Personal Finance
Evelyn paid $32 a share and later received $38 a share.
What percentage return did Evelyn make on the stock?
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12. Math for Personal Finance
Solution: ($38 - $32)/32 = or 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
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13. Math for Personal Finance
Laine paid $65 a share and later received $72 a share.
What percentage return did Laine make on the stock?
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14. Math for Personal Finance
Solution: ($72- $65)/65= 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
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15. 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.
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16. 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
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17. Figure 14.4
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18. 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
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19. 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?
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20. Math for Personal Finance
Solution: $1,000 x .085 = $85 per year x 5 years = $425
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21. 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?
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22. Math for Personal Finance
Solution: $5,000 x .07 = $350 per year x 3 years = $1050
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23. Types of Bonds Investors can choose from several types of bonds
These include:
Treasury bonds
Municipal bonds
Federal agency bonds
Corporate bonds
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