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

2. 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. 21-2 1. 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.

3. 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

4. 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

5. 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

6. STOCK QUOTATIONS IN NEWSPAPERS 21-6

7. 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 = $39.09 17 = $2.30

8. 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. 2014 Dividends paid0 Preferred stockholders Paid: 0 Owe: 20,000 x $.80 = $16,000 Common Stockholders0 2015 Dividends paid $512,000 Paid for 2014 16,000 Paid for 2015 16,000 $ 32,000 Total dividend $512,000 Paid preferred for ‘14 & ’15 - 32,000 To Common $480,000 $480,000 = $1.20 per share 400,000 shares 21-8

9. CALCULATING RETURN ON INVESTMENT Suppose you bought 200 shares of General Mills stock at $39.09 and sold them 1 year later at $41.10. 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 = $7,818.00 Commission at 1% = 78.18 Total cost $7,896.18 Sold 200 shares at $41.10 = $8,220 Commission at 1% = - 82.20 Total receipt $8,137.80 Total cost -7,896.18 Net Gain $241.62 Dividends+ 242.00(200 x $1.21) Total Gain $483.62 $ 483.62 $7,896.18 6.12% rate of return 21-9

10. 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. 21-10

11. BOND QUOTATIONS IN NEWSPAPERS 21-11 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%.

12. BOND QUOTATIONS IN NEWSPAPERS The interest on the Aflac bond is 4%. The company pays the interest semiannually. The bond matures in 2022. 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.04 21-12

13. BOND QUOTATIONS IN NEWSPAPERS = 4.02% Yearly interest: Cost of bond: (.04 x $1,000) (.9950 x $1,000) = $40.00 $995.00 = 21-13 This is the same as 99.50%.

14. CALCULATING BOND YIELDS Jim Smith bought 5 bonds of Aflac at the closing price of 99.50. 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 21-14 Example: 5 x $995 = $4,975

15. 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: 21-15 (5 bonds x $40 interest per bond per year)

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

17. 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

18. 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

19. HOW TO READ MUTUAL FUND QUOTATIONS FUND Net YTD3-Yr. NAME NAV Chg % Ret % Ret. Grln P 13.82 -0.068.971.6 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. 21-19

20. MUTUAL FUNDS 21-20 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) = $333,333.33 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: $333,333.33 - $250,000 = $83,333.33

21. DISTRIBUTION OF PROFITS AND LOSSES IN A PARTNERSHIP 21-21 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

22. 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 = $24,166.67 21-22 Profits (losses) are divided equally among the partners.

23. DISTRIBUTION BY RATIO 21-23 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 1+2+3 = 6 equal shares. Now we can determine each ratio and calculate each distribution. Partner 1: 1 0 1+2+3 = 1616 x $72,500 = $12,083.33 Partner 2: 2 0 1+2+3 = 2626 x $72,500 = $24,166.67 1313 = Partner 3: 3 0 1+2+3 = 3636 x $72,500 = $36,250 1212 =

24. DISTRIBUTION BY ORIGINAL INVESTMENT 21-24 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 = $9,666.67 Partner 2:$110,000 $300,000 x $72,500 = $26,583.33 Partner 3:$150,000 $300,000 x $72,500 = $36,250

25. DISTRIBUTION BY SALARY AND INVESTMENT 21-25 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

26. DISTRIBUTION BY SALARY AND INVESTMENT 21-26 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

27. 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 = $10,333.33 Partner 2: 2626 x $62,000 = $20,666.67 1313 = 21-27 Partner 3: 3636 x $62,000 = $31,000 + $10,500 = $41,500 1212 =