Principles of Investment Midterm #1

Primary Markets

Markets in which corporations raise capital by issuing new securities Ex: IPOs

Private Market

Markets in which transactions are worked out directly between two parties.

Time Value of Money

Money's potential to grow in value over time. The relationship between time, money, a rate of return, and earnings growth. Dollar today vs. Dollar tomorrow

Property

Real investments such as land, buildings, tangible property.

American Deposit Receipt

Represents interest in the foreign share Removes some currency risk

investment yield

Return on Assets over premiums

Event Risk

Risks outside the financial markets like natural disasters, corporate takeovers, etc. 9/11

The efficient Frontier

Shows investors the best possible return they can expect form their portfolios, given the level of risk they are willing to accept. Optimal portfolios should lie on the curve. Be able to draw

Diversification

Spreading out investments to reduce risk

Preferred Stock

Stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold

International diversification

The attempt to reduce risk by investing in more than one nation. By diversifying across nations whose economic cycles are not perfectly in phase, investors can typically reduce the variability of their returns.

liquidity Risk

The chance that an investment cannot be readily converted to cash.

Discount rate

The interest rate on the loans that the Fed makes to banks

marginal tax brackets

The marginal tax brackets work is that you pay tax depending on the amount of income you earn that is taxable.

Capital Gains

The positive difference between the purchase price of a stock and its sale price.

Ask Price

The price a seller is willing to accept for a security, also known as the offer price. investor pays this

Risk-free rate

The rate of return that can be earned with certainty. Ex: short-term US treasury bills

Income investing

This type of investing represents the process of selecting stocks or bonds that produce regular income payments. i.e. investing in bonds that pay incomes

External Characteristics

War, Shortages, interest rates, political issues, and inflation/ deflation

Price weighted

With respect to index construction, an index in which each security in the index is weighted according to its absolute share price.

round lot

a designation given to 100 shares of stock or multiples of 100 shares that are bought or sold together

odd lot

a designation given to fewer than 100 shares of stock that are bought or sold together

Treasury Stock

a firm buying back their own stock to reduce the number of shares outstanding. the firm will do this when they see that their stock is undervalued

Stock split

a firms annoucing that it will increase the number of shares outstanding 2 for 1 3 for 2 used to enhance trading appeal.

Stockbroker

a person who handles the transfer of stocks and bonds between buyer and seller

par value

a value assigned to a share of stock and printed on the stock certificate

Total Return

adding up capital gains (losses) and income

Indirect investment

an investment in a collection of securities or properties managed by a professional investor. Ex: mutual funds

dividend yield

annual cash dividends per share / market price per share

current yield

annual coupon divided by bond price

Mutual Funds

basket of securities which results in a diverse portfolio. Prices of the mutual fund reflect the funds holdings. These funds can be much more efficient than buying individual companies.

Absolute Risk

beyond human control

Market orders

buy/sell orders to be executed immediately

Interest rate risk

changes in interest rates and the affect on a securities value interest rates decrease bonds increase.

Tax Risk

congress making unfavorable tax laws. Affects the after-tax returns

Market Indexe

current price behavior in relations to one of an earlier time represent the performance of a specific security market, market segment or asset class

The security market line

depicts the tradeoff between risk and return.

yield

dividend / price

Portfolio Income

earnings generated from, saving accounts, stocks, bonds, and mutual funds to options and futures. Consists of interest, dividends, and capital gains.

intern-industry diversification

emphasizes "balancing" the portfolio by assembling a wide variety of stocks and/or bonds.

rights offering

existing stockholders are given the first opportunity to buy the new issued stock.

Book value

how much all their stiff is worth. The total worth of all their stockholders equity.

Passive Income

income derived from real estate, limited partnerships, and other for of tax-advantaged investments

Nondiversifiable Risk or Systematic Risk

inescapable portion of an investment's risk. i.e war, inflation, political events

compound interest

interest calculated on both the principal and the accrued interest

simple interest

interest paid on the principal alone

Securities

investments issued by firms, governments, an other organizations that represent financial claim on the resources of the issuers. Most Common: Stocks and Bonds

Long Purchase

investor buys securities in hope that they will increase in value and can be sold at a later date for profit, makes money when prices rise

business risk

is the degree of uncertainty associated with an investment's earnings and the investments ability to pat the return (interest, principle, dividends) owed to investor.

public offering

is the first time a corporation issues stock that may be purchased by the general public.

Dealers

link buyers and sellers by buying and selling securities at a stated price

Passive Investments

made to earn a return on funds that may be needed for future short-term or long-term purposes; include debt securities; fair value method is used; investing company owns less than 20% of outstanding voting shares

Internal Characteristics

management and dividend policies

Secondary Markets

markets in which securities and other financial assets are traded among investors after they have been issued by corporations

Beta

measures the nondiversifiable risk or market risk

Real Returns

nominal - the inflation rate This measures the increase in purchasing power provided by an investment.

Spin-off

occurs when a company gets rid of one of their subsidiaries or divisions. essentially making a stand-alone company

Broker

person who acts as a go-between for buyers and sellers of stocks and bonds

Descriptive information

presents factual data on the past behavior of the economy, the market, the industry, the company or a given investment

Analytical Information

presents projections and recommendations about potential investments based on current data.

Growth investing

purchase stocks whose growth potential is above average investing in stocks

Market Risk

risk that affects all companies in the stock market

Short Selling

selling stock borrowed from a broker that must be replaced at a later time

Convertible Securities

special type of fixed-income obligation. Benefits of a bond (interest) while offering the price appreciation (capital gain) potential of common stock.

Disadvantages of stock Returns

stocks are subject to various types of risk, financial and business, purchasing power risk, market risk and event risk. earnings and performance are subject to large standard deviations

Pros of Stock Ownership

substantial returns provides investors protection against inflation prices are usually within reach of most investors

Total Risk

system + unsystematic risk

Nominal Returns

the actual return in current dollars

payment date

the date of the actual cash distribution of dividends

declaration date

the day on which the board of directors declares the cash dividend to be paid

Holding Period Return

the period of time over which one wishes to measure the return of an investment F: (income during period + capital gain (losses) during period ) / beginning investment value

Bid Price

the price a dealer is willing to pay for a security

Market Value

the price a seller can expect to receive for a product in a competitive marketplace. Price * shares outstanding

Bond Yield

the return an investor would receive on a bond if it were purchased and held to maturity

maturity

the time at which payment to a bondholder is due

Purchasing Power Risk

the unanticipated changes in price levels (inflation, deflation) that will adversely affect investments returns

Financial Risk

the uncertainty surrounding a firm's ability to meet financial obligations because it borrowed money.

Present Value

the value today of receiving some amount in the future

Investment Value

the worth an investor places on the stock based on expected returns and risk characteristics

Bonds

type of investment in which you lend or loan money to a company, government, or organization for a specific period of time at a specific interest rate

Diversifiable Risk or Unsystematic risk

uncontrollable or random events that are firm-specific i.e labor strikes, lawsuits

Modern Portfolio Theory

utilizes several basic statistical measurements to develop a portfolio plan. invest in securities that have a negative correlation.

Direct investment

when an investor directly acquires a claim on a securities or property. Ex: Common Stock of IBM --> you have part ownership of firm.

Market average

1. Dow Jones Industrial Average gives the average price behavior at a given point in time

financial planner

A qualified investment professional who helps individuals and corporations meet their long-term financial objectives by analyzing the client's status and setting a program to achieve that client's goals.

Correlation

A relationship between two variables in which a change in one coincides with a change in the other.

Limited order

A request to buy (or sell) a stock at a specific price.

Cash Dividends

Corporations may pay their stockholders dividends, which can be in the form of cash or additional shares

Market Capitalization

Current share price X total number of shares issued

Date of record

Date directors specify for identifying stockholders to receive dividends.

ex-dividend date

Date on which the right to the next dividend no longer accompanies the stock when a new investor buys it

Income

Earnings from work or investment

Investment Goals

Establishing financial objectives 1. Accumulating retirement funds. 2. enhancing income 3. Saving for major expenditures 4. Sheltering income from taxes

Active Income

Income that comes from wages or a business.

Public Market

Individuals and companies that buy stocks, bonds and insurance.

Active Investment

Investment strategy where managers try to outperform the market benchmarks.

stock dividend

Is a distribution od additional shares of a corporation's own stock.

stop-loss order

An order to sell stock at the market price when the price of the stock falls to a specified level

Margin transactions

Borrowing cash to buy securities and using the securities themselves as collateral