Chapter 11: Investment strategies, Stocks and Bonds

bull/bear market

- A bull market is when prices are increasing. Investors purchase securities because they feel prices will continue to increase. The demand for securities causes the price to increase. - Bear market is when prices are going down. Investors expect the price to decline, so they sell more stocks.

Risk tolerance categorization

- Conservative, moderate or aggressive

Five Investment Risk Factors:

- Inflation risk, Interest rate risk, Business failure risk, Market risk and Global investment risk

Influences on bond values

- Interest rate changes causes the bond to sell at a discount or premium - The financial rating of the issuing company - The supply and demand of bonds

Why investors purchase bonds

- Steady income - Safety: Another reason to purchase bonds is if you know you will need the money at a specific time and you want to keep it relatively safe. As part of a portfolio diversification strategy, many investors shift their money away from stocks and towards bonds as they get closer to retirement. - Debt priority: If a company is liquidated or undergoes bankruptcy, the bondholders have priority over the assets ahead of the shareholders because they are owed a debt—the principal paid to the company in exchange for interest payments.

Types of speculative risks:

- Stocks or bonds - Commodities - Options - Precious metals - Collectibles

The three largest marketplaces in the United States:

- The New York Stock Exchange (NYSE), the largest market in the united states. - National Association of Securities Dealers Automated Quotation System (NASDAQ), the largest global and first electronic marketplace for stock trades. - The American Stock Exchange (AMEX), specializes in trades of electronically traded fund (ETF).

The key factors for asset allocation are based on

1. Financial goals 2. Amount of capital 3. Time horizon 4. Risk tolerance 5. Time horizon

The most common investments

1. Stocks 2. Bonds 3. Commercial and residential estate 4. Annuities

Structure of investments

1. The principle is the money that you invest 2. Investment income is the money that flows from principle invested. With stocks the income received is call dividends. With bonds, it is called interest. 3. A capital gain/loss is the amount of growth or loss of the principal in addition to any income received while holding an investment.

5 types of treasury securities offered by the U.S. government:

1. Treasury bills (T-bills) 2. Treasury notes (T-notes) 3. Treasury bonds 4. Treasury Inflation-Protected Securities (TIPS) 5. U.S. government savings bonds

Treasury Bills

A Treasury note or T-note is issued in $100 increments, face value, with a maturity between one and ten years. Investors purchase these bonds at a price less than face value and then receive that amount at some point in the future. Since investors have to wait longer to receive their money back, the interest rates are slightly higher than those on the T-bill. Since T-notes make actual interest payments, they are similar to corporate bonds with interest paid every six months and the face value paid out at maturity. A 4-week federal government bond.

Stocks

A stock is an ownership interest in a company. Investment income from stocks refers to the money you can receive in the form of dividends. Dividends are in the form of dollars or cents per share.

dollar cost averaging

An investment strategy where the investor places the same dollar amount into the investment a regular intervals.

Bonds

Bonds do not issue dividends based on profits. Bonds make interest payments to their investors, called bondholders. - Interest payments on bonds are: Usually paid semi-annually (every six months) A fixed amount based on the stated rate of the bond at issuance.

To begin investing in the stock​ market, you will utilize some type of​ __________ with licensed stockbrokers

Brokerage firm

Market risk

No matter how well a company is performing market conditions can prevent growth and profits. These factors include political and social conditions.

Primary and secondary markets

Primary markets for securities are available to large institutional investors (pensions funds, mutual funds etc.)

Types of stocks

The two types of stocks that are commonly issued are common stocks and preferred stocks.

Savings bonds

There are two types of U.S. government savings bonds currently being issued: 1. Series EE bonds 2. Series I bonds

Asset allocation

choosing how much of your money to invest in various assets or asset classes.

The Russell 2000 Index

compromised of small company stocks in the bottom 2,000 of the Russell 3,000 index which is an index that measures the performance of the largest 3,000 publicly traded companies in the US.

Investors use the​ ______________ ratios in order to determine the price at which they are willing to pay for a share of stock

earnings per share and price-earnings ratios

Commission charges

one of the most overlooked obstacles to building wealth and making money in the stock markets. - Every time you buy shares of stocks and sell shares of stocks you pay a commission.

Real estate

real estate can provide a steady stream of income. Owning real estate is more time-intensive .

Provisions for repayment

Bond issuers have certain rules or provisions that they agree to follow. These provisions are called a bond indenture, which accompanies each bond issuance.

The amount of growth of an investment is referred to as:

Capital gains

Types of Corporate Bonds

- Debenture - Mortgage bond - Subordinated bond - Convertible bond

The well-known indices

- Dow Jones Industrial Average (DIJA) - The S&P 500 Index - NASDAQ Composite Index - The Russell 2000 Index - Wilshire 5000 Index

High risk examples

- Gerald just turned 20. He plans to work until he's 60. He invested 100% in his stocks. - Candice is 26 years old. Her goal is to use her investments for a new car before he turns 30. Her account mix is 55% stocks and 45% bonds.

Bond ratings

- Just as individuals are rated according to a credit score, companies are also rated on their bond default risk, but using a different scale. The two main bond rating agencies are Standard & Poor's Corporation and Moody's Investor Service. Both agencies rate bonds as high-grade, medium-grade, speculative or junk bonds, or default bonds. The two rating agencies use slightly different scales. The highest ratings have multiple A's, the medium grade is generally A or B bonds, while the speculative or junk bonds are a lower grade B, and the C and D ratings represent the default bonds.

Full-service firms

- Often charge large commissions such as $20 or more per transaction

Bond Repayment at Maturity

- the original principal, or face value, of the bond (usually $1,000) is repaid at maturity. Maturity simply means the agreed-upon date that the bond stops paying interest and pays back the face value.

Five sources of investment info:

1. The internet 2. Newspapers and news programs 3. Business periodicals and government publications 4. Corporate Reports 5. Investor Services and Newsletters

Series EE bonds

A Series EE bond can be purchased for as little as $25 up to a maximum of $10,000 each year through a Treasury Direct account. You can purchase them one time or arrange to purchase them through payroll direct deposit. EE bonds issued after May 2005 are issued at a fixed rate for the life of the bond. Previous EE bonds were given a variable rate. They must be held for at least one year before you can redeem them, but if you redeem them less than five years after the issue date, you will sacrifice the previous three months' worth of interest.

Series I bonds

A Series I bond can be purchased for as little as $25 up to a maximum of $10,000 each year through a TreasuryDirect account. You can purchase them one time or arrange to purchase them through payroll direct deposit. They must be held for at least one year before you can redeem them but if you redeem them less than five years after the issue date, you will sacrifice the previous three months' worth of interest. They earn interest for up to thirty years. The interest is paid monthly but compounded semi-annually. The interest rate on I bonds is determined by two factors: 1) a fixed rate of return and 2) an inflation index that is calculated twice per year based on the CPI-U. It is possible that the CPI-U will be negative, which will reduce your total return to less than the fixed rate, but your return cannot go below zero. The interest is taxable by the federal government, but not the state.

Inflation Risk

Cost of goods rise faster than your return, you lose purchasing power. Inflation can outpace your investments and eat you returns.

What is the best approach to keep steady stream of income pouring into the market?

Dollar cost averaging

Securities Market Regulation

In the US, Securities and Exchange Commission (SEC) regulates securities. - The SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use in order to judge for themselves whether to buy, sell or hold a particular security.

Business failure risk

Stocks, corporate bonds, mutual funds etc. can lose all value if the business is not managed. Lower profits could result in the assets decreasing, lower, no dividend payments or bankruptcy, which results in huge losses on bond values.

TIPS

TIPS are also sold in $100 units. They are currently sold with 5-, 10-, or 20-year maturities. Based on the Consumer Price Index (CPI), the principal amount increases when inflation exists and decreases with deflation. Since the principal adjusts, the interest you are paid adjusts as well, because the rate is multiplied by the current principal amount. Just as you earn more from your bank account if there is more in it, or less if you take money out, you can earn more or less interest based on the amount of principal. When the TIPS mature, you receive the greater of a) either the adjusted principal or b) the original principal. The interest, as well as the growth in principal, is exempt from state and local taxes, but not federal taxes.

Government bonds

The needs for these bonds may be due to the irregular flow of cash from tax revenues, lower-than-anticipated tax revenue, higher-than-anticipated expenses, or one-time projects such as a new bridge or community center.

Preferred stocks

The owners of preferred stock: 1. Receive dividends, which are fixed so they don't partake in the profits of the corporation. 2. Receive cash dividends before the owners of common stock receive their cash dividends. 3. Have no voting rights.

Bon yield calculations

Two methods can be used to calculate the yield of the bond (or your return on your investment): 1. Current yield 2. Yield to maturity

Global investment risk

When investing in foreign assets, currency conversion can affect your return.

Why corporations sell bonds

When you need to borrow money, you go to the bank and get a loan. When a corporation needs a small amount of money, it may do the same. But when it needs a large amount of money, it issues bonds instead. It sells debt to investors. It may need the money for expansion or to cover cash shortages or for some other business need. But it needs cash and it does not want to issue stock to give up ownership or dilute the shares (the percentage ownership) of the current stockholders.

Securities

a financial term that refers to investment vehicles where the investor own part of an asset or company, or is the creditor of company or individual.

The Wilshire 5000

an index of all equity securities actively traded in the US. When it first launched, it tracked nearly 5000 companies.

Annuities

annuities are contracts sold by insurance or investment companies. An annuity is a stream of payments paid to purchasers of an annuity, either for a fixed period (period certain annuity).

Treasury bonds

are also issued in $100 units but they have a 30-year maturity. Interest rates are slightly higher than it is for T-bills or T-notes because, once again, the investor has to wait longer to receive their principal or face value back. Again, similar to corporate bonds, interest is paid every six months.

Aggressive investors

are willing to take large risks in hopes of earning large returns, and are comfortable with putting their entire investment at risk.

When determining the right bond to purchase you should consider:

commission, taxes, and fees

convertable bonds

gives the bondholder the option to convert it from a bond (debt) to a specified number of shares of stock (equity) of the issuing company. Because of this conversion feature, which is a benefit to the investor, the rates paid are usually 1 or 2 percentage points lower for these bonds. The advantage to investors is that if the company stock increases enough, they can convert their bond and get a better return on their investment. If they simply hang on to the bond, the value of the bond will increase because of the rising stock price.

Subordinated bond

is a riskier bond because it lays claim to assets and payments only after regular bondholders, so you are second in line for repayment in the case of default. Because of the increased risk, interest payments are higher.

Mortgage bond

is a secured bond, because an asset, such as real estate owned by the company, secures the bond. If the company fails to make payments, the assets may be sold to satisfy the terms of the bond.

Common stocks

is ownership in the company. When a company is owned by one person, then they own 100% of the equity of the company, They make 100% of the decisions, take 100% of the risk and the profits.

The DIJA

named after Standard and Poor's financial services LLC. It tracks 500 of the largest companies on the NYSE and the NASDAQ based on market capitalization.

Discount brokers

offer trade on commissions $10 or less

The SEC's mission is to:

protect investors, maintain fair, orderly and efficient markets and facilitate capital formation

A debenture bond

simply means there is no collateral, so you are trusting the issuing corporation's reputation. If the company fails, you will likely receive little or no money for your bonds.

Market Capitalization

simply the share price times the number of outstanding shares.

Examples of securities

stocks and bonds

Foreign securities markets

such as Tokyo Stock Exchange or the London Stock Exchange operate like NYSE.

Primary markets

the market used to issue new securities on an exchange from companies or governments

Broker and Dealer Markets

to keep the stock market running, there are brokers and dealers. Brokers do not take possession of the stocks; they facilitate the trade. They can help you buy or sell securities.

Dealers

unlike brokers, they take possession of the stock. They specialize in particular stocks. Their goal is to keep a certain number of shares in the inventory. If the stock becomes to popular and too many people want shares, the supply goes down. - Dealers charge a different price to sell (ask price) stock than they do to buy (bid price). - The difference between these prices are called spread or the dealer's spread.

Initial Public Offering (IPO)

when a company issues its stock in the form of this, these shares of stocks are offered in primary markets.

Secondary markets

where most investor activity and financial activity takes place. Where individual investors can buy and sell shares of stocks or bonds. This is for individual investors, hedge fund managers need to be aware of this.

Conservative investors

would rather earn a small amount of interest if it means keeping their risk low and initial investment intact.

To make money in the stock market

you want to determine when to buy the shares, buy the shares, determine when to sell the shares, and sell those shares for more than their purchase price.

To begin investing in financial markets:

you will utilize some type of brokerage firm with licensed brokers also called account executives. A stockbroker could be conservative or aggressive investor. Find a stockbroker that aligns with your risk tolerance. - You can choose between full-service brokerage firms and discount brokerage firms. Full service firms provide more hands on advice and analysis, while discount firms let you manage your own transactions with little guidance.

Provisions for bond repayment

• Call feature - allows the issuing company to call—or pay off —the bond before the maturity date. Usually, this is done when interest rates fall and the company can reissue new bonds at a lower interest rate. • Sinking fund - is where the bond issuer sets aside money periodically to redeem a portion of the issued bonds. Keep in mind that bonds, unlike loans, only require interest payments, which means the bond issuer has to pay back the entire amount of the original loan (all of the bonds sold) at maturity. • Serial redemption - bonds that mature in a series of consecutive years instead of all maturing at the same time. For instance, a 25-year serial bond may actually have 10% of its bonds mature each year from years 15 through 25.

Speculative risk

When an investor aims for returns well above market averages; assets that have wildly unpredictable outcomes.

Interest rate risk

When interest rates rise, assets have a fixed rate payment (bonds, preferred stock) will fall in value. Bonds and savings accounts are vulnerable because they have a fixed return for a long period of time.

Moderate investors

accept some risk in order to achieve better returns.

Market index

is designed to track the changes in markets over time. An index measures the value of a group of stocks.