Fundamentals of Investing Chapter Fifteen

McGraw-Hill/Irwin

Objective 1:Explain why you should establish an investment program

Establishing Investment Goals

Performing a Financial Checkup

Getting the Money Needed to Start an InvestingProgram

The Value of Long-Term Investing Programs

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Pay yourself first.

Take advantage of employer-sponsored retirement programs.

Participate in elective savings programs.

Make a special savings effort one or twomonths each year.

Take advantage of gifts, inheritances, andwindfalls.

Getting the Money Needed to Start an Investing Program

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Safety in any investment meansminimal risk of loss.

Risk means a measure ofuncertainty about the outcome.

Investments range from very safe to very risky.

The potential return on any investment should bedirectly related to the risk the investor assumes.

Factors Affecting the Choice of Investments

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Inflation risk - during periods of high inflation yourinvestment return may not keep pace with the inflationrate.

Interest rate risk – the value of bonds or preferredstock may increase or decrease because of changes ininterest rates in the economy.

Business failure risk - affects stocks and corporatebonds.

Market risk - prices fluctuate because of behaviors ofinvestors.

Components of the Risk Factor

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Income

-An investment will provide a predictable source of income.

Growth

- means investment will increase in value.

–Common stock usually offers the greatest potential forgrowth.

–Mutual funds and real estate may also offer growthpotential.

Liquidity

–Ability to buy or sell an investment quickly withoutsubstantially affecting the investment’s value.

Investment Growth and Liquidity

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Asset allocation is the process of spreading yourassets among several different types ofinvestments. Other factors to consider include:

–The time factor

–Your age

–Your role in the investment process

Objective 3:Identify the factors that can reduce investment risk.

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Objective 3:Identify the factors that can reduce investment risks.

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Type of Investment

Safety

Risk

Income

Growth

Liquidity

Common stock

Average

High

Average

Preferred stock

Average

High

Average

Corporate bonds

Average

High

Low

Average

Governmental bonds

High

Low

High

Mutual funds

Average

Real estate

Average

Low

FACTORS TO BE EVALUATED

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Most investors consider securities issued by the U.S.Treasury to be risk free.

Backed by the full faith and credit of the U.S.government

Securities include

–Treasury Bills

–Treasury Notes

–Treasury Bonds

–Treasury Inflation-Protected Securities (TIPS)

U.S. Government Treasury Bills and Notes

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Municipal bonds - sometimes called munis.

Issued by a state or local government, including cities,counties, school districts, and special taxing districts.

Use funds for ongoing costs and to build major projectssuch as schools, airports, and bridges.

General obligation bonds are backed by the state orlocal government that issues them.

Revenue bonds are repaid from money generated bythe project the funds finance, such as a toll bridge.

State and Local Government Securities

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Tax-exempt yield

___________________

1.0 - Your tax rate

Example:

0.06

Taxable equivalent yield = __________

1.0 - 0.28

= 0.083 = 8.3%

Taxable Equivalent Yield

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Corporation’s written pledge to repay a specifiedamount of money with interest.

Facts about corporate bonds:

–The face value is the dollar amount that thebondholder will receive at the bond’s maturity date.

–Bondholders receive interest payments every sixmonths at the stated interest rate.

–Typically a corporation issues debenture, mortgage,or convertible bonds.

Characteristics of Corporate Bonds

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Call Feature of a Bond - Corporation can call inor buy back outstanding bonds from currentbondholders before the maturity date.

Sinking fund – Corporations deposit money in thisfund annually or semiannually and use the money topay off the bondholders when the bond issue comesdue.

Serial bonds – Bonds of a single issue that matureon different dates.

Provisions For Repayment

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For interest income.

–Investors know the interest rate.

–Interest will be paid to investors twice a year.

Dollar appreciation of bond value.

–May be able to sell the bond to someone else at ahigher price if the interest rate on the bond ishigher than the current interest rate.

Bond face amount will be repaid at maturity.

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Objective 4: Recognize Why Investors Purchase

Corporate Bonds

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The following can be used to evaluate bondinvestments

The Internet

Newspapers

Bond Ratings

Bond Yield Calculations

Business Periodicals

Government Sources

Objective 6: Evaluate bonds when making an investmentdecision

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The Decision to Buy or Sell a Bond

Bond Ratings

Moody’s Ratings range from Aaa (the highest) toC (the lowest)

Standard & Poor’s ratings range from AAA (thehighest) to D (the lowest).

The first four categories are consideredinvestment grade securities.