Sept 24-1 - Investing Investing WSJ Chapter 4 EE 0822 Sec 3...

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Unformatted text preview: Investing Investing WSJ Chapter 4 EE 0822 Sec 3 Class # 6 Wall Street Wall • Investing in stocks, bonds, and mutual funds • The New York Stock Exchange is a place to trade securities • More than a billion share exchange hands everyday • Wall street is a catch phrase for the entirety of the investment universe: stocks, bonds, mutual funds, exchange traded fund, variable annuities, options, and everything in between Wall Street Wall • Wall street is not only the New York Stock Exchange, but it includes the American Stock Exchange, the Nasdaq, and large number of brokerage firms • Brokerage firms like Merrill Lynch and Morgan Stanley (full service), and E*Trade and Fidelity Investments (online) Brokerage Firms Brokerage • Full Service • Firms employ brokers who call you every now and then with investment suggestions • You may call them to buy or research stocks, bonds, or mutual funds • They employ researchers who analyze various companies or industries and determine if a particular stock is buy, sell, or hold. • Some of this research is good, some is pretty lousy, and some is outright hype. • Commission based for investors who want broker to call with investment ideas or access to research Brokerage Firms Brokerage • They broker does not make money from buy­and­hold investors • Fee­based: these are best suited for investors who trade a lot or who need hand holding, advice , and financial planning services without having to pay for every transaction or service • The brokerage firm charges a single flat fee • Fee depends on the size of the account (2% for small accounts, 1% for a large accounts) Brokerage Firms Brokerage • Discount Brokers: Discount • For do-it-yourself investors • Commission are substantially small typicall $5-$10 Commission per transaction • They do not employ brokers, research analysts, or They provide broad menu of services provide • They also provide other services CDs, annuities, They life insurance, and retirement planning services life • Charles Schwab, E*Trade, Fidelity Investments, … • Good for accounts less than $100,000 Investing Investing • Growth Investing: emphasizes revenue and earning that are growing quickly and consistently above average • Revenue or sales is all the money the company generates selling its products and services • Earning or profit is all the money left after paying salaries, production costs, taxes • Above average is relative (15%­50% annual erning growth) • Growth stocks seems to be overpriced • High Price to Earning ratio P/E (25­50) • Cisco Systems was traded near P/E of 160 in late 2000 • Price went down to single digits later at one point Investing Investing • Value Investing: bargain basement investing • Value investors buy stocks at prices that they believe underestimate a company’s true profit potential or undervalue its known assets • Stocks trade at relatively low p/e multiple often in the single digit • Majority of investors believe company’s earning potential is limited • Concern about financial issues the company has or expected to have • Value investors scrutinize stocks in terms of their relative valuation, stock history , industry peers, and market condition Investing Investing • Main factor is P/E, as well as the price in relation to company cash flow, book value, and sales • Cash flow is the real earning of the company(before adding depreciation) • Book value is company’s net worth • Kodak shares fell from above $90 in 2001 to the low $20s by 2003, at that point value investors snapped up the stock which began to rebound to the mid $30s The Indexes The • Index is used to measure performance • Russell 2000 tracks small company stocks • The Wilshire 5000 measures the performance of the entire U.S. market • The SOX targets the semiconductor sector • Morgan Stanley has an index for Europe, Australia, and Far East The Three Big Indices • Standard and Poor 500 (S&P 500), measure the performance of the 500 largest company in the United States. Is considered the benchmark of the U.S. market • The Dow Jones Industrial Average is made up of thirty very large stocks (companies) selected by the editors of the Wall Street Journal. • The Nasdaq Composite, started in 1971. The index is laden with technology shares that do not represent the broader economy Reading assignments Reading By Now You Should Have Read: Four Pillars • Chapters 3,4,5,6 Wall Street Journal • Chapters 2,3,4 I WANT YOU TO THINK BACK TO EVERYTHING YOU HAVE READ AND HEARD SO FAR IN THE COURSE… COURSE… INVESTING FOR THE FUTURE INVESTING LET’S TAKE A FEW MINUTES AND LOOK BACK….. Attention grabbers Attention Some things, although Some important, were not very interesting… interesting… Some things held your interest Some for one reason or another… for Some things may have even Some grabbed your attention… grabbed Define compelling Define • Gripping • Significant • Immediately useful • Forceful • Undeniable • Persuasive • Convincing What was compelling What • Stop & Think…. • What have you read or heard so What far that was compelling? far • You have 5 minutes to write it You down down • Don’t over-analyze • What’s the first thing that popped What’s into your head into Stocks Stocks • A stock certificate implies partial ownership of a company or a business • Stockholders are known as equity holders, own common stock and share proportionally in the profit stream of the business • If profit rise over time , then share price tend to rise too • If profit fall or slip into losses , the share price falls • Stock holders are entitled to a share of any dividends a company might pay. Stocks Stocks • Stocks are priced based on their earnings • As earnings grows, the stock price grows even quicker because of the P/E ratio • If P/E is 15, then every 10­cent increase in earning moves the stock price up by $1.5 (15x 0.10) • P/E is not constant, it depends on the market condition, and how valuable the investors think about the company stock and earning potential • Stockholders have voting right in the company. One vote per share Microsoft Corp. Microsoft MSFT 26.48 ­0.21 ­0.79% After Hours: 26.55 +0.07 / +0.26% Vol. 71,340 Previous Close 26.69 Bid 19.05 Open 26.38 Bid Size 100 Day's High 26.99 Ask 27.50 Day's Low 26.28 Ask Size 200 Volume 88.99 Mil 52 Week High 37.50 52 Week Low 23.50 Avg. Daily Vol. (13 wk.) 74.17 Mil Reading Stock Tables Reading YTD 52­week YLD VOL NET %CHG Hi LO Stock (SYM) DIV % 100s CLOSE CHG P/E ­24.4 55.47 37.80 RCL .52 1.3 9447 41.15 ­0.15 17 Royal Caribbean = RCL (ticker symbol ) • Companies listed on the New York or American Stock exchange have one­ to three­letter symbols • Citigroup C, AT&T T, Anheuser Busch BUD • YTD % chg indicates the stock is down 24.4% year­to­date • Number of shares traded 9447 x 100 = 944, 700 • Shares fell 15 cents compared to previous day Microsoft Corp. Microsoft MSFT Earnings/Share 1.87 Forward P/E 12.40 Market Cap. 241.77 Bil P/E 14.30 Total Shares Out. 9.13 Bil The Bid-Ask Spread The • Stock quotes come in pair $41.13­$41.16 that is the spread • The highest offer (the bid) buyers are willing to offer for the stock at the moment is $41.13 • The lowest offer (ask) that the owners will accept for their shares is $41.16 • Buyers who want the stock will offer $41.16 and the stock price may move up if there is demand (spread may move to $41.16­$41.18) • Sellers who want to cash out will accept $41.13 and more sellers will accept the lower price before the shares slips (spread becomes $41.11­ $14.13) Preferred Stock Preferred • Is a class of company stock designed to pay a set (fixed) dividend every quarter (year) • The dividend rate is based on the share face value when it was originally sold to the public • It is “preferred “ to common stock in the event of bankruptcy or restructuring, it has preference over common stock when it comes to paying dividend • Dividend is cumulative – company owes you for every dividend skipped Preferred Stock Preferred • Rising or falling company earnings don’t impact the price of the share as common stock • True preferred stocks generate dividends from the company’s profit, making the dividens qualify for a 15% tax rate (typical face value is $50 and $100) • Hybrid preferred shares (Trust Preferred Securities) income comes from interest payment not from earnings. Dividends are considered as ordinary income (taxed at higher rate) Foreign Shares Foreign • Foreign shares must list in the USA through a new class of stocks classified as American Depositary Shares (ADRs) and Global Depositary Shares (GDRs) • Equivalent to the ordinary shares traded in the company home market • Trade is done in dollars (not yen, pounds, or Euro). Price is not one­to­one equivalent • Good for investors who want access to international companies – access only for major foreign players • Other stocks can be accessed through country specific or international mutual fund Key Numbers Key • Earning per share: the net income of a company divided by the number of outstanding company shares (this is what they cal the bottom line) • Price­earning ration (P/E):this is the current price of the stock divided by the sum of its most recent four quarters of earnings • Dividend yield: A company annual dividend payment divided by the stock current price Investing for the future Investing EE 0822 Section #3 Fall Semester Professor Theune Bonds Bonds • Bonds provide a certain safety of principal and pay a set amount of interest on regular schedule (6 months) • Bonds are nothing more than an IOU (I owe you), a promise by a company, federal government, or your township to repay you a certain amount of money overtime for the dollars that you lend it • In some cases collateral is used to back up the bond, but in most cases the only assets backing up the bonds is the full faith and credit of the issuer Bonds Bonds • Company income is used to pay the interest, or income from taxes if government bond • Principal will be paid in full when the bond matures • Maturity varies (few months – 30 years) • Key numbers are price and yield • Par value is the face value of the bond (typically $1000) , and the amount of money the bondholder will pay at maturity • Par value does not change, but bond price fluctuate between the issue date and maturity date Bonds Bonds • Bond priced at 96% will cost you $960 to buy a $1,000 bond • Bond priced at 105 will cost you $1,050 to buy $1000 bond) • Troubled bonds may trade at a much lower value (20 0r 30, $200­$300) • For a newly issued $1,000 bond with 5% yield you will get $50 annually (.05 x 1000) Bonds Bonds • If you bought the bond several years after it was issued and you paid $1,100 your interest would be 50/1,100= 4.55% • If the bond was trading for $950, your interest would be 50/950=5.26% • The interest payment does not change ($50), but bond price moves continually. If the price of bond rises yield falls, and if the price falls, yield rises. Yield-to-Maturity Yield-to-Maturity • Assume you bought a bond at 107 ($1,070), with a yield 6% ($60/year), after 3 years of issue (7 years remaining) • Current yield is 60/1,070 = 5.61% • In the remaining year you will get $60 per year • At maturity you will get $1000 (you paid $1,070), you lost $70. • Yield to maturity 4.81% (not 6%) • Yield-to-Maturity Yield-to-Maturity • Formula used to calculate yield­to­maturity ****** c(1 + r)­1 + c(1 + r)­2 + . . . + c(1 + r)­Y + B(1 + r)­Y = P where c = annual coupon payment (in dollars, not a percent) Y = number of years to maturity B = par value P = purchase price r= yield­to­maturity rate ****** Know This Formula Yield-to-Maturity Yield-to-Maturity • Callable bonds can be paid ahead of maturity date on a stated call dates • Will be called if interest rates fall • Callable bonds are typically repurchased at a premium $1,100 for a $1,000 bond • Yield after 4 years of purchase 97 years of issue) 6.24% • For bonds with multiple call dates, you need to calculate yield­ to­worst rate • If a recall happens at year 8 at par value, yield­to­worst will be 4.42% Bond Risk and Rating Bond • Credit risk: when a company can not make the scheduled principal and interest payment. This is called “default” • Credit­rating agencies analyze bonds and assign grades like AAA, AA, Baa2 • Most widely used agencies are: Standard & Poor, and Moody’s Investor Services • Junk bonds are those rated BB or lower (S&P) • Junk bond rated CCC historically default with 2.8 years of issue, and 29% default in the first year • Highly rated bond has less than 1% default rate • State and local government occasionally default – but rare Treasury Bonds Treasury • Treasuries are United States sovereign debt issued by the federal government • Interest is exempted from state and local government, you pay federal taxes • They come in three flavors • Treasury Bills (T­Bills), short term, maturing in one year or less • Interest rate increases as the term increases • Issued at discount to their face value (you pay $9,750 for and receive $10,000 at maturity­ 2.5% rate) Treasury Bonds Treasury • Treasury notes (T­notes) are issued for periods of 2,3, 5, 10 years • Issued at face value and redeem at face value, and pay fixed rate every 6 months • Treasury bonds (T­bonds) are issued for periods exceeding 10 years (typically 30 years)­ no longer exists • Treasury Inflation Protected Securities (TIPS), Interest and principal fluctuates with the Consumer Price Index. If deflation occurs, you get the face value at maturity Municipal Bonds Municipal • Issued by state and local governments for new schools, water and sewer plants, hospitals, roads, airports, …,etc • Municipals or Muni bonds pay interest every 6 months, and interest is exempted from local, state, and federal income taxes • You may need to live in the state that issued the bond to qualify for state and local tax exemption • Default rate is less than 0.26% (last 20 years) • Good investment for people in the high tax bracket (not taxed) Corporate Bonds Corporate • Corporates are issued by companies and sold to finance the construction of new plants, helping in the acquisition of other companies, or just refinance other debt • Income is taxable, and iterest is paid every 6 months • Default risk is greater with corporates, but default rates among the highest­graded corporate bonds “ investment­grade debt” is very small • Default rate around 3.5% around 2002 Investing in Bonds • Buying bonds can be expensive for small investors ($1000­$5000) • Many choices which can be confusing • Bonds trade infrequently, which make it difficult to sell at good price • You can buy bonds through or BONDS BONDS • You pay the par value, commission is included in the price • Many of these bonds pay interest monthly, good for investors living of f the income of their bonds • Relatively illiquid, good if you do not need to sell Tax-Equivalent Yield Tax-Equivalent • Because of default risk, corporate bonds pay higher interest rates • Higher interest rates does not mean highest net income (after tax) • You need to subtract taxes from interest income to determine “tax­equivalent yield” • Tax­equivalent yield for Muni can be very attractive for people in high tax bracket Investing in Bonds Investing • As the price of bonds goes up, its effective yield goes down and vice versa. • High quality bonds are safe , you get their value at maturity • You may lose money if you sell before maturity if interest rates are rising • High­yield bonds are called “junk bonds” since there is a high risk of default • You can have junk bonds in your portfolio through mutual funds that specializes in junk bonds­ keep that as a small percentage of your investment • Make bonds part of your portfolio to balance the risk of owning stocks Investing for the future Investing MUTUAL FUNDS EE 0822 SEC 3 PROFESSOR THEUNE Mutual Funds Mutual • Investors pool their money and mutually Investors mutually own a portfolio of investments that are managed by professionals that have the authority to buy and sell stocks as they see fit fit • The fund owners share the investment The income and gain broader diversification than they could achieve on their own they • 8,100 mutual funds available, $7.5 trillion in 8,100 investment investment Open-end versus Closed-end Open-end • Most mutual funds are open­ended • The share value is determined by total assets value divided by the number of shares issued­ known at Net Assets Value (NAV) • Fund assets $10 million, number of shares 1 million, then share price is $10 • Open­ended mutual funds are not traded on stock markets, but they are sold and redeemed by the mutual fund company itself • Mutual fund share price is determined daily after stock market closes Open-end versus Closed-end Open-end • Closed­end fund trade like shares on the stock exchange • These funds issue a limited number of shares that exchange hands between investors through brokerage firms • They have NAV, but do not trade at this value • Because of a fixed number of shares, market price is determined by supply­and­demand • Shares are said to trade at a “premium” if share price is above NAV, or at a “discount” if they trade below NAV No-Load versus Load No-Load • Mutual funds charge either a “load”, or are “no­load” • Loads are sales commission paid to brokers who sell the fund • They can be front­end if paid at the time you buy the fund shares, or back­end , if they charge you when you withdraw the money, or they can charge you a percentage annually for few years • There are instance when paying a load is a better choice, if the fund has a history of outperforming the market­ better return than no­load • Make sense for long term investors if the fund has low Expense Ratio Expense Ratio Expense • Expense ratios are ongoing annual fees that the fund company charges to run its operation and market the fund • These fees are deducted from the fund’s assets cutting your return • For bond funds the ratio is about 0.75% ($7.5 per $1000 of investment) • Index fund charge typically 0.1%­ passively managed, they just invest in the companies that make the index • Actively managed fund charge between 0.5%­0.75% • Small­company stock funds, sector funds, and international funds charge about 1.5% Types of Mutual Funds Types • There is a mutual fund for every investment strategy (remember 8100 funds exist) • Bond funds: invest in bonds • Index funds: arm­chair investment, these are low­maintenance, mutual funds that mimic the price movement of some particular stock or bond index (for example S&P 500) • Index fund offers broad diversification within various segments of the market • Index funds will keep up with market , actively managed fund try to outperform the market Types of Mutual Funds Types • With hundreds of index funds, you can build a well diversified, balanced, and inexpensive portfolio • One good reason to own index fund is that 80% of actively managed mutual funds underperform the market • With index funds you are the market Types of Mutual Funds Types • Balanced funds: invest in a mix of stocks and bonds • These funds seek a balance of both income (bonds, preferred stocks, and stocks with sizable dividend income), and capital appreciation from stocks • Balanced fund do not necessarily outperform the market in good times, and protect investors in bad times Types of Mutual Funds Types • Life cycle funds: target a particular retirement year 2015, 2020, 2025, 2030 funds • Very popular with 401 (k) crowd , because of targeted maturity • The objective of these funds is to make the fund your single investment • For example a fund targeting retirement at year 2030, has 70% of its assets in domestic stocks, 14% in international stocks, and 16% in bonds • For retirement in year 2015, 48% are invested in stocks, 7% in international stocks, and 39% in bonds, the rest in cash (money market) Types of Mutual Funds Types • Sector funds: they invest in a particular segment in the stock market; health care, financial services, transportation, energy, communications,…,etc. • They are risky but they can be winning long term investment • Money market funds: are mutual funds that seek to preserve NAV or share price of $1 • Low risk investment , a place to keep your cash for emergency spending, or for home home purchase • You have complete access to your money, but not FDIC insured Types of Mutual Funds Types • Exchange Traded Funds (ETF): they are similar to mutual funds but they trade like shares on an exchange, and are priced continuously through out the day. • ETFs track everything from indexes, individual countries, individual industries, specific bond duration, or even the price of gold. • ETFs perform in line with the index • You pay taxes only when you sell your shares, very tax efficient How to Pick Good Fund How • Do not associate near term performance with success • Past success does not mean future profit • Pay attention to long term history ; you want to know how the fund performed in good times and bad times • As long as you don’t chase hot funds and hot stock tips, as long as you don’t try to time the market, and as long as you balance your account annually, a balanced mix of assets that makes you comfortable will do just fine over time Asset Allocation Asset ...
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This note was uploaded on 09/12/2011 for the course FINANCE 101 taught by Professor Staff during the Spring '10 term at Temple.

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