(C) 2001 Contemporary Eng ineering Economics 1 Investing in Financial Assets Investing in Financial Assets Investment Strategies Investment Strategies Investing in Stocks Investing in Stocks Investing in Bond Investing in Bond Lec. 9 Investing in Financial Investing in Financial Assets Assets Investment Strategies Investment Strategies Investing in Stocks Investing in Stocks Investing in Bond Investing in Bond PRINCIPLES OF INVESTING PRINCIPLES OF INVESTING
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Investing in Financial Assets Investment Strategies Investing in Stocks Investing in Bond
PRINCIPLES OF INVESTING. Investing in Financial Assets Investment Strategies Investing in Stocks Investing in Bond. Investing in Financial Assets Investment Strategies Investing in Stocks Investing in Bond. Lec. 9. Investment Basics. Liquidity – How accessible is your money? - PowerPoint PPT Presentation
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(C) 2001 Contemporary Engineering Economics
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Investing in Financial AssetsInvesting in Financial Assets Investment StrategiesInvestment Strategies Investing in StocksInvesting in Stocks Investing in BondInvesting in Bond
Lec. 9
Investing in Financial AssetsInvesting in Financial Assets Investment StrategiesInvestment Strategies Investing in StocksInvesting in Stocks Investing in BondInvesting in Bond
PRINCIPLES OF INVESTINGPRINCIPLES OF INVESTING
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Investment Basics• Liquidity – How accessible is your money?
- money markets funds and saving accounts are very liquid
- mutual funds are growth investments
• Risk – What is the safety involved?
- biggest risk is not investing at all
• Return – How much profit will you be able to expect from your investment?
Annual Investment Yield (Base investment of $1,000)
Investment Case 1 Case 2 Case 3 Case 4 Case 5 Case 6
Year 1 9% 5% 0% 0% -1% -5%
Year 2 9% 10% 7% 0% -1% -8%
Year 3 9% 12% 20% 27% 29% 40%
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How to Determine Expected Financial Risk
• Risk: the chance that some unfavorable event will occur.- volatility and changing market condition
• Volatility measures the deviation from the expected value, or sudden swings in value—from high to low, or the reverse.
• Standard deviation measures the degree of volatility when you have the probabilistic information about the uncertain event.
• Beta measures how closely a fund’s performance correlates with broader stock market movement.
• Alpha shows whether a fund is producing better or worse returns than expected, given the risk it takes.
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Investment Strategies
• Trade-Off between Risk and Reward– Cash: the least risky with the lowest returns– Debt: moderately risky with moderate returns– Equities: the most risky but offering the
• Within equity investments – two similar assets; two different assets; multiple assets
• Reduce market volatility
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Broader Diversification Increases Return
Amount Investment Expected Return
$2,000 Buying lottery tickets
-100% (?)
$2,000 Under the mattress 0%
$2,000 Term deposit (CD) 5%
$2,000 Corporate bond 10%
$2,000 Mutual fund (stocks)
15%
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Option Amount Investment Expected Return
Value in 25 years
1 $10,000 Bond 7% $54,274
$2,000 Lottery tickets -100% $0
$2,000 Mattress 0% $2,000
2 $2,000 Term deposit (CD)
5% $6,773
$2,000 Corporate bond 10% $21.669
$2,000 Mutual fund (stocks)
15% $65,838
$96,280
1
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Investing in Stocks
• Stocks: Ownership shares in a corporation
• Ownership: If a company issues 1M shares, and you buy 10,000 shares, you own a 10% of the company.
• Valuation: (1) cash dividend and (2) share appreciation at the time of sale
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Conceptual Stock Valuation
IBM Computer:Given:Stock price as of July 20, 2001: $105.50/shareEarnings growth for next 5 years: 13%Expected cash dividend in 2002: $2.00/shareExpected stock price in 3 years: $230/shareRequired return on your investment: 10%Find: Current value of stock
P
$2
( . )
$2( . )
( . )
$2( . ) $230
( . )
$175. $105. ,
1 010
1 013
1 010
1 013
1 010
61 50
2
2
3
underpriced
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What Are Your Odds?
Your chance of making return on your investment per year
If you hold stocks for
Your chance of losing money
0-10% 10-20% 20+ %
1 year 26% 18% 20% 37%
3 years 14% 28% 39% 19%
5 years 10% 31% 49% 10%
10 years 4% 42% 53% 1%
20 years 0 37% 63% 0
Source: Newsweek, November 10, 1997
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What is Financial Option?
Call Option Put Option
100 shares of stock
At a predetermined
price
On or beforea predetermined
date
Strike (Exercise) price
Expiration date
AOL July Call (2001)
AOL stock
$50
July 20, 2001
The right To buy
The rightTo sell
Underlying asset
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Call Option
$1.45 $60$39.47
Current Price(04/09/01)
Option Premium
Stock PriceJuly 20, 2001
StrikePrice
$50
AOL Call Option July 2001
Profit: $8.55BreakevenPrice
$51.45 Do NotExercise:Loss limited to $1.45
Take partial loss
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Hold to maturityand trade at thestrike price
AOLDate:Feb 13, 2001Price:$48.09Strike price:$75Premium:$5,900 for 1000 shares
Expiration:Jan 2003
Trade for profit before optionexpires
Let the option expire If stock price drops to $70
If stock price rises to $100
If stock price rises to $78
If stock price rises to $90
If stock price rises to $80
($100-$75)* 1000=$25,000 from trade-$ 5,900 premium$19,000 profit
$5,000 from trade-$5,900 premium$ 900 loss
$15,000 from trade-$ 5,900 premium$ 9,100 profit
$3,000 from trade-$5,900 premium$2,900 loss
Lose yourpremium only$5,900 loss
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Investing in Bond
• Bonds: Loans that investors make to corporations and governments.
Types of Bonds and How They Are Issued in the Financial Market
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How Do Prices and Yields Work?
• Yield to Maturity: The actual interest earned from a bond over the holding period
• Current Yield: The annual interest earned as a percentage of the current market price
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Bond Quotes
AT&T 7s05 6.5% 5 million 108 1/4
Coupon rate of 7%
Maturity (2005)
Current yield
Trading volume
ClosingMarket price
$1,082.50$70/108.25= 6.47%
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Yield to Maturity
(a) Yield to maturity:
per semiannual period
(b) Current yield:
per semiannual period
$996. $48. ( / , ,20) $1, ( / , ,20)
.
( . ) .
$48.
$996..
25 13 000
4 84%
1 0 0484 1 9 91%
13
254 83%
2
P A i P F i
i
ia
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Summary
• The three basic investment objects are: growth, income, and liquidity.
• The two greatest risks investors face are inflation and market volatility.
• Portfolios with long-term horizons need equities to offset inflation while short time frames requires debt and/or cash investments to reduce volatility
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• Dollar-cost averaging is a planned transfer, over a period, of equal amounts from one assets to another.
• Diversification by combining assets with different patterns of return, it is possible to achieve a higher rate of return without increasing significant risk.
• Investing in stocks and bonds is one of the most common investment activities among the American investors.