Principles of Finance Part 5. Requests for permission to make copies of any part of the work should be mailed to: Thomson/South-Western 5191 Natorp Blvd.

Principles of FinancePart 5

Requests for permission to make copies of any part of the work

should be mailed to: Thomson/South-Western

5191 Natorp Blvd.Mason, OH 45040

Chapter 16

Investment Concepts

Investment Concepts

Investors individuals who purchase investments with

current savings in anticipation of relatively stable growth on average, or in the long term

Investment Concepts

Speculators individuals who search for mispriced

securities in an effort to earn abnormal returns

Investment Concepts

Speculatorsgamble on whether the prices of financial

assets believed to be mispriced will adjust accordingly in the market

Investment objectives1. Retirement planning

The Investment Process

Investment objectives2. Supplement current income



Investment objectives3. Shelter current income from taxes


Investment objectives4. Achieve future goals


Income securitiespreferred stock corporate bonds steady dividend or interest payments


Investor’s attitude toward risk risk tolerance level

an investor’s ability and willingness to tolerate, or accept, risk

Implementation to Achieve Investment Objectives

Transaction costs the costs associated with trading securities,

which include the costs of time, effort, and phone calls, as well as brokerage commissions that are incurred

Investment portfolioa combination of investment instruments

Stock

Bond

Real Estate


Asset allocation the proportion of funds invested in various

categories of assets, such as money market instruments, long-term debt, stocks, and real estate



Monitoring the investment positions1. to make sure goals are met

2. to adjust to changing economic and legal conditions

3. to include new investment instruments

Securities Transactions

Brokerage firms versus financial intermediariesbroker

agent (middleman) who helps investors trade financial instruments such as stocks, bonds, and derivatives

investors directly provide funds to users of those funds


Brokerage firms versus financial intermediariesfinancial intermediaries

banks, credit unions, and S&Lsmanufacture financial products such

as mortgages, automobile loans, NOW accounts, or pension funds

allow savers to indirectly provide funds to borrowers


Brokerage firms full-service brokerage firm

offers a variety of services to its clients, including research information, monthly publications that contain investment recommendations, advisory services, etc...


Brokerage firmsdiscount brokerage firm

offers clients only the basic services associated with trading securities

provides trade execution and related reporting requirements


Trading securities

trading quantitiesround lots -multiples of 100 sharesodd lots - trades with shares that

are not in multiples of 100


Trading securities types of orders

market orderan order to execute a transaction at the

best price available when the transaction reaches the market

stop orderan order that specifies the price at which

an order to buy or sell at the market price (a market order) is initiated



limit orderan order to buy or sell a stock at no worse

than a specified priceday order (DO)

instruction to cancel an order if the price conditions are not met by the end of the trading day



good ‘til cancelled (GTC)indicates an order is active until the

price limitations are met or until the investor cancels it

fill or kill orderinstructs the broker to cancel the order

if it cannot be executed immediately


Trading securitiesevidence of ownership

physical possession of shares registered in your name

brokerage firm holds shares in street name (registered to the brokerage firm)


Trading securitiessecurity insurance

provided by most brokerage firmsSIPC limit of $500,000additional limits from private

organizations

Investment Information

Value Line Investment Survey

Moody’s Investment Services

Standard and Poor’s


Newspapers New York Times The Wall Street Journal Barron’s Investor’s Business Daily

Magazines Business Week Forbes Fortune Money


Stock Quotes


Bond Quotes


Treasury Quotes

Individual security

01 P - P INC

investment of investment of received return

value Beginning - value Ending Income Dollar

Computing Investment Returns


Holding period return (HPR) the return earned over the period of time an

investment is held

Rate of k

Income Ending value - Beginning value

of investment of investment

Beginning value of investment

return

INC P1 - P0

P0

Holding period

return

(HPR)

Dividend yield the part of the total return associated with

the dividends paid by the firm computed by dividing the amount of

dividends paid by the stock price

Capital gain (loss) change in the market value of a security


Annualized rate of return

k INC P1 - P0

P0

360

T


Simple arithmetic average return computed by summing each return and

then dividing by the number of returnsdoes not consider compounding


Simple arithmetic average return

k A k1 k2 kn

n

kt

t1

n

n



Geometric average return computed by taking the nth root of the

growth multiple and subtracting 1.0 takes into account compounding

Geometric average return

k G 1 k1 1 k2 1 kn 1

n 1.0

1 kt t1

n

1

n

1.0



Computing the return on a portfolio

kp

Value of

Security 1

Portfolio

value

k1

Value of

Security 2

Portfolio

value

k2

Value of

Security N

Portfolio

value

kn

w1k1 w1k1 w nkn

w jk j

j1

n

Indexes Measuring Market Returns

Dow Jones Industrial Average (DJIA) 30 largest industrial firms in U. S.

Standard & Poor’s family of indexes S&P 500, S&P 400, S&P Industrials

Exchange indexes NYSE, AMEX, NASDAQ

Russell 3,000 Wilshire 5,000


Market capitalization the total market value of a firm’s stock computed by multiplying the number of

shares outstanding by the market price per share


Bull market rising stock market

Bear market falling stock market

Alternative Investment Strategies

Buy-and-hold strategyStrategy where investors purchase

securities with the intent of holding them for a long period, perhaps a number of years


Margin trading type of trade that allows an investor to

borrow from his or her broker some portion of the funds needed to purchase an investment


Margin requirement the minimum percent of the total purchase

price an investor must have to buy stock (or other investments) on margin


Hypothecation agreementassigns securities as collateral for a margin

loan


Broker loan rate the rate charged by brokers to borrow

funds for margin trading


Actual margin the percentage of investor’s equitymust meet the margin requirement when

the stock is purchased


Actual margin

investment of valueMarket

equity sInvestor'

share

per Price shares #

borowed

Amount

share

per Price shares #


Margin calla call from the broker to add more funds to

a margined account

Maintenance margin the lowest actual margin the broker will

permit margined investors to have at any time


Short selling type of trade that allows an investor to

borrow the stock of another investor and then sell it, but with a promise to replace the stock at a later date

cannot sell short on a downtick


Downticka decrease in price from one trade to

another


Uptickoccurs when the price of the most recent

trade is higher than the previous trade


Zero-plus tick occurs when the price of the latest trade equals

the price of the previous trade, but exceeds the price from one trade earlier

Shorting against the box occurs when an investor short sells a stock he or

she also owns refers to having the securities in a strong, or safe

deposit, box

End of Chapter 16

Investment Concepts

Principles of Finance Part 5. Requests for permission to make copies of any part of the work should be mailed to: Thomson/South-Western 5191 Natorp Blvd.

Documents

investment positionsto

investment conceptsrequests

investment recommendations

mispriced securities

prices of financial

market price

current savings

basic services