STANDARD Personal Finance 2: Explain that banks and other financial institutions are businesses which channel funds from savers to investors. C – give.

STANDARDPersonal Finance 2: Explain that banks and other

financial institutions are businesses which channel funds from savers to investors.C – give examples of the inverse relationship between risk and return.D – evaluate a variety of savings and investment options, including stocks, bonds and mutual funds.

What’s an investment?

•An investment is something you buy with the expectation that it will increase in value over time.

Financial Intermediaries

- Channel funds from savers to investors/borrowers- Provide information that reduces costs (time

and money) to investors.- Share risk – diversification

- Provide liquidity – allow savers to easily convert assets to cash

Examples of Financial Intermediaries

• Banks, Savings and Loan Associations, Credit Unions

• Finance Companies (higher risk, higher interest)

• Mutual Funds (pool savings of many and invest in stocks, bonds, etc.)

• Life Insurance Companies (lend out portion of premiums to investors)

• Pension Funds (set up for retirees, managers invest)

What is a bond?

- An IOU – represents a debt that the government or a corporation must repay to an investor.

- Bonds are loans that investors make to corporations and governments.

- Lenders earn interest, borrowers get the cash they need.

Types of Bonds

- Savings (low denominations ($50 - $10,000, issued by government, virtually no risk, interest paid at maturity,not monthly.)

- Treasury Bonds, Bills, Notes (issued by US Treasury Dept., various maturities, safe investment, “full faith and credit” of US government)

Types of Bonds

• Municipal (munis, issued by state and local governments, most are safe – based on health of governments, tax exempt so attractive to investors)

- Corporate – issued by corporation to raise money, large denominations ($1,000, $5,000, $10,000), moderate risk (no tax base to guarantee repayment), watched by SEC, S&P’s and Moody’s

Types of Bonds

• Junk – high yield securities, lower rated, potentially high paying

- greater than average chance that the issuer will fail to repay the debt.

Bonds- 3 components of bonds

- Coupon rate (interest rate paid to holder)

- Maturity (time payment is due to holder)

- Par value (amount paid to purchase bond, will be repaid to investor at maturity)

Advantages/Disadvantages

• Advantages:- Relatively safe for

investor

- Interest rate doesn’t change once bought (issuer)

- Don’t own part of company, not a stockholder, don’t share profits (issuer)

• Disadvantages- Company must make

fixed interest payments even if not making money or if interest rates drop. (issuer)

- Bonds can be downgraded if not doing well, hurts bond-rating (issuer) – makes bonds hard to sell unless discounted.

Rating Bonds

Time is Money

• When bonds have the same ranking but different terms, those with longer terms typically pay higher rates to encourage investors to commit their money for an extended period.- Greater risk for inflation

STOCKS

• Stocks represent ownership in the corporation.

• a/k/a equities

• shareholders receive a share of the profit, paid quarterly (dividends)

• 4 types: income, growth, common, and preferred.

Types of Stocks

1. Income – pays dividend regularly throughout the year.2. Growth – pays few or no dividends, company reinvests

earnings in the business, value increases over time.3. Common – investors are voting owners of the company, 1

vote = 1 share, elect board of governors, owners at risk if company fails.

4. Preferred – investors are non-voting owners, receive dividends before owners of common stock, if company fails they get money before owners of common stock.

Stock Exchanges

- Market for buying and selling stock- NYSE = largest, most powerful

- 1792- Handles only the largest and most established companies (blue chip companies

– largest and most consistently profitable, list changes)- 2,813 listed

- OTC = electronic marketplace- investors buy directly from a dealer or a broker who

searches for the best price. - Nasdaq (National Association of Securities Dealers Automated)

- American market for over-the-counter securities - 1971

- 2nd largest securities market in US, 3rd in world- 4,247 listed

What is Daytrading?

- Try to predict minute-by-minute price changes, based on computer programs

- Risky

- Not long-term holders

Comparison of NYSE and Nasdaq

• Founded: 1792 Membership: 1,366 seats, 338 member firms, seven specialist firms Listings:* 3,556 Avg. Daily Stock Volume, July: 1.45 billion Aggregate Market Value, Aug. 14:** $10.1 trillion Initial Listing Market Value: At least $60 million Initial Listing Fee: $150,000 to $250,000 Annual Fee: $35,000 to $500,000 Newly Listed Companies:*** 47 Regulatory Delisting/Suspension:*** 33 Most Valuable Company:** General Electric, $280 billion Least Valuable Company:** BMC Industries,

• Founded: 1971 Membership: 267 market makers Listings:* 3,629 Avg. Daily Stock Volume, July: 1.77 billion Aggregate Market Value, Aug. 14:** $2.58 trillion Initial Listing Market Value: At least $8 million Initial Listing Fee: $100,000 to $150,000 Annual Fee: $21,225 to $60,000 Newly Listed Companies:*** 47 Regulatory Delisting/Suspension:*** 152 Most Valuable Company:** Microsoft, $275 billion Least Valuable Company:** Juniper Group, $1.1 million

Global Stock Exchanges

• many stock exchanges located in just about every country around the world.

• American markets are undoubtedly the largest, but they still represent only a fraction of total investment around the globe.

• The two other main financial hubs are London, home of the London Stock Exchange, and Hong Kong, home of the Hong Kong Stock Exchange.

• The last place worth mentioning is the over-the-counter bulletin board (OTCBB). – The Nasdaq is an over-the-counter market, but the term commonly refers

to small public companies that don’t meet the listing requirements of any of the regulated markets, including the Nasdaq.

– The OTCBB is home to penny stocks because there is little to no regulation. This makes investing in an OTCBB stock very risky.

Measuring Stock Performance

• Dow Jones Industrial Average – index showing how certain stocks have traded daily since 1896.– 30 companies in various industries (food,

entertainment, and technology

Measuring Stock Performance

• S & P 500 – – index shows price changes of 500 different

stocks

- Reports mainly on stocks listed on NYSE, some traded on Nasdaq and OTC markets

Bull or Bear?

• Bull – steady rise in stock market over a period of time.– is when everything in the economy is great, people are

finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Easy to pick stocks because everything is going up.

• Bear – steady drop in stock market over a period of time.– the economy is bad, recession is looming and stock

prices are falling. Bear markets make it tough for investors to pick profitable stocks.

Comparison of Bonds and Stocks

• BONDS- Loans to companies- Don’t represent

ownership- Somewhat safer

investment

- Lower return

• STOCKS

- ownership

- riskier investment

- higher return, if successful

MUTUAL FUNDS•What are they?

–An investment tool which allows small investors to hold a diverse portfolio of stocks without the associated costs and time

MUTUAL FUNDS•Where do I get

them?–Brokers–Direct Sales–Internet

•How can I tell a good one from a bad one?–Newspaper–Financial magazines

–Rates of return

MUTUAL FUNDS• Pros–Easy to buy and sell–Easy to manage–Allows small investors the advantage of a diverse portfolio

• Cons– Investor has little control over mutual fund investment decisions

–High rates of return in some stocks are counteracted by low rates of return on others

Reading a Stock Table

• Columns 1 & 2: 52-Week High and Low – These are the highest and lowest prices at which a stock has traded over the previous 52 weeks (one year). This typically does not include the previous day’s trading.

• Column 3: Company Name & Type of Stock – This column lists the name of the company. If there are no special symbols or letters following the name, it is common stock. Different symbols imply different classes of shares. For example, “pf” means the shares are preferred stock.

• Column 4: Ticker Symbol - This is the unique alphabetic name which identifies the stock. If you watch financial TV, you have seen the ticker tape move across the screen, quoting the latest prices alongside this symbol. If you are looking for stock quotes online, you always search for a company by the ticker symbol. If you don’t know what a particular company’s ticker is you can search for it at: http://finance.yahoo.com/l.

• Column 5: Dividend Per Share – This indicates the annual dividend payment per share. If this space is blank, the company does not currently pay out dividends.

• Column 6: Dividend Yield – The percentage return on the dividend. Calculated as annual dividends per share divided by price per share.

• Column 7: Price/Earnings Ratio - This is calculated by dividing the current stock price by earnings per share from the last four quarters. For more detail on how to interpret this, see our P/E Ratio tutorial.

Column 8: Trading Volume – This figure shows the total number of shares traded for the day, listed in hundreds. To get the actual number traded, add “00″ to the end of the number listed.

• Column 9 & 10: Day High and Low - This indicates the price range at which the stock has traded at throughout the day. In other words, these are the maximum and the minimum prices that people have paid for the stock.

• Column 11: Close - The close is the last trading price recorded when the market closed on the day. If the closing price is up or down more than 5% than the previous day’s close, the entire listing for that stock is bold-faced. Keep in mind, you are not guaranteed to get this price if you buy the stock the next day because the price is constantly changing (even after the exchange is closed for the day). The close is merely an indicator of past performance and except in extreme circumstances serves as a ballpark of what you should expect to pay.

• Column 12: Net Change - This is the dollar value change in the stock price from the previous day’s closing price. When you hear about a stock being “up for the day,” it means the net change was positive.

Why do stock prices change?

• Supply and Demand

• If more people want to buy a stock (demand) than sell it (supply), then the price moves up.

• If more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Reading Stock Charts

• Look at general trend over last 6 months – shows general health

• Look for recent spikes (up or down) – means something significant is going on, game changers, worth noting

• See if there are charts for similar companies (competitors) and compare.