Post on 19-Dec-2015
transcript
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Chapter 11 – Investment Basics
• Investment is something that generates a return through dividends, interest and/or market appreciation– Speculation – a bet price will go up or down
• Financial Planning – everything begins with your goals– Checklist: set goals, focus on time frame, be
realistic, risk appetite, taxes, reality of plan
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Goal Setting
• Write them down and then ask
– Consequence of failing?– Willing to make necessary sacrifices?– How much money needed?– When?
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Starting the Program
• Longer you postpone, harder to reach goal– Time is your best ally
• Set aside savings first, can spend the rest• Take advantage of Uncle Sam and
employer– Tax–free or tax-deferred– Company match savings plans
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Personal Profile
• Age and stage in career
• Need for liquidity and cash flow needs
• Size of portfolio
• Income tax bracket
• Required rate of return
• Your risk tolerance
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What’s Important to You?
• Liquidity and safety
• Current versus future income
• Capital growth
• Diversification
• Marketability
• Ease of management
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Types of Investments
• Lending investments – fixed returns known in advance; has maturity date
• Ownership investments – stocks and real estate (but illiquid)
• Stocks – ownership interest in a corporation– As profits and dividends increase, so should
price; no upside limit
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Bonds
• Pay interest periodically– Usually semiannually
• Often fixed for life of the bond
• At maturity repay principal
• Many, many kinds and features
• Subject to different types of risk
• As interest rates rise, bond prices fall
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Interest Rates
• Nominal yield is the quoted rate, such as a bond yielding 10%
• Starts with risk-free rate – return with no risk such as short-term Treasury bills– To get to the nominal rate, add premiums
for inflation, default, maturity and liquidity risks to risk-free rate
• Real rate – nominal rate less inflation
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Common Stock
• Common stockholders own the company and elect directors
• Returns come from increase in market value and dividends
• Rate of return equalsEnd value – Begin Value + Dividends
Beginning Value
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Annual Rates of Return1926 to 2000
Avg Ann Stand RiskSecurity Returns Dev PremSmall Co Stocks 17.3% 33.4% 13.4%Common Stock 13.0 20.2 9.1L-T Corp Bonds 6.0 8.7 2.1L-T Govt Bonds 5.7 9.4 1.8Med-term Govt 5.5 5.8 1.6US T-Bills 3.9 3.2 0Inflation 3.2 4.4
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2004
• Dow – 30 Industrials +3.15%
• S&P 500 +8.99
• S&P Small Cap +21.59
• Treasury Bonds flat
• Dollar down
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2005
• My guess – stocks up modestly (5 to 10%); bonds down
• Wild cards– Inflation– Corporate earnings– Interest rates– Exchange rates
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Diversification
• Purchase a variety of securities– Good and bad returns cancel each other– Reduces risk but not returns
• You cannot eliminate all risk– Stock prices tend to move together– If have 25 – 30 stocks, adding one more does
not reduce risk by much.
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Total Risk in Stock_______________
Systematic Risk
Or Market Risk
Cannot be eliminated by buying different
stocks
Unsystematic Risk or
Company Unique Risk
Eliminated by buying different stocks
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Investment Time Horizon
• Time horizon -very important– More volatility over one year than in 20
• As time horizon increases, can take more risk– Time horizon has important role in
determining how to invest savings
• Attitude towards risk varies by person