CHAPTER 11:

INVESTMENT PLANNING

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The Objectives & Rewards Of Investing

Investing—usually considered a long-term activity. Future values and returns expected to increase through time.

Speculating—usually considered a short-term activity. Future values and returns highly uncertain.

Adequate insurance coverage and emergency funds should be in place before starting to invest.

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How Can You Get Started Investing?

Accumulate money by regularly allocating a portion of your earnings for investing—PAY YOURSELF FIRST!

Take advantage of automatic investment and dividend reinvestment programs.

While saving, learn as much as possible about investments and "play" trade.

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Coming Up With the Capital Determine your financial objective.

How much money will it take?

Do you have a lump sum to invest now, or will you systematically save toward your goal?

Your investment plan provides direction in helping you attain your goal!

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What Are Your Investment Objectives?

Supplement current income— appropriate for retired persons.

Save for major expenditures— such as college education, down payment on a home, or starting a business.

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Shelter income from taxes—to preserve more of your earnings.

Save for retirement—to live comfortably in your "golden years."

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Different Ways to Invest

1. Common Stock

2. Bonds

3. Preferreds and Convertibles

4. Mutual Funds

5. Real Estate

6. Commodities, Financial Futures, and Options

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–Represents a share of ownership in a company.

–Greater potential returns, but at a higher level of risk.

2. Bonds–Represent the debt of a company.

–Provide current income.

– Lower level of risk than stocks, but with lower expected returns as well.

–Bond valuations inversely related to changes in prevailing interest rates.

1. Common Stock

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–An equity security that behaves like debt—provides current income and possible price appreciation.

–However, company has no legal obligation to declare dividends.

Convertible Bonds–Usually offer lower interest rates than

regular bonds, but —

–Can be converted into common stock.

–Risk that common stock will not do well and investor simply gets lower return.

3. Preferred Stock

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–Collection of professionally managed securities offered by an investment company.

–Returns and level of risk depend on characteristics of underlying portfolio.

5. Real Estate–Can invest directly or through buying

shares of a REIT.

–Estimating risk and expected return can be difficult. Investors must be aware of economic cycles.

4. Mutual Funds

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–Originally designed for agricultural producers to manage price risks; participants are now mostly speculators.

– Traders enter contracts to buy or sell a certain physical or financial item at a future date.

Options– Contract which conveys the right, but not

the obligation, to buy (call) or sell (put) the underlying asset at a specific price on or before the expiration date.– Learn more at www.cme.com.

6. Commodities and Futures

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Securities Markets

Place (not always physical) where financial instruments are traded.

Capital market—where long-term securities (those with maturities greater than 1 year) are traded.

Money market—where low-risk, short-term securities (those with maturities less than 1 year) are traded.

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Secondary market—for trading previously issued securities. Trading is done between investors; issuing company gets nothing.

Primary market—for new issues which are available for the very first time. The issuing company gets the proceeds.

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–Secondary markets for trading listed securities.

–Physical marketplaces, such as the NYSE, AMEX, and regional exchanges.

–Utilize brokers to facilitate trading between buyers and sellers.

–Handle transactions of larger, well-known companies' securities.

Organized securities exchanges

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–Secondary market where securities are traded via a telecommunications network.

– Investors trade directly with securities dealers.

–Larger, actively traded issues make up NASDAQ, while smaller, thinly traded issues are listed on "pink sheets."

Over-the-counter market

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–Organized securities exchanges exist in more than 100 countries worldwide.

–Found in major industrialized nations such as Japan, Great Britain, Germany and Canada.

–Also found in developing markets around the globe.

Foreign securities markets

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Federal and state laws regulate the sale of securities.

Purpose is to provide for adequate and accurate disclosure of financial information.

Securities and Exchange Commission (SEC) is the agency in charge of administering federal securities laws.

Regulating the Securities Markets

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Bull market—generally rising securities prices for an extended period of time.

–Reflects investor optimism.

–Associated with favorable economy.

Bear market—generally falling securities prices for an extended period of time.

–Reflects investor pessimism.

–Associated with economic downturn.

Market Trends:

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Making TransactionsIn the Securities Markets

Stockbrokers purchase and sell securities for investors.

Select from full-service, discount, or online broker, depending on your needs.

Consider brokerage fees when making securities transactions.

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Securities Investor Protection Corp. protects customer accounts against financial failure of brokerage firm.

SIPC insures accounts up to $500,000 (brokerage firms often purchase even greater amounts of coverage).

Guarantees securities or cash held by broker will be replaced (does not guarantee dollar value of securities!).

Investor Protection:

11-21Executing Trades:

Investor must first establish account with broker.

Trades can be executed by phone, at the brokerage firm, or online.

Odd lots (less than 100 shares) may incur extra fee. Round lots (multiples of 100) do not.

Market orders generally take less than a minute!

11-22Investor placesthe order with the broker.

11-23Investor placesthe order with the broker.

Broker transmitsorder to the market via tele-communications equipment.

11-24Investor placesthe order with the broker.

Broker transmitsorder to the market via tele-communications equipment.

Order isfilled at themarket byother buyersand sellers.

11-25Investor placesthe order with the broker.

Broker transmitsorder to the market via tele-communications equipment.

Order isfilled at themarket byother buyersand sellers.

Execution ofthe order isconfirmedto the broker.

11-26Investor placesthe order with the broker.

Broker transmitsorder to the market via tele-communications equipment.

Order isfilled at themarket byother buyersand sellers.

Execution ofthe order isconfirmedto the broker.

Broker confirms order fulfillment. Investor has 3 days to settle account.

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Types of Orders:

Market order—trade now at best available price.

Limit order—trade when a specified price or better is reached; investor is seeking opportunity.

Stop-loss order—sell if price drops to certain price; investor is seeking to limit losses.

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Margin Trading:

Allows investor to purchase securities on credit by borrowing part of purchase price from broker.

Increases gains when

returns are positive.

Increases losses when returns are negative.

11-29Example of Margin Trade with Profit:

(See Exhibit 11.3 in text)

Transaction w/out w/margin Initial investment (100 shares @ $50)

Amount invested $5,000 $2,500

Amount borrowed $ 0 $2,500

Total purchase $5,000 $5,000

Price INCREASES (100 shares @ $70)

Gross proceeds $7,000 $7,000

Less interest (9%) $ 0 $ 225

Net proceeds $7,000 $6,775

Net profit $2,000 $1,775

11-30Example of Margin Trade with Loss:

Transaction w/out w/margin Initial investment (100 shares @ $50)

Amount invested $5,000 $2,500

Amount borrowed $ 0 $2,500

Total purchase $5,000 $5,000

Price DECREASES (100 shares @ $30)

Gross proceeds $3,000 $3,000

Less interest (9%) $ 0 $ 225

Net proceeds $3,000 $2,775

Net loss ($2,000) ($2,225)

11-31Margin Trade Returns:

Return = Profit (loss) Amount Invested

w/out w/margin

Price Increase $2,000 $1,775$5,000 $2,500

Return 40% 71%

Price Decrease ($2,000) ($2,225)$5,000 $2,500

Return (40%) (89%)

11-32Short Selling: Allows investor to sell securities

borrowed from the broker or broker's accounts.

Before period is over, investor must replace the borrowed securities.

Investor loses if security’s price has increased.

Investor profits if security’s price has declined.

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Example of Short Sale:(See p. 459 in text)

Investor wishes to short 100 shares of ABW now selling at $52.50/share.

Broker sells borrowed shares for investor:

100 x $52.50 = $5,250 proceeds

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Costs 100 x $40 = $4000 to replace shares.

Investor receives:

$5250 – $4000 = $1250 profit!!

Scenario A:

Price of security drops to $40/share & investor repurchases:

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Costs 100 x $60 = $6000 to replace shares.

Investor receives:

$5250 – $6000 = ($750) loss!!

Scenario B:

Price of security rises to $60/share & investor repurchases:

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To profit from short selling: Not only must the price of the security fall, but it must do so within the given time period.

Double jeopardy!

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Becoming an Informed Investor

Types of Information to Follow:

–Economic developments and current events

–Alternative investment vehicles

–Current interest rates and price quotations

–Personal investment strategies

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Available Investment Information :

Annual Reports Financial Press

(WSJ and financial magazines) Brokerage Reports Advisory Services Investment Advisors On-Line Sources

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Online Investing

Online services Educational

material Investment

tools Investment

planning

Research and screening

Portfolio tracking

Day trading

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Using the Internet Wisely:

Do your own research.

Realize that frequent trades mean higher transaction costs.

Don’t believe everything you read.

Avoid online scams!

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Questions to Ask:

Is the stock registered? Who is making the sales pitch? Is it too good to be true?

Refer to SEC Web site:www.sec.gov

(Search on “investment scams.”)

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Managing Your Investment Holdings

Build a diversified portfolio of securities based upon your goals and personal situation.

Allocate your assets according to your objectives.

Track your investments and rebalance your portfolio as your needs change.

THE END!