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11A Investing Basics and Evaluating Bonds #1. What does this chart tell you about investing?. 11- 1. Why People Invest. To achieve financial goals, such as the purchase of a new car, a down payment on a home, or paying for a child’s education. To increase current income.

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11A Investing Basics and Evaluating Bonds #1

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11A Investing Basics and Evaluating Bonds #1

What does this chart tell you about investing?

11-1


Why People Invest

  • To achieve financial goals, such as the purchase of a new car, a down payment on a home, or paying for a child’s education.

  • To increase current income.

  • To gain wealth and a feeling of financial security.

  • To have funds available during retirement years.


Objective 1Explain Why You Should Establish an Investment Program

Establishing Investment Goals

  • Financial goals should be:

    • Specific

    • Measurable

    • Tailored to your financial needs

    • Aimed at what you want to accomplish

  • Financial goals should be the driving force behind your investment plan

11-3


Establishing Investment Goals

  • What will you use the money for?

  • How much money do you need to satisfy your investment goals?

  • How will you obtain the money?

  • How long will it take you to obtain the money?

  • How much risk are you willing to assume in an investment program?

  • What possible economic or personal conditions could alter your investment goals?

  • Considering your economic circumstances, are your investment goals reasonable?

  • Are you willing to make the sacrifices necessary to ensure that you meet your investment goals?

  • What will the consequences be if you don’t reachyour investment goals?

11-4


Performing a Financial Checkup

  • Work to balance your budget

    • Do you regularly spend more than you make?

    • Pay off high interest credit card debt first

  • Obtain adequate insurance protection

  • Start an emergency fund you can access quickly

    • Three months of living expenses

  • Have access to other sources of cash for emergencies

    • Pre-approved line of credit

    • Cash advance on your credit card

11-5


Surviving a Financial Crisis

  • Establish a larger than usual emergency fund

  • Know what you owe

    • Identify debts that must be paid

  • Reduce spending

  • Pay off credit cards

  • Apply for a line of credit at your bank, credit union, or financial institution

  • Notify credit card companies and lenders if you are unable to make payments

  • Monitor the value of your investment and retirement accounts

11-6


Getting the Money Needed to Start an Investing Program

  • Pay yourself first

  • Take advantage of employer-sponsored retirement programs

  • Participate in elective savings programs

  • Make a special savings effort one or two months each year

  • Take advantage of gifts, inheritances, and windfalls

11-7


The Value of Long-Term Investing Programs

  • Even small amounts invested regularly grow over a long period of time

  • If you begin saving $2,000 each year. depending on the rate of return, you could have over $1 million by the time you are age 65 (See Exhibit 11-1 on page 356)

  • The higher the rate of return, the greater the investment risk

11-8


Objective 2Describe How Safety, Risk, Income, Growth, and Liquidity Affect Your Investment Decisions

Factors Affecting the Choice of Investments

  • Safety and risk

    • Risk = uncertainty about the outcome

    • Investment Safety = minimal risk of loss

    • Risk-Return Trade-Off

      • The potential return on any investment should be directly related to the risk the investor assumes

    • Speculative investments are high risk, made by those seeking a large profit in a short time

11-9


Components of the Risk Factor

  • Inflation Risk during periods of high inflation, your investment return may not keep pace with inflation; lose purchasing power

  • Interest Rate Risk the value of bonds or preferred stock may increase or decrease with changes in interest rates

  • Business Failure Risk affects stocks and corporate bonds(when business is not profitable)

  • Market Risk the risk of being in the market versus in a risk-free asset (stocks follow market cycle)

11-10


Investment Income, Growth and Liquidity

  • Investment Income

    • A predictable source of income (dividends or interest)

    • Most conservative = passbook savings, CDs and government securities

    • Other choices:

      • Municipal and corporate bonds

      • Preferred stock

      • Utility stocks

      • Selected common stocks

      • Selected Mutual funds

      • Rental real estate

11-11


Investment Income, Growth and Liquidity

  • Investment Growth

    • Growth in value (price appreciation)

    • Common stock usually offers the greatest potential for growth

    • Mutual funds and real estate offer growth potential

  • Investment Liquidity

    • 2 Dimensions:

      • Ability to buy or sell investment quickly

      • Without substantially affecting the investment’s value

      • Bank accounts VERY liquid; CDs have penalties; stocks and bonds could lose money upon sale

11-12


Traditional Investment Evaluation Factors

11-13


Objective 3Identify the Factors That Can Reduce Investment Risk

Asset Allocation = The process of spreading your assets among several different types of investments (choose % weightings in each)

  • The ratio of stocks, bonds, cash assets, other securities in your portfolio(Conservative, Moderate, Aggressive portfolios with different asset weights: conservative portfolio = less stock)

  • Most important determinant of overall investment success

    = Diversification (“eggs in different baskets”)

11-14


Portfolio Management & Asset Allocation

Other Factors to Consider:

  • Your Tolerance for Risk

    • At what point can you no longer sleep easily?

    • See http://njaes.rutgers.edu/money/riskquiz/

  • Your Investment Time Horizon

    • When will you need the money?

    • How long can your money continue to grow?

  • Your Age

    • Growth vs. income (olderpeople more conservative)

    • Recovery time if investments nosedive

    • One guideline: 110 – age = % of portfolio in stock

11-15


Your Role in the Investment Process

  • Evaluate potential Investments

  • Monitor the value of your investments

  • Keep accurate records

  • Other factors

    • Seek help from personal financial planner

    • Consider the tax consequences of selling investments

11-16


Objective 4Understand Why Investors Purchase Government Bonds

  • Government bonds = written pledge to:

    • Repay a specified sum of money (face value)

    • At maturity

    • Along with periodic interest (coupon payments)

  • Sold to fund the national debt and the ongoing costs of government

  • Three levels of government issues:

    • Federal

    • State

    • Local municipalities

11-17


U.S. Treasury Bills, Notes and Bonds

Treasury Bills (T-Bills)

  • $100 minimum

  • 4, 13, 26 and 52 weeks to maturity

  • Sold at a discount

  • Federal, but no state, tax on interest earned

  • “Reciprocal immunity” doctrine

    Treasury Notes

  • $100 units

  • Typical maturities = 2, 3, 5, 7, and 10 years

  • Interest paid every six months

  • Higher rate than T-bills (Why?)

  • Federal, but no state, tax on interest earned

11-18


U.S. Treasury Bills, Notes and Bonds

Treasury Bonds

  • Issued in minimum units of $100

  • 30 year maturity dates

  • Interest rates higher than Treasury notes & bills

  • Interest paid every six months

    Treasury Inflation-Protected Securities (TIPS)

  • Sold in minimum units of $100

  • Sold with 5, 10 or 20 year maturities

  • Principal changes with inflation (measured by CPI)

  • Pays interest twice a year at a fixed rate

11-19


Federal Agency Debt Issues

  • Essentially risk free

  • Slightly higher interest rates than Treasury securities (Why?)

  • Minimum investment may be as high as $10,000 to $25,000

  • Maturities range from 1 – 30 years

  • Average maturity = 12 years

  • Issuing agencies sample:

    • Fannie Mae

    • Freddie Mac

    • GNMA

    • TVA

11-20


State and Local Government Securities

Municipal Bonds (“Munis”)

  • Issued by a state or local government

    • Cities

    • Counties

    • School districts

    • Special taxing districts

  • Funds used for ongoing costs and to build major projects such as schools, airports, and bridges

  • General Obligation Bonds

    • Backed by the full faith, credit and taxing authority of the issuing state or local government

  • Revenue Bonds

    • Repaid from money generated by the project the funds finance, such as a toll bridge

11-21


State and Local Government Securities

Municipal Bonds (“Munis”)

  • Key characteristics:

    • Interest exempt from federal taxes

    • Capital gains may NOT be tax exempt

    • Usually exempt from state and local taxes in state where issued

    • Exempt status determined by use of funds

    • Lower rate of return than on taxable bonds

  • Insured municipal bonds

    • Private insurance to reduce risk

11-22


Taxable Equivalent Yield Formula

Used to compare tax-exempt and taxable bonds

11-23


Wrap Up

  • Concept Check 11-1- Why Develop Specific Investment Goals? Why Participate in Employer Retirement Savings Plan? How the TVoM Affects Investing.

  • Exhibit 11-2- A Quick Test to Measure Investment Risk

  • Concept Check 11-2- Four Components of Risk

  • Concept Check 11-4- Taxable Equivalent Yields


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