slide1 n.
Download
Skip this Video
Loading SlideShow in 5 Seconds..
He wants to make money ( generate a return ) on his investment . He wants to keep his money safe . PowerPoint Presentation
Download Presentation
He wants to make money ( generate a return ) on his investment . He wants to keep his money safe .

Loading in 2 Seconds...

play fullscreen
1 / 29

He wants to make money ( generate a return ) on his investment . He wants to keep his money safe . - PowerPoint PPT Presentation


  • 111 Views
  • Uploaded on

Investing. I.N. Vestor is the top plastic surgeon in Tennessee. He has $10,000 to invest at this time. He is considering investing in Frizzle Inc. What factors will influence his investment on Frizzle, Inc.?. He wants to make money ( generate a return ) on his investment .

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'He wants to make money ( generate a return ) on his investment . He wants to keep his money safe .' - tocho


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
slide2

Investing

I.N. Vestor is the top plastic surgeon in Tennessee. He has $10,000 to invest at this time. He is considering investing in Frizzle Inc. What factors will influence his investment on Frizzle, Inc.?

  • He wants to make money (generate a return) on his investment.
  • He wants to keep his money safe.
return on investment
Return On Investment
  • After the investment is made.

The return

is the percentage either gained or lost on the original investment.

In order to make an educated investment decision, I.N. Vestor can research the return that the investment has generated in the past. (also known as historical return)

historical return realized return
Historical Return/Realized Return
  • Historical Return (Realized Return): Historical measure of what an investor has earned based on actual historical cash flows during a specific holding period.
holding period
Holding Period

The time frame starting when the initial investment in the stock/bond begins and ending on the day the stock/bond is sold.

Realized Return = Dividend + (P1 – P0)

P0

historical realized return
Historical/Realized Return

Example: I.N. Vestor purchased Stock ABC one year ago for $33. The stock paid a dividend of $1.75 and now has a price of $37.25. What realized (historical) return did he earn over the one-year period?

Solution: If I.N. Vestor sells the stock now for $37.25 then he will collect

$37.25 plus the $1.75 dividend that was paid during the year

Realized return =

Dividend + (price @ end of period - price @ beginning of period)

Price @ beginning of the period

On his initial investment of $33, the realized (historical) return is

1.75 + (37.258 - 33) / 33 = 18.2%

The Realized Return is 18.2% in one year per share of ABC.

Questions to Consider:

  • Is that a good return?
  • Is that return better than the return a bank offers?
  • Is it a good investment decision?
components of stocks realized return
Components of Stocks’ Realized Return

Dividends: A portion of a company’s earnings distributed to their stockholders.

  • The issuer can elect to suspend payment of the dividend and reinvest that amount into additional purchase of the stock.

Capital gain: Profit that is realized when the security is sold and the selling price of the security is greater than the purchase price. If the price of the stock drops during the period, a capital loss is realized.

Capital Gain (Loss) = P1 –P0

  • A capital gain is realized when the outcome is positive.
  • A capital loss will is realized when the outcome is negative.
components of stocks realized return1
Components of Stocks’ Realized Return

Capital gain: Profit that is obtained when the security is sold and the price of a security is greater than the purchase price. If the price of the stock drops during the period, a capital loss is realized.

Capital Gain (Loss) = P1 –P0

  • A capital gain is realized when the outcome is positive.
  • A capital loss will is realized when the outcome is negative
components of bonds realized return
Components of Bonds’ Realized Return

Coupon: Periodic payment of interest that the issuer is required to pay at set intervals, (typically semiannually) until maturity.

components of bonds realized return1
Components of Bonds’ Realized Return

Capital gain: If the bond is held to maturity, the investor receives the full principal value.

  • If the bond is sold prior to maturity, a capital gain or loss may be realized depending on the bond’s market price at the time of sale.
time value of money
Time Value of Money

The idea that a dollar received today is worth more than a dollar received in the future. A dollar received today can be either used for consumption purposes or be reinvested, earning additional income from return or interest.

Time Value of Money is the principle that drives the expected return model.

present value formula
Present Value Formula

Present Value Formula:The Present Value Formula determines how much a sum of money received in the future would be worth today. The Future value of money is discounted using the interest rate. The Future value of money is discounted using the interest rate.

PV = Present Value of the $

FV = Future Value of the $

i = interest rate

n = number of interest periods

present value
Present Value

Discounting:Finding the present value of an investment by taking the future value of that investment and discounting it by the interest rate.

an application of the time money value
An Application of the Time Money Value
  • Congratulations! You have won a cash prize of $20,000! You have two options:

Or

B. The choice is clear: most people will choose to take the money today.

2) Now, what if the options are:

Or

Here, the choice is less clear.

The option you would choose is based on how much interest you think you can earn on $20,000 today.

  • B. Receive $20,000 in three years
  • A. Receive $20,000 now
  • A. Receive $20,000 now
  • A. Receive $23,000 in three years
an application of the time money value1
An Application of the Time Money Value

Situation 2: Now assume the interest rate is 4%, compounded annually. After three years, you will have $22,497.28 so you would rather take the $23,000 in the future.

FV = PV*(1+i) n

FV= 20,000(1+.04)3= $22,497.28

So taking the $23,000 in three years would be the best option.

  • Situation 1: Assume the interest rate is 5%, compounded annually. After three years you will have $23,152.50 so you would still take the $20,000 today rather than the $23,000 in the future.
  • Using the Present Value Formula:
  • PV= FV/(1+i)n
  • I = 5%
  • N = 3
  • PV = 20,000
  • *The formula can be adjusted to solve for any of the variables.
  • FV= PV*(1+i)n
  • FV= 20,000(1+.05)3 = $23,152.50
  • So taking the $20,000 today would still be the best option.
compound vs simple interest
Compound vs. Simple Interest

Simple Interest:

  • In the simple interest calculation, coupons or dividends paid are not assumed to be reinvested and, thus, do not generate additional interest.

The formula for simple interest is:

Interest = Principal*Interest Rate*Time

compound vs simple interest1
Compound vs. Simple Interest

In the compound interest calculation, the coupons and dividend payments are assumed to be reinvested. So, the coupons and dividends generate additional interest after they are paid to the investor because the investor reinvests the payments. Compound interest causes your money to grow at a faster rate

The formula for compound interest is:

M = P(1+i)n

M = The amount generated (including the initial principal)

P = Principal, the initial investment

i= Interest rate

n= Number of interest periods

compound vs simple interest2
Compound vs. Simple Interest

Example: I.N. Vestor wants to know how much he will make in 3 years if he puts $10,000 into his savings account today. The savings account interest rate is 4% compounded annually. How much will I.N. Vestor have after 3 years?

Solution:

i = 4%

n= 3

P= 10,000

M= 10,000 (1+.04) 3= $11,248.64

I.N. Vestor will have $11,248.64 after 3 years.

return
Return

Expected/Required Return: Return an investor requires or expects for assuming a certain amount of risk with the investment. The expected return is based on future expected cash flows for a set period of time.

  • Holding period in the expected return calculation is based on the period beginning today (n=0) and ending at an established time in the future.
expected rate of return for stocks
Expected Rate of Return for Stocks

Components of Stocks’ Expected Return

  • Future expected dividends.
  • Expected price of stock at the end of the holding period.

Unlike bonds, stocks have no maturity date. To recover principal, an investor must sell stock in the stock market.

expected rate of return formula stocks
Expected Rate of Return Formula- Stocks

P0 = + + + … +

P0 = price of the stock today

i = expected rate of return

D1 = dividend year1

D2 = dividend year2

D3 = dividend year3

= price of the stock in future

expected rate of return formula stocks1
Expected Rate of Return Formula- Stocks

Example: I.N. Vestor buys 1 share of stock XYZ at $1,000 per share. It pays a 2% annual dividend ($20 per year). The price of the stock after 1 year is $1,200. What is the expected rate of return?

Solution: 1,000 = _20_+ 1200

(1+i) (1+i)

1000 (1+i) = 1220

1000i = 220

i = 0.22 = 22%

The expected rate of return is 22%

expected rate of return for bonds
Expected Rate of Return for Bonds

Components of Bonds’ Expected Return

A company that issues a bond must pay the coupons or coupon payments to the bondholder.

Coupon

  • The original investment.

Principal

bond cash flows
Bond Cash Flows
  • Company that issues a bond must pay the coupon payment (interest) to the bondholder for a scheduled time period.
  • Coupon payments are paid to the bondholder, usually semi-annually.
  • When the bond matures, the issuer repays the principal to the bondholder.

Long-term bonds have higher coupon rates than short-term bonds. This is because of risk. Bonds with longer maturities have higher coupon rates because the longer time frame makes them riskier to an investor because there is a greater change of default.

cash flow of bonds
Cash Flow of Bonds

Yield to Maturity:In the bond market, this is the rate of return that an investor would earn if he bought the bond at its current market price and held it until maturity.

Solution using Formula:

i = 3% = 1.5% (because of semi-annual coupons)

n = number of periods = 4 (2 years*2 payments/year)

C = 25M = par value = 1,000

P = 25/(1+.015)1+ 25/(1+.015)2+ 25/(1+.015)3+ 25/(1+.015)4+ 1000/(1+.015)4

P = 24.63054187 + 24.2665437 + 23.9079248+23.55460576+942.1842303

P = $1,038.54

example1
Example
  • Suppose your bond has a face value of $1,050 and has a coupon rate of 5%. It matures in 5 years and the par value is $1,000. What is the YTM?

YTM = Yield To Maturity

Solution

YTM= C+ (F-P)/n

(F+P)/2

YTM = 50+ (1050-1000)/5

(1050+1000)/2

YTM= 5.85%

The yield to maturity is 5.85%

C= 50

F= 1,050

P= 1000

n= 5