Notes and Reading Guide Chapter 11 Investment Basics

Transcription

1 Notes and Reading Guide Chapter 11 Investment Basics Name: 1. Your investing goals should be to your money and. It is important to understand investing from a perspective. A solid grounding in investing knowledge will help you reach your and avoid. 2. Before you invest, decide what your investing are. How much can you set aside to meet those goals? Know the difference between and. 3. An investment is an that generates a return. A return is an or an increase in (profit) when the asset is sold. 4. An income return is a return received, usually in the form of dividends or interest payments. 5. A dividend is a payment made by a company to its, usually as a distribution of. 6. Speculation is buying an asset whose value depends solely on. 7. An example of a speculative purchase is baseball cards because they are worth more in the future only if. 8. Derivative securities are securities whose value is derived from the. An option is an example of a derivative security. It is the right of the option owner to buy or sell an asset, usually, at a. 9. With investing, the value of an asset is determined by, not by and. Investments produce and, so investing is much than speculating. 10. Reading Guide. Go to the Stop and Think box on page 370. Read over the information about gold, and explain why gold is technically speculating, not investing: 11. When making your financial plan, you should: a. your goals and them. b. Attach to them 1 P a g e

2 c. Figure out when the money for these goals. d. Periodically your goals. 12. Short-term goals will be completed within 13. Intermediate-term goals will be completed in years 14. Long-term goals will take over years to complete. 15. Goals should also be realistic so they accurately reflect your financial situation. Ask yourself: a. What are the, if I don t accomplish this goal? b. Am I willing to to reach the goal? c. How much is needed? d. When do I? 16. Before you start investing, take a financial reality check: a. Have a grip on your b. Make sure you are. c. Have adequate. d. Keep. 17. Reading Guide. Go to page 372 and summarize the tips to come up with enough money to start investing: a. Pay yourself first: b. Make investing automatic: c. Take advantage of Uncle Sam and your employer: d. Windfalls: e. Make 2 months a year investment months: 18. Remember that the marginal tax rate is the tax rate you pay on your. The higher your marginal tax rate, the more tax-free investments are. Compare all investment returns on basis. 19. Tax deferred investments Examples are and. The money you invest now is. That means that the amount you invest now reduces your. You don t pay taxes on investments or profits until you 20. With taxes, and are better than income because they are taxed at a lower % rate. 21. There are two investment choices: lending investments, which are and, which are debt instruments issued by and the ; and 2 P a g e

3 ownership investments, which are stocks and stocks, which represent, along with income-producing real estate. 22. Reading Guide. Go to the section on Lending Investments on page 373 and answer the following questions: a. What is the maturity date? b. What is par value? c. What is the coupon interest rate? d. If you have bought a 20-year government bond, with a par value of $1,000 and an interest rate of 8%, how much in interest will you receive every year? $. Is this simple interest or compound interest?. At maturity, you will receive the par value, which is $. 23. Reading Guide. Go to the section on Ownership Investments on page 374 and answer the following questions: a. The two major forms of ownership investments are and. b. The main types of real estate investments are apartments, malls, and. In each case, you are investment in something that generates a return:. c. The major disadvantage of real estate investments is d. The most popular ownership investment is stocks. When you purchase shares of stock, you have purchased. e. Explain what a dividend is: f. In the case of preferred stock, the dividend is generally, with the preferred stockholder receiving an annual as long as the firm has cash to pay. 24. You can receive a return (or ) on your investment in two ways: a capital gain or loss, which is a or when you the capital asset; and an income return, which is any you receive directly from the or organization in which you ve invested. The two main income returns are on bonds and on stocks. 25. The formula for rate of return is: ( - ) + divided by. (Be sure to move the decimal place on the answer two places to the right.) 26. Example: you buy a stock for $10,000. You get $100 in dividends for the next five years. At the end of five years you sell the stock for $12,000. What is the rate of return? [($ - $ ) + $ ] / $ = % 27. Now practice: a. You buy a stock for $15,000 and sell it a year later for $17,000. What is your rate of return? 3 P a g e

4 b. You buy a stock for $25,000 and sell it 20 years later for $60,000. You also receive a total of $5,000 in dividends during those years. What is your rate of return? 28. Investors need to understand because interest rates affect the value of,, and. Interest rates also determine earning on and are closely tied to. 29. The nominal (or quoted) rate of return is the rate of return earned on an investment without any, 30. The real rate of return is the current or rate of return minus the rate. For example, if you earn 8% on an investment while the inflation rate is 3%, your real rate of return is % - % or % 31. Nominal interest rates on have dropped somewhat over the past years. As inflation slowed during that time, investors demanded a on money they lent, which resulted in a drop in. 32. The real rate of return can even be. In 2011, the nominal rate on Treasury bills was %, and inflation was %, resulting in a real rate of return of % - % = % 33. When interest rates go up, investors demand a higher return on. For example, the risk on stocks is than the risk on bonds, so investors demand a return on stocks. If bond rates are higher than, no one would invest in stocks. 34. Investments that produce higher have of risk associated with them. 35. Reading Guide. Go to pages and answer the following questions about types of risk associated with investing: a.. When market interest rates rise, the price of declines because new bonds with are now available. The same relationship holds for common stock. When market interest rates rise, the price of drops. That is because alternative investments such as bonds are when interest rates rise, and that makes stocks look to them. It is to eliminate interest rate risk. b.. Inflation risk is the risk that rising prices will the purchasing power of your. c.. Business risk deals with in investment value because of or bad decisions by management, or how or the firm s products are doing in the. d.. Financial risk is risk associated with the use of by the firm. As a firm takes on more, it also takes on and payments that must be made regardless of. If the firm can t make the payments, it could go. 4 P a g e

5 e.. Liquidity risk deals with the inability to liquidate a security and at a. For investments that are infrequently traded, it can be hard to. f.. Market risk is risk associated with. There are periods of bull markets, times when seem to move, and times of bear markets, when all stocks tend to. g.. Political and regulatory risk results from unanticipated changes in the or environments that have been imposed by the. h.. Exchange rate risk refers to the variability in earnings resulting from changes in. For example, if you invest in a German bond, you first convert your dollars into. When you liquidate that investment, you sell your bond for and convert those euros into. You could lose money in this process. i.. Call risk is the risk to callable bondholders that a bond may be called away from them before. Calling a bond refers to redeeming the bond, and many bonds are callable. 36. Diversification is the elimination of risk by investing in. It allows extreme and returns to. Diversification reduces risk without affecting the. 37. A portfolio is a group of held by an individual. Systematic Risk is the portion of a security s risk that cannot be eliminated through. Unsystematic risk is risk that eliminated with diversification. 38. You need to recognize your tolerance for risk and. Take a risk tolerance test, and review your past actions to determine how. 39. As the length of the investment horizon increases, or the, you can afford to invest in assets. If the investment horizon is longer, you will probably end up with if you invest in assets. 40. With any long-term investment, there will be years and years. With time, the variability of returns in these years converges toward the. 41. Asset allocation is how you divide your money among,, and other. Common stocks are more appropriate for the horizon because they are. Asset allocation is the most important investing task that is not a decision. You should continue to allocate your investments. 42. Reading Guide. Go to Table 11.1 on page 386, and answer the following questions about the three factors which affect your asset allocation decision. a.. The more time until you need the money, the more you can afford to take. The longer time horizon gives you more time to make in your portfolio, 5 P a g e

6 , and working if your investments perform poorly during the early years. b.. Some questions you should ask yourself when deciding how much risk to take on are: i. How secure is your? ii. Do you have a at work that will provide a steady income at retirement? iii. How much money do you or have you? iv. Do you have a big enough fund to allow you to avoid tapping into your investments at an inopportune time? c.. Different people have for risk. It is still probably necessary to take some risks and invest in. 43. The early years, a time of wealth accumulation (through age 54). The investment horizon is quite, so investors should place the majority of their savings into. A common approach is to put % in common stocks and % in bonds. 44. The golden years, asset allocation and approaching retirement (ages 55-64). During these years, preserve your level of and allow it to. Start moving some of your retirement portfolio into. Maintain a diversified portfolio with % stocks and % bonds. 45. The retirement years (over age 65). During these years, you will be more than. Income is the consideration, is secondary. You will keep your money safe with away from stocks. A good breakdown is % in stocks, % in bonds, and % in T-bills. 46. An efficient market is a market in which information about the stock is reflected in the. The more efficient the market, the prices react to new information. If the stock market were truly efficient, there would be no benefit from. 47. Beating the Market. How tough is it to consistently beat the market? Very tough! Half the time you should the market, and half the time you should. It is very difficult for superstars of investing to and the market. Keep your plan and invest. If you try to time the market, you are just as likely to miss as you are to avoid a. 48. Reading Guide. Go to Checklist 11.1 on page 391 and answer the following tips about investing: a. Systems don t beat the market. It s that work. There is no fool-proof method for. Beware of and cold calls from stockbrokers. 6 P a g e

7 b. Keep to the plan. Don t try to the market. Keep in mind that stock prices and interest rates go and go, but it is almost impossible to buy only when stock prices are and sell only when they are. c. Focus on the process. Spend your energy on the appropriate asset allocation given your, your, and where you are in your financial. d. Keep the down. Because it s difficult to beat the market, make sure you don t give away too much of your in the way of. e., diversify, diversify. The benefits of diversification are still. f. If you don t feel comfortable,! Don t let the fear of keep you out of the game. See the help of a. 49. Reading Guide. Go to pages and summarize the following common behavioral biases that affect investors: a. Overconfidence: b. Disposition Effect: c. House Money Effect: d. Loss then Risk Aversion Effect: e. Herd Behavior: 7 P a g e