Principles of Business and Personal Finance NC Competency 009: Explain the theory of savings and investments in our economy. NC Objective 9.02: Summarize various types of stock and bond investments. I. Investing Bonds A. Purpose of Bonds: interest-bearing or discounted certificate of indebtedness, paying a fixed rate of interest over the life of the obligation, hence the name fixed income security. The issuer is obligated by a written agreement (the bond indenture) to pay the holder a specific sum of money, usually semiannually but sometimes at maturity, as is the case with zero-coupon bonds, and the face value, or par value, of the certificate at maturity. 1. Bond-holder: Individual who lends money to a corporation. B. Terms: any condition specifying how a loan is to be repaid, for example, the annual percentage rate finance charge, monthly payment, number of payments, balloon payment, and so on. 1. Face Value: Amount being borrowed by the seller of the bond. 2. Coupon Rate: Rate of interest on the bond. C. Types of Bonds: 1. Corporate Bonds: debt instrument issued by a private corporation, as distinct from one issued by a government agency or a municipality and are used to finance buildings and equipment. Corporate’ typically have four distinguishing features: a. they are taxable b. they have a par value of $1000 c. they have a term maturity, which means they come due all at once, and are paid for out of a sinking fund accumulated for that purpose d. they are traded on major exchanges, with prices published in newspapers 2. Municipal Bonds: debt obligation of a state of local government entity. The funds may support general governmental needs or special projects such as schools, roads, airports, etc. 3. Treasury Bonds: long-term debt instrument with maturities of 10 years or longer issued in minimum denominations of $1000. a. Issued by federal government. b. Known as Savings or Federal Bonds 4. Series EE Bonds: U. S. government bond issued in face value denominations ranging form $50 to $10,000. Starting in 1980, Series EE bonds were issued as a discount of half their face value. Series EE bonds earn interest for 30 years. The interest from savings bonds is exempt from state and local taxes, and no federal tax on EE bonds is due until redemption. 5. Treasury Bills: short-term securities with maturities of one year or less issued at a discount from face value. Auctions of 91-day and 182-day bills take place weekly, and the yields area watched closely in the money markets for signs of interest rate trends. Many floating-rate loans and variable-rate mortgages have interest rates tied to these bills. The treasury also auctions 52-week bills once every four weeks. 6. Treasury Notes: intermediate securities with maturities of 1 to 10 years. Denominations range from $1000 to $1 million or more. The notes are sold by cash subscription, in exchange for outstanding or maturing government issues, or at auction. 7. Treasury Bonds: long-term debt instruments with maturities of 10 years or longer issued in minimum denominations of $1000. II. Investing in Stocks A. Terms associated with the stock market: 1. Stock: share of ownership in a business. 2. Stock Certificate: proof of ownership in a corporation 3. Market Value: price at which a stock can be bought or sold. 4. Dividends: part of profits shared with stockholders. B. Types of Stocks: 1. Preferred: class of capital stock that pays dividends at a specified rate and that has preference over common stock in the payment of dividends and the liquidation of assets. Preferred stock does not normally carry voting rights. 2. Common: units of ownership of a public corporation. Owners typically are entitled to vote on the selection of directors and other important matters as well as to receive dividends on their holdings. In the event that a corporation is liquidated, the claims of secured and unsecured creditors and owners of bonds and preferred stock take precedence over the claims of those who own common stock. For the most part, however, common stock has more potential for appreciation. C. Reading a Stock Quotation Table: 1. 52 Week Hi: Highest price during previous 52 weeks 2. 52 Week Lo: Lowest price during previous 52 weeks 3. Stock: Company name abbreviated 4. Stock Symbol: Ticker symbol 5. Dividend: Current dividend in dollars per share based on the last dividend paid 6. Yield: Dividend yield based on the current selling prices per share 7. PE: Price/Earnings ratio, comparing the price of the stock with earnings per share. 8. Volume: Number of shares traded. 9. High: Highest price during the day. 10. Low: Lowest price during the day. 11. Close: Closing price for the day. 12. Net Change: Change in the closing price today compared with closing price on the previous day. D. Buying and Selling on NYSE: A typical transactions follow these steps: 1. Account executive receives your order to sell stock and relays to the brokerage firm’s representative at the stock exchange. 2. A clerk signals the transaction to a floor broker on the stock exchange floor. 3. Floor broker (buyer) goes to the trading post at which time this specific stock is traded. It is traded with the floor broker (seller) who has an order to buy. 4. Floor broker (buyer) signals the transaction back to the clerk. Then a floor reporter — an employee of the exchange — collects the information about the transaction and inputs it into the ticker system. 5. The sale appears on the price board, and a confirmation is relayed back to your account executive, who then notifies you of the completed transaction. E. Brokerage Firm: Sells stocks for consumers 1. Broker: person who acts as a go between for buyers and sellers of securities. 2. Commission: fee charged by a brokerage firm for the buying and/or selling of a security. F. Stock Exchanges: organized marketplace in which stocks, common stock equivalents, and bonds are traded by members of the exchange, acting both as agents (brokers) and as principals (dealers or traders). Most exchanges have a physical location where brokers and dealers meet to execute orders from institutional and individual investors to buy and sell securities. Each exchange sets its own requirements for membership; the New York Stock Exchange (NYSE) has the most stringent requirements. 1. New York Stock Exchange (NYSE) 2. National Association of Securities Dealers Automated Quotation (NASDAQ) 3. American Stock Exchange (AMEX) G. Types of Markets: 1. Bull Market: prolonged rise in the prices of stocks, bonds, or commodities. Bull markets usually last at least a few months and are characterized by high trading volume. Usually occur when investors are feeling optimistic about the economy. 2. Bear Market: prolonged period of falling prices. A bear market in stocks is usually brought on by the anticipation of declining economic activity, and a bear market in bonds is caused by rising interest rates. Usually occurs when investors are feeling pessimistic about the economy. H. Numerical measures for a Corporation 1. Current Yield: annual interest on a bond divided by the market price. It is the actual income rate of return as opposed to the coupon rate (the two would be equal if the bond were bought at par) or the yield to maturity. Example: A 10% (coupon rate) bond with a face (or par) value of $1000 is bought at a market price of $800. The annual income from the bond is $100. But since only $800 was paid for the bond, the current yield is $100 divided by $800, or 12½%. 2. Price/Earnings Ratio (P/E): price of a stock divided by its earnings per share. The P/E ratio may either use the reported earnings from the latest year (called a trailing P/E) or employ an analyst’s forecast of next year’s earnings (called a forward P/E). In general, low P/E stocks have higher yields than high P/E stocks, which often pay no dividends at all. I. Selling a Stock 1. Total Return: is the calculation that includes the annual dividend as well as any increase or decrease in the original purchase price of the investment. 2. Capital Gains: difference between an asset’s adjusted purchase price and selling price when the difference is positive. Profit from the sale of an asset such as stocks, bonds, or real estate is taxed as income. 3. Capital Loss: amount by which the proceeds from the sale of a capital asset are less than the adjusted cost of acquiring it. Capital losses are deducted first against capital gains, and then against up to $3,000 of other income for married couples filing jointly, and up to $1,500 for married couples filing separately. Any capital losses in excess of $3,000 may be carried over into future tax years.