Garman/Forgue
Personal Finance
Ninth Edition
Chapter 14:
Investing in Stocks
and Bonds
PPT slide program prepared by
Amy Forgue and Ray Forgue.
Learning Objectives
1. Explain how stocks and bonds are
used as investments.
2. Classify common stocks according to
their major characteristics.
3. Describe fundamental and numerical
ways to evaluate stock values.
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Learning Objectives
4. Determine whether an investment’s
potential rate of return is sufficient.
5. Use the Internet to evaluate common stocks
in which to invest.
6. Summarize how stocks are bought and
sold.
7. Describe how to invest in bonds.
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The Role of Stocks and Bonds in
Investments
• Corporation
• Public Corporation
• Startup Capital
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Common Stock
• Stocks
• Cash Dividends
• Market Price
• Shareholder (or Stockholder)
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Common Stock
• Residual Claim
• Limited Liability
• Board of Directors
• Management
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Preferred Stock
• Cumulative Preferred Stock
• Noncumulative Preferred Stock
• Convertible Preferred Stock
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Bonds
• Principal
• Maturity Date
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Dividends and Splits
• How do stock dividends and stock
splits work?
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The Major Characteristics of Common
Stocks
• Match your investment choices using
P/E ratio and Beta.
• Price/Earnings (or P/E) Ratio
– Trailing P/E Ratio
– Projected P/E (or Forward P/E) Ratio
– Earnings Yield
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The Major Characteristics of Common
Stocks
• Use Beta to Compare a Stock to Similar
Investments
– Beta (or Beta Value or Beta Coefficient):
Measure of stock volatility.
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The Major Characteristics of Common
Stocks
• Income Stocks
• Growth Stocks
– Well-known growth stocks
– Lesser-known growth stocks
• Value Stocks
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The Major Characteristics of Common
Stocks
• Value Stocks
• Speculative Stocks
• Tech Stocks
• Blue-Chip Stocks
• Large-cap, Mid-cap, Small-cap, and Microcap
Stocks
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The Major Characteristics of Common
Stocks
• Most stocks are cyclical and some are
countercyclical.
– Cyclical stock
– Countercyclical (or defensive) stock
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How to Evaluate Stock Values
• Use fundamental analysis to evaluate
stocks.
– Fundamental Analysis
– Technical Analysis
• Corporate earnings are most
important.
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How to Evaluate Stock Values
• Earnings per share
• Price/Sales ratio
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Numerical Measures to Evaluate Stock
Prices
•
•
•
•
•
•
•
Cash Dividends
Dividends Per Share
Dividend Payout Ratio
Dividend Yield
Book Value
Book Value Per Share
Price-to-Book Ratio
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About Employee Stock Options
• An employee stock options is a gift,
like a bonus, from an employer to an
employee that allows that allows
employees to benefit from the
appreciation of their employer’s stock
without putting any money down.
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Calculating a Stock’s Potential Rate of
Return
• Alpha Statistic
• Use beta to estimate the risk of the
investment.
• Estimate the market risk (or
systematic risk).
• Calculate your required rate of return.
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Calculate the Stock’s Potential Rate of
Return
• Add up projected income and price
appreciation.
– Potential Rate of Return
– Approximate Compound Yield (or ACY)
• Compare the required rate of return with
the potential rate of return on the
investment.
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How To Use the Internet to Evaluate
and Select Stocks
• Begin by setting criteria for your stock
investments.
• Basic investment information:
– Fool.com
– kiplinger.com/personalfinance/
– money.cnn.com/pf/indes.html
– finance.yahoo.com/marketupdate?u
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How To Use the Internet to Evaluate
and Select Stocks
• Stock-Screening Tools:
– Screen.yahoo.com/stocks.html
– screen.morningstar.com
• Security analysts’ research reports
• Corporate news
– Annual reports, 10-K reports, prospectus
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How To Use the Internet to Evaluate
and Select Stocks
• Stock research firms
• The two most popular firms that offer
stock advisory research services:
– Morningstar
– Value Line
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How To Use the Internet to Evaluate
and Select Stocks
• Economic data
• Stock market data (Securities market
index)
– Dow Jones Industrial Average
– Standard & Poor’s 500 Index
– NASDAQ Composite Index
– Russell 3000 Index
– Wilshire 5000 Index
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How To Use the Internet to Evaluate
and Select Stocks
• Securities exchanges (stock markets)
– Securities Exchange (or Stock Market)
– Over-The-Counter (or OTC) Marketplace
– NASDAQ
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How To Use the Internet to Evaluate
and Select Stocks
• Use portfolio tracking to monitor your
investments:
– E*Trade: us.etrade.com/e/t/home
– MSN Money: moneycentral.msn.com
– Morningstar: morningstar.com
– InvestorGuide.com
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Buying and Selling Stocks
• Stockbroker (or Account Executive)
• Security’s street name
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Buying and Selling Stocks
• Discount, online, and full-service (or
general) brokers
– Many of these use a cash account.
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Buying and Selling Stocks
• Broker commissions and fees
– Round Lots
– Odd Lot
– Differential: The odd-lot portion of the
transaction.
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Buying and Selling Stocks
• How to order stock transactions:
– The process of trading stocks involves a
floor broker and a specialist.
– Securities prices are either matched or
negotiated.
• Negotiated price: bid Price, ask price, spread
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Buying and Selling Stocks
• Types of stock orders (executing an
order):
– Market order
– Limit order
– Stop order (or stop-loss order)
– Time limits: fill-or-kill order, day order,
open (or good-till-canceled [GTC]) order
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Buying and Selling Stocks
• Margin buying and selling short are
risky trading techniques.
• Margin trading is buying stocks on credit
(using a margin account).
– Margin buying
– Margin rate
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Buying and Selling Stocks
• Buying on margin can increase returns.
• Buying on margin can also increase
losses.
• A margin call makes matters even
worse.
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Buying and Selling Stocks
• Selling short is selling stock borrowed
from your broker.
– Buying long
– Selling short
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Investing In Bonds
• Investment-Grade Bonds
• Par (or Face) Value
• Speculative Grade (or Junk) Bonds
• Default Rate
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Investing In Bonds
• Corporate, U.S. government, and
municipal bonds
– Bond rating
– Default (or Credit) risk
• U.S. government bills, notes, and bonds
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Investing In Bonds
• Treasury bills (t-bills), notes, and
bonds
– Discount yield, I-bonds
– TIPS (or Treasury Inflation-Protected
Securities)
– U.S. Government savings bonds
– Series EE savings bonds
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Investing In Bonds
• Federal agency debt issues
• Municipal Government Bonds (or
Munis)
• Tax-Free (or Tax-Exempt) Bonds
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Investing In Bonds
• Unique characteristics of bond investing:
– Coupon rate (or coupon, coupon yield, or
stated interest rate)
– Serial or sinking fund
– Secured bond or unsecured bond
(debenture)
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Investing In Bonds
• Unique characteristics of bond investing:
– Registered and issued
– Book entry
– Callable (call option)
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Evaluating Bond Prices and Returns
• Interest rate risk results in variable
value.
– Market interest rates
– Interest rate risk
– Fixed yield
– Premium
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Evaluating Bond Prices and Returns
• Premiums and discounts
• Current yield
• Yield to maturity
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Six Decisions for Bond Investors
•
•
•
•
•
•
Decide on credit quality.
Decide on maturity.
Determine the after-tax return.
Select the highest yield to maturity.
Consider selling.
Think about investing in bond mutual
funds.
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The Top 3 Financial Missteps of
Investing in Stocks and Bonds
People slip up in investing in stocks and
bonds when they do the following:
1. Seek to invest in just one stock that
promises to make them a lot of
money.
2. Neglect to carefully research
investment choices.
3. Hold onto a lousy investment too
long instead of cutting losses by
selling it.
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Good Money Habits in Investing in
Stocks and Bonds
• Include stocks and bond or mutual
funds that own stocks and bonds in
your investment portfolio.
• Use fundamental analysis to determine
a company’s basic value before
investing in a stock.
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Good Money Habits in Investing in
Stocks and Bonds
•
Resist putting money into so-called hot
stocks.
•
Invest part of the conservative portion
of your portfolio in TIPS to beat
inflation.
•
Use zero-coupon bonds to help fund a
child’s education and your retirement.
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