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Transcript
Stock Terminology (continued) • Investors make money in stocks in two ways: – Dividends • Companies may make payment to shareholders as part of the profits. Different types of companies have different dividend policies, which may change over time – Capital Gains (CG) • Investors purchase shares in companies with the expectation that the price of the shares will increase. This increase in share 4 Stock Terminology (continued) • General Classifications of Common Stock – Blue-chip stocks • Stocks of the largest and best managed firms. This is not a specific list, but changes over time – Growth stocks • Companies which are growing faster than average and which generally reinvest dividends. They generally have higher PE and PB ratios than the market as a whole – Value stocks 5 Stock Terminology (continued) • Income stocks – Companies which pay dividends regularly • Cyclical stocks – Companies whose share prices move up and down with the state of the economy • Defensive stocks – Companies whose share prices move opposite to the state of the economy 6 D. Why Stocks Fluctuate in Value? • Why do stocks change in value? – There are many different reasons why stocks fluctuate in value. A few of the more common reasons are due to changes in: • Interest rates • Perceived risk of the company • Expected company earnings, dividends, and cash flow • Supply and demand • Investor sentiment and the market 8 Why Stocks Fluctuate in Value (continued) • Interest rates – Investors require a certain “expected return” or discount rate to invest in stocks. A major component of this discount rate is interest rates • As interest rates decrease, shareholder’s discount rate also decreases (which is tied to interest rates), and future earnings are discounted by this lower rate, increasing the value of the firm • As interest rates increase, shareholders require a higher discount rate, with all 10 Why Stocks Fluctuate in Value (continued) • Perceived Risk of the Company – There is an inverse relationship between perceived risk of the firm and price • As the perceived riskiness of a firm decreases, investors are willing to pay more for the company stock, resulting in an increase in stock price • As the perceived riskiness of a firm increases, investors are willing to pay less for the stock, resulting in a decrease in stock price 12 Why Stocks Fluctuate in Value (continued) • Expected Earnings, dividends, and cash flow – As earnings, dividends, and cash flow per share increase beyond what was expected, generally investors are willing to pay more for the stock, and the stock price increases – As earnings, dividends, and cash flow per share decreases beyond what was expected by the market, investors are less willing to pay for the stock, and 14 Why Stocks Fluctuate in Value (continued) • Supply and demand – Stock prices may rise or fall based on supply and demand for their shares • If a large shareholder needs to sell shares of a stock to meet cash needs, supply increases and the price is likely to decline • Likewise, if a large investor gets new money into their account, and decides to increase their holding in the stock, the price of that stock will likely rise as the investor must pay a higher price to encourage others to sell the stock 16 Why Stocks Fluctuate in Value (continued) • Investor sentiment and the market – Stock prices may rise or fall based on general investor sentiment and how the overall market is performing • If investors are generally positive on stocks, and the market is performing well, investors will likely bid up the price of all stocks • If investors sentiment is negative, and the market is performing poorly, investors will likely reduce their willingness to purchase the stock, resulting in a lower stock price 18 B. Major Types of Mutual Funds • What are the major types of Mutual funds? – The types of mutual funds generally follow the major asset classes • Money market , stock, and bond mutual funds – Others specialty funds • • • • Index funds Exchange Traded Funds (ETFs) Balanced funds Asset allocation funds Types of Mutual Funds (continued) • Money market mutual funds – Money market mutual funds are funds which invest the majority of their assets in short-term liquid financial instruments such as commercial paper and government treasury bills • Their goal is to obtain a higher return, after fees and expenses, than traditional bank savings or checking accounts Types of Mutual Funds (continued) • Stock mutual funds – Stock mutual funds are funds which invest a majority of their assets in common stocks of listed companies – These funds generally have a specific objective, i.e. “large-cap,” “small-cap”, “value,” “growth,”, etc. which relates to the types of stocks the mutual fund invests in • Their goal is either to outperform their relative benchmarks or to have a consistently high total return Types of Mutual Funds (continued) • Bond mutual funds – Bond mutual funds are funds which invest a majority of their assets in bonds of specific types of companies or institutions – These funds generally have a specific objective, i.e. “corporate,” “government”, “municipals,” “growth,”, etc. which relates to the types of bonds the mutual fund invests in – In addition, most have a specific maturity objective as well, which relates to the average maturity of the bonds in the mutual fund’s portfolio • Their goal is to generally outperform their relative benchmarks Types of Mutual Funds (continued) • Index funds (822 as of 3/3/2010 – Morningstar) – Index funds are mutual funds designed to match the returns of a specific index or benchmark – Index funds can track many different benchmarks, including the S&P500 (Large-cap stocks), Russell 5000 (smallcap stocks), MSCI EAFE (international stocks), Lehman Aggregate (corporate bonds), DJ REIT (Real estate investment trusts), etc. Types of Mutual Funds (continued) • Balanced funds – Balanced funds are mutual funds which purchases both stocks and bonds generally in a specific percentage or relationship, i.e. 60% stocks and 40% bonds. – Their benefit is that they perform the asset allocation, stock selection, and rebalancing decision for the investor in the fund. • Their goal is to exceed the return of their percentage-weighted relative benchmarks Types of Mutual Funds (continued) • Asset allocation funds – Asset allocation funds are mutual funds which rotate among stocks, bonds, and cash – Asset allocation funds invest the fund’s assets in the asset classes expected to perform the best over the coming period of time • Their goal is to exceed the return of their percentage-weighted relative benchmarks after costs and fees Types of Mutual Funds (continued) • Life-cycle funds – Life cycle funds are funds which change their allocation between stocks and bonds depending on the age of the investor – As an investor ages, life cycle funds reduce their allocation to stocks and increase their allocation to bonds, more consistent with the goals and objectives of an older investor – These funds seek to perform the asset allocation decision normally done by the investor and to reduce transaction costs as well • Their goal is to exceed the return of their percentage-weighted relative benchmarks after costs and fees