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CHAPTER 11: INVESTMENT PLANNING Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-2 How Can You Get Started Investing? Accumulate money by regularly allocating a portion of your earnings for investing. Take advantage of automatic investment and dividend reinvestment programs. While saving, learn as much as possible about investments and "play" trade. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-3 What are Your Investment Objectives? Supplement current income— appropriate for retired persons. Save for major expenditures— such as college education, down payment on a home, or starting a business. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-4 Save for retirement—to live comfortably in your "golden years." Shelter income from taxes—to preserve more of your earnings. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-5 Different Ways to Invest Common Stock Bonds Preferreds and Convertibles Mutual Funds Real Estate Commodities, Financial Futures, and Options Copyright 2002 by Harcourt, Inc. All rights reserved. 11-6 Securities Markets Place (not always physical) where financial instruments are traded. Capital market—where long-term securities (those with maturities greater than 1 year) are traded. Money market—where low-risk, shortterm securities (those with maturities less than 1 year) are traded. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-7 Primary market—for new issues which are available for the very first time. The issuing company gets the proceeds. Secondary market—for trading previously issued securities. Trading is done between investors; issuing company gets nothing. Copyright 2002 by Harcourt, Inc. All rights reserved. Organized Securities Exchanges 11-8 – Secondary markets for trading listed securities. – Physical marketplaces such as the NYSE, AMEX, and regional exchanges. – Utilize brokers to facilitate trading between buyers and sellers. – Handle transactions of larger, wellknown companies' securities. Copyright 2002 by Harcourt, Inc. All rights reserved. Over-the-counter Market 11-9 – Secondary market where securities are traded via a telecommunications network. – Investors trade directly with securities dealers. – Larger, actively traded issues make up NASDAQ, while smaller, thinly traded issues are listed on "pink sheets." Copyright 2002 by Harcourt, Inc. All rights reserved. Foreign securities markets 11-10 – Organized securities exchanges exist in more than 100 countries worldwide. – Found in major industrialized nations such as Japan, Great Britain, Germany and Canada. – Also found in developing markets around the globe. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-11 Regulating the Securities Markets: Federal and state laws regulate the sale of securities. Purpose is to provide for adequate and accurate disclosure of financial information. Securities and Exchange Commission (SEC) is the agency in charge of administering federal securities laws. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-12 Market Trends: Bull market—generally rising securities prices for an extended period of time. – Reflects investor optimism. – Associated with favorable economy. Bear market—generally falling securities prices for an extended period of time. – Reflects investor pessimism. – Associated with economic downturn. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-13 Making Transactions In the Securities Markets Stockbrokers purchase and sell securities for investors. Select from full-service, discount, or online broker, depending on your needs. Consider brokerage fees when making securities transactions. Copyright 2002 by Harcourt, Inc. All rights reserved. Investor Protection: 11-14 Securities Investor Protection Corp. protects customer accounts against financial failure of brokerage firm. SIPC insures accounts up to $500,000 (brokerage firms often purchase even greater amounts of coverage). Guarantees securities or cash held by broker will be replaced (does not guarantee dollar value of securities!). Copyright 2002 by Harcourt, Inc. All rights reserved. 11-15 Executing Trades: Market orders generally take less than 2 minutes! Investor must first establish account with broker. Trades can be executed by phone, at the brokerage firm, or online with a PC. Copyright 2002 by Harcourt, Inc. All rights reserved. Investor places the order with the broker Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-16 Investor places the order with the broker Broker transmits order to the market via telecommunications equipment. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-17 Investor places the order with the broker Broker transmits order to the market via telecommunications equipment. Order is filled at the market by other buyers and sellers. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-18 Investor places the order with the broker Broker transmits order to the market via telecommunications equipment. Execution of the order is confirmed to the broker. Order is filled at the market by other buyers and sellers. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-19 Investor places the order with the broker Broker confirms order fulfillment. Investor has 3 days to settle account. Execution of the order is confirmed to the broker. Broker transmits order to the market via telecommunications equipment. Order is filled at the market by other buyers and sellers. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-20 11-21 Types of Orders: Market order—trade now at best available price. Limit order—trade when a specified price or better is reached; investor is seeking opportunity. Stop-loss order—sell if price drops to certain price; investor is seeking to limit losses. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-22 Margin Trading: Allows investor to purchase securities on credit by borrowing part of purchase price from broker. Increases gains when returns are positive. Increases losses when returns are negative. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. Example of Margin Trade with Profit: 11-23 Transaction w/out w/margin Initial investment (100 shares @ $50) Amount invested $5,000 $2,500 Amount borrowed $ 0 $2,500 Total purchase $5,000 $5,000 Price INCREASES (100 shares @ $70) Gross proceeds $7,000 $7,000 Less interest (9%) $ 0 $ 225 Net proceeds $7,000 $6,775 Net profit $2,000 $1,775 Copyright 2002 by Harcourt, Inc. All rights reserved. Example of Margin Trade with Loss: 11-24 Transaction w/out w/margin Initial investment (100 shares @ $50) Amount invested $5,000 $2,500 Amount borrowed $ 0 $2,500 Total purchase $5,000 $5,000 Price DECREASES (100 shares @ $30) Gross proceeds $3,000 $3,000 Less interest (9%) $ 0 $ 225 Net proceeds $3,000 $2,775 Net loss ($2,000) ($2,225) Copyright 2002 by Harcourt, Inc. All rights reserved. Margin Trade Returns: 11-25 Return = Profit (loss) Amount Invested Price Increase Return Price Decrease Return w/out $2,000 $5,000 40% w/margin $1,775 $2,500 71% ($2,000) ($2,225) $5,000 $2,500 (40%) (89%) Copyright 2002 by Harcourt, Inc. All rights reserved. Short Selling: 11-26 Allows investor to sell securities borrowed from the broker or broker's accounts. Before period is over, investor must buy securities to replace those borrowed. Investor profits if security’s price has declined. Investor loses if security’s price has increased. Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-27 Example of Short Sale: Investor wishes to short 100 shares of ABW now selling at $52.50/share. Broker sells borrowed shares for investor: 100 x $52.50 = $5,250 proceeds Copyright 2002 by Harcourt, Inc. All rights reserved. 11-28 Scenario A: Price of security drops to $40/share & investor repurchases: Costs 100 x $40 = $4000 to replace shares. Investor receives: $5250 – $4000 = $1250 profit!! Copyright 2002 by Harcourt, Inc. All rights reserved. 11-29 Scenario B: Price of security rises to $60/share & investor repurchases: Costs 100 x $60 = $6000 to replace shares. Investor receives: $5250 – $6000 = ($750) loss!! Copyright 2002 by Harcourt, Inc. All rights reserved. 11-30 To profit from short selling— not only must the price of the security fall, but it must do so within the given time period. Double jeopardy! Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-31 Becoming an Informed Investor Types of Information to Follow: – Economic developments and current events – Alternative investment vehicles – Current interest rates and price quotations – Personal investment strategies Copyright 2002 by Harcourt, Inc. All rights reserved. 11-32 Available Investment Information : Annual Reports Financial Press (WSJ and financial magazines) Brokerage Reports Advisory Services Investment Advisors On-Line Sources Copyright 2002 by Harcourt, Inc. All rights reserved. 11-33 Online Investing Online services Educational material Investment tools Investment planning Research and screening Portfolio tracking Day trading Copyright 2002 by Harcourt, Inc. All rights reserved. Clip Art 2001 Microsoft Corporation. All rights reserved. 11-34 Using the Internet Wisely: Do your own research. Realize that frequent trades mean higher transaction costs. Don’t believe everything you read. Avoid online scams. Copyright 2002 by Harcourt, Inc. All rights reserved. 11-35 Questions to Ask: Is the stock registered? Who is making the sales pitch? Is it too good to be true? Refer to SEC Web site: www.sec.gov/consumer/offertip.htm Copyright 2002 by Harcourt, Inc. All rights reserved. 11-36 Managing Your Investment Holdings Build a diversified portfolio of securities based upon your goals and personal situation. Allocate your assets according to your objectives. Track your investments and rebalance your portfolio as your needs change. Copyright 2002 by Harcourt, Inc. All rights reserved. THE END! Copyright 2002 by Harcourt, Inc. All rights reserved.