INVESTING IN

STOCKS AND BONDS

E R S:
O RT IT
RE P E K
K I TP DO
PE U I A
O RQ S
P O NE
M
RA N
A ZO
R LES
O B U EZ
R RIG
D
RO R ON
E
SAB
 CORPORATION- Corporation- is a state-chartered legal entity that can
conduct business operations in it’s own name.

PUBLIC CORPORATION- is one that issues stock purchased by the general

public and trade on stocks markets.

PRIVATELY HELD CORPORATION- is held by a relatively small number of

people and is not traded on a public
stock exchange.

START-UP CAPITAL- funds initially invested in a business enterprise.

 Three types of Securities
\
Securities- negotiable instruments of ownership or dept, including
Common stock, preferred stock, and bonds.

01 COMMON STOCK- most basic form of ownership of a corporation

Stocks- shares of ownership in a business corporation’s assets and earnings.

Investors in common stock usually have two expectations:

in cash, which is usually between
Cash dividends- a share of profits distributed
30 and 70 percent of corporate earnings.

Market price- the current price of a share of stock that a buyer is willing to pay a
willing seller.
Residual claim- common stockholders have a right to share in the income
and assets of a corporation only after higher-priority claims are satisfied

Limited liability- as their responsibility for business losses is limited to the

amount invested in the shares of stock owned.

Board of directors- this group of individuals sets policy and names the
principal officers of the company

Management- who run the firm’s day-to-day operations.

Proxy- shareholder’s written authorization to someone else to represent

them and to vote their shares at a stockholder’s meeting.
 02 PREFERRED STOCK- type of fixed-income ownership security in a
corporation that pays fixed dividends.

Noncumulative preferred stock- the preferred stockholders would have

no claim to previously skipped dividend

03

BOND- is an interest-bearing negotiable certificate of long-term debt

issued by a corporation
 Investors lend the issuer a certain amount of money- the principal
with two expectations

Principal- face amount of a bond

They will receive regular interest payments at a fixed rate of

return for many years.

They will get their principal returned on a specific day in the

future, called the maturity date
Profit- money left over after a firm pays all expenses and
interest to bondholders.

After-tax profit- money left over after a firm has paid

expenses, bondholder interest, and taxes

Retained earnings- money left over after a firm has paid

expenses, bondholder interest, taxes, preferred stockholder
dividends, and common stockholder dividends

Pre-emptive right- right of common stockholders to purchase

additional shares before firm offers new shares to the public.
14.2 HOW TO EVALUATE COMMON STOCKS
INCOME STOCK - a stock that may not grow too quickly, but year after
year pays a cash dividend higher than that offered by most companies.
GROWTH STOCK - the stock of a company that offers the promise of
much higher profits tomorrow and has a consistent record of relatively
-rapid growth in earnings in all economic conditions.
BLUE-CHIP STOCKS - stocks that have been around for a long time
have a well - regarded reputation, dominate its industry, and are known
for being solid, relatively safe investments.
COUNTERCYCLICAL STOCK - the stock of a company whose profits are
greatly influenced by changes in the economic business cycle.
VALUE STOCK - A stock that tends to trade at a low price relative to its
company fundamentals (dividends, earnings, sales, and so on) and thus
is considered undervalued by a value investor.
LARGE-CAP, SMALL CAP, AND MID-CAP STOCKS - A company's size
classification in the stock market is based on market capitalization.
Large caps are those firms valued at or more than $10 billion. Mid-caps
are $ 2 billion to $10 billion. Small caps is $ 300 million to 2 billion.
TECH STOCK - a company in the technology sector that offer
technology - based products and services, biotechnology, internet
services, network services, wireless communications, and more.
SPECULATIVE STOCK - A company that has a potential for substantial earnings at
some time in the future but those earnings may never be realized; betas above 2.0.
Examples : computer graphics firms, internet applications firms, small oil
exploration businesses, genetic engineering firms, and some pharmaceutical
manufacturers.
14.2a USE BETA TO COMPARE A STOCK TO
SIMILAR INVESTMENTS
BETA VALUE (beta coefficient) - A measure of stock volatility; that is,
how much the stock price varies relative to the rest of the market.

14.2b MOST INVESTORS USE FUNDAMENTAL ANALYSIS TO

EVALUATE STOCKS
FUNDAMENTAL ANALYSIS - School of thought s in market analysis that
assumes each stock has an intrinsic (or true) value based on its
expected stream of future earnings.

14.2c SOME INVESTORS USE TECHNICAL ANALYSIS TO

EVALUATE STOCKS
 TECHNICAL ANALYSIS - do not attempt to measure a security's intrinsic
value but instead use charts, graphs, mathematics and software
programs to identify and predict future price movements.

14.2d EVALUATE STOCKS USING CORPORATE EARNINGS

CORPORATE EARNINGS - The profits a company makes during a
specific time period that indicate to many analysts whether to buy or
sell a stock.

EARNINGS PER SHARE (EPS) - A firm’s profit divided by the number of

outstanding shares.

PRICE/ EARNINGS (P/E ratio) - The current market price of a stock

divided by earnings per share (EPS) over the past four quarters; used as
the primary means of valuing a stock.
EARNINGS YIELD - The earnings per share of a stock divided by its
price, and inversion of the price/ earnings ratio helps investors more
clearly see investment expectations.
TRAILING P/E RATIO - Calculated using recently reported earnings,
usually from the previous four quarters.
PROJECTED P/E RATIO (Forward price/ earnings ratio) - Because
investors need to look to the future rather than the past, this measure
divides price by projected earnings over the coming four quarters. Also
known as forward price/earnings ratio.

PEG RATIO (Prices-earnings growth) - A way to rationalize buying a

stock that has high growth is to calculate by dividing the P/E ratio by the
company's projected growth rate.

PRICE/SALES RATIO (P/S ratio) - Tells The number of dollars it takes to

buy a dollar's worth of a company's underwater revenues, calculated by
dividing company's total market capitalization by it sales for the past
four quarters.
BOOK VALUE (shareholder's equity) - Net worth of a company,
determined by subtracting total liabilities from assets.

BOOK VALUE (shareholder's equity) - Net worth of a company,

determined by subtracting total liabilities from assets.

BOOK VALUE PER SHARE - Reflects the book value of a company

divided by the number of shares of common stock outstanding.

PRICE-TO-BOOK RATIO (P/B ratio) - Current stock price divided by the

per-share net value of a firm's plant, equipment, and other assets (book
value).
BOOK VALUE (shareholder's equity) - Net worth of a company,
determined by subtracting total liabilities from assets.

BOOK VALUE (shareholder's equity) - Net worth of a company,

determined by subtracting total liabilities from assets.

BOOK VALUE PER SHARE - Reflects the book value of a company

divided by the number of shares of common stock outstanding.

PRICE-TO-BOOK RATIO (P/B ratio) - Current stock price divided by the

per-share net value of a firm's plant, equipment, and other assets (book
value).
14.2e CALCULATING A STOCKS POTENTIAL RATE OF RETURN IN FIVE
STEPS

1. USE BETA TO ESTIMATE THE RISK OF THE INVESTMENT

2. ESTIMATE THE MARKET RISK
3. CALCULATE YOUR REQUIRED RATE OF RETURN
4. CALCULATE THE STOCK'S POTENTIAL RETURN
5. COMPARE THE REQUIRED RATE OF RETURN WITH THE POTENTIAL
RATE OF RETURN ON THE INVESTMENT
MARKET RISK - also known as systematic risk, is the possibility for an investor
to experience losses due to unknown factors that affects the overall
performance of the financial market

TREASURY BILLS (T-bills) - Known as T-bills, U.S. government securities with

maturities of less than one year.
ESTIMATE OF THE REQUIRED RATE OF RETURN OF AN INVESTMENT - A calculation
that multiplies the beta value of an investment by the estimated market risk and adds
the risk-free T-bill rate that suggests to investors the return required to put their
money at risk.

POTENTIAL RETURN - Determined by adding anticipated income (from dividends,

interest, rents or other sources) to the future value of investment and then
subtracting the investment's origin.
APPROXIMATE COMPOUND YIELD (ACY) - a measure of the annualized
compound growth of any long-term investment stated as a percentage.

14.3 Use the Internet to Evaluate and Select Stocks

14.3a Begin by setting criteria for your stocks investment.

- the process of setting criteria for a stock investment starts with
a review of your investment plan. To make informed selections of
the stock investments that match your investment goals.
Annual report
- Legally required yearly report about financial performance,
activities and prospects sent to major stockholders and made
available to general public

Prospectus
- highly legalistic information presented by a firm to the SEC and
to the public with any new issue of stock
14.3h. Use Stock Analyst Research Reports

- stock analyst working for independent stock advisory firms or

stock brokerages write research reports on companies and
industries. Reports based on fundamental analysis are quite
informative.
14.3i. Read Research Newsletters

- A google search for "stock advisory newsletters" will reveal

dozens of firms that offer guidance on stock selections, market
updates and investment advice.
-www.morningstar.com
-www.valueline.com
-www.marketwatch.com
-www.reuters.com

14.3j. Be aware of economic trends

- to be an effective investor you need to know the stage of

business cycle (recession or prosperity) and the current rates for
interest and inflation. You also need to undesrtand how economic
conditions are likely to change over the next 12-18 months.
14.3k. Pay Attention to Securities market Indexes

Securities Market Index - Measures the average value of a

number of securities chosen as a sample to reflect the behavior
of a more general market.
Dow Jones Industrial Average (DJIA) - The most widely reported
of all stock market indexes that tracks prices of 30 actively traded
blue-chip stocks, including well - known companies such as
American Express and AT&T.

Standard & Poor ' s 500 Index - the popular Standard and Poor ' s
(S&P) 500 index reports price movements of 500 of large,
established, publicly traded firms.
NASDAQ Composite Index & and other Indexes - It provides a
measures of companies not as popular or as large as those traded
on the popular exchanges.

Dow Jones Wilshire 5,000 Index - is a market capitalization-

weighted index of the market value of all stocks actively traded in
the United States.

The Russell 2,000 Index - is a small-cap stock market index of

relatively small capitalized companies and is the most widely
quoted measure of the overall performance of the small-cap to
midcap company shares
14.3l. Securities Exchanges (Stock Markets)

Securities exchange - (also called stock market) is a market where

agents of buyers and sellers can find each other easily by
providing an orderly, open plan to trade securities.

stock split - occurs when the shares of a stock owned by existing

shareholders are divided into a larger number of shares.

OTC or Over-The-Counter Trading Over-The-Counter (OTC) or

off-exchange trading is used to refer to stocks that trade via a
dealer network made over a telephone and computer system
rather than on the floor of a centralized exchange
14.3m. Looking Up a Stock Price
What affects the price of a stock the most is supply and demand.
When more people want to buy, the price goes up. When more
people want to sell, the price goes down.
14.3n. Using Portfolio Tracking to watch your Investments
Watching your investments requires record keeping, particularly
for income tax purposes, although when you sell any securities
your brokerage firm will provide you with sufficient details.
Portfolio tracking - automatically updates the value of your
portfolio after you enter the symbols of the stocks you own and
the number of shares held
 14.4 BUYING AND SELLING STOCKS
Securities transactions require a licensed broker to serve as a
middleman between a seller and the buyer and collect a fee on
each purchase or sale of securities.

STOCKBROKER (also known as an account

executive)
is licensed to buy and sell securities on behalf of the brokerage
firm’s clients. Institutional stockbrokers work with fund managers
and other financial institutions, but there are also retail investors.
OPENING A BROKERAGE ACCOUNT
You will need a brokerage firm to act as your agent to trade securities. You can

open an account at a full-service general brokerage firm or a discount brokerage

firm. The firm charges a commission for any trading it conducts on your behalf.
RULES OF THUMB ON HOW TO INVEST
There are certain things that smart people do when investing
Trust yourself and your intuition
Get my investment goals straight
Be knowledgeable before investing
Be cautious, premeditated, and levelheaded
Decide where you are on risk tolerance
Invest little by little
Start small
Invest on a regular basis
Diversify widely
Learn from any miscalculations
GENERAL (FULL-SERVICE) BROKERAGE
FIRM
Offer a full range of services to customers including investment advice and
research
DISCOUNT BROKERS
Charge commissions to execute trades that are often 30 to 80 percent less than
the fees charged by full-service brokers, but also offers fewer services.

ONLINE DISCOUNT BROKERS

Also called as internet or electronic discount brokers.
 Regulations Help Protect Against
investment fraud
1. Securities and Exchange Commission (SEC) - The SEC is the federal government agency
that focuses on ensuring the disclosure of information about securities to the investing
public and on approving the rules and regulations employed by organized securities
exchanges.
2. Self Regulatory Agencies - The Financial Industry Regulatory Authority (FINRA) and other
self-regulatory organizations, such as New York Stock exchange, enforce standards of
conduct for their members and their member's organizations. They dictate rules for listing
and for trading securities.
3. Brokerage Firms - individual brokerage firms have established standards of conduct for
brokers that govern how they deal with investors
4. Security Investors Protection Corporation (SIPC) - The SIPC is a limited insurance
program to protect the investing public when an SEC-registered brokerage firm fails.
5. Financial Services Oversight Council (FSOC) - The mission of the FSOC is to eliminate
expectations that any American financial firm is “too big to fail” and to respond to emerging
threats to US financial stability.
 BROKER COMMISSIONS AND FEES
Brokerage firms receive a commission on each securities transaction to cover the
direct expenses of executing the transaction and other overhead expenses.

DAY TRADING IS RISKY

Day Trading is speculation in securities, specifically buying and selling financial
instruments within the same trading day with the hope that prices will move
enough to cover transaction costs and earn some profits. Strictly day trading is
trading only within the day, such that all positions are closed before the market
closes for the trading day. Transactions are executed online because they can be
done quickly with low commissions. This type of trading often relies on technical
analysis, looking for short-term price movements, rather than fundamental
analysis looking at underlying value. Day Trading is a risky practice.

Check the background of your stockbroker or

investment advisor
As a customer of a brokerage firm, you should be very careful about who you
trust to safeguard and invest your life savings, as there are many instances where
brokers and brokerage firms violate the rules that are designed to protect the
public investor.
Dividends
The dividend is a reward paid to the shareholders for their investment in a
company’s equity, and it usually originates from the company's net profits.

Capital Gains and Losses

Capital gain is an economic concept defined as the profit earned on the sale of an
asset which has increased in value over the holding period.

INVESTING IN BONDS
While bonds usually offer a lower return to investors than stocks, there are good
reasons to include bonds in one’s portfolio. You should consider investing in bonds if
you wish to receive steady income from a portion of your investments.

Investment- grade bonds

offer investor a reasonable certainty of regularly receiving periodic income (interest)

and retrieving the amount originally invested (principal).

Zero- coupon bonds

Municipal, corporate and Treasury bonds that are issued at a sharp discount from
face value and pay no annual interest but are redeemed at full face value upon
maturity.
Speculative-grade bonds
pay a high interest rate. These are often derisively called junk bonds, and they
are long term, high-risk, high-interest-rate corporate (or municipal) IOUs issued
by companies (or municipalities) with weak or no credit ratings.

Default
Not repaying bond investors.
 Unique Characteristics of Bonds
Coupon rate
The bond’s coupon rate (also known as the coupon, coupon yield, or stated interest rate)
is the interest rate printed on the certificate when the bond is issued. It reflects the total
annual fixed rate of interest that will be paid.
Serial or Sinking Fund
Occasionally bonds rate retired serially. That is, each bond is numbered consecutively
and matures according to prenumbered schedule at stated intervals. These investments
are known as serial bonds. Many bonds include a sinking fund through which money is
set aside with a trustee each year for repayment of the principal portion of the debt.
Secured or Unsecured
A corporation issuing a secured bond pledges specific assets as collateral in the indenture
(written legal agreement between debtor and lenders) the principal and interest guaranteed by
another corporation or a government agency. An unsecured bond does not name collateral as
security for the debt and is backed only by the good faith and reputation of the issuing agency.
Registered and issued
By law, all bonds issue now are registered bonds. This provides for the recording of
the bondholder’s name so that checks or electronic funds transfers for payment of
interest and principal can be safely forwarded when due.
Book Entry
All bonds today are issued in book-entry form, which means that certificates are not
issued. Instead, an account is set up in the name of the issuing organization or the
brokerage firm that sold the bond, and interest is paid into this account when due.
Callable
An issuer might desire to exercise a call option when interest rates drop
substantially.
Corporate bonds
are interest- bearing certificates of long-term debt issued by a corporation. They
represent a needed source of funds for corporations.
Bond rating
Represents the opinion of an outsider on the quality- or creditworthiness of the
issuing organization.
Default risk
Uncertainty associated with not receiving the promised periodic interest payments
and the principal amount when it becomes due at maturity.

14.5b Government Securities

U.S Treasury securities issued by the federal government are the world’s safest
investment because it has never intentionally defaulted on its debt.
Treasury securities
known as the treasuries, securities issued by the U.S government, including bills,
notes, and bonds.
Municipal government bonds (also called munis)
are issued by states, municipalities and local government agencies.
14.5c Evaluating Bond Prices and Returns
Investors can utilize the standard factors to evaluate bond prices and potential
returns: interest rates, premiums and discounts, current yield, and yield to
maturity.
Interest Rate Risk Results in Variable Value
A bond’s price, or its value on any given day is affected by a host of factors.
Market Interest rates
Current long- and short-term interest rates paid on various types of corporate and
government debts that carry similar levels of risk
Long- Term Interest Rates Set by Investors Plus Occasional Fed interventions
Long term rates largely reflect bond investors’ buying and selling decisions,
primarily based on their expectations of future inflation.
14.5d Pricing a Bond in Today’s Market
Interest rate risk- Risk that interest rates will rise and bond prices will fall, thereby
lowering the prices on older bond issues.
Bond premium
A sum of money paid in addition to a regular price.
Bond Prices and Interest Rates Have an Inverse
Relationship
Investors regularly compare the returns on their current investments to what they
could get elsewhere in the market.
Premiums and Discounts
When a bond is first issued, it is sold in one of three ways:
1. As its face value (the value of the bond stated on the certificates and the amount
the investor will receive when the bond matures)
2. A discount below its face value
3 A premium above its face value

Current Yield
Equals the bond’s foxed annual interest payment divided by its bond price.
Yield to Maturity
is the total annual effective rate of return earned by a bondholder on a bond if the
security is held to maturity.