Transcript Stocks, Bonds, Options

ECONOMICS
What Does It Mean To Me?
The Financial System
STOCKS, BONDS, MUTUAL
FUNDS & OPTIONS
CONTENT
Introduction to Stocks
a) Terminology
b) Shorting a stock
Bonds & Other Financial Markets
a) Terminology
b) Who Issues Bonds?
c) Reading stock indexes
c) Bond Ratings
d) Stock Exchanges
d) Options
e) Dow Jones Average
e) Mutual Funds
f) Stock Market Crashes
g) World Stock Markets
f) Financial
Intermediaries
Considerations/Selecting a Stock
a)Analysis Terms
b) Firm Numbers
c) Industry Considerations
d) The Economy
The Financial System
The financial system consists of the group of
institutions in the economy that help to
match one person’s saving with another
person’s investment.
It moves the economy’s scarce resources
from savers to borrowers.
FINANCIAL INSTITUTIONS
IN THE U.S. ECONOMY
The financial system is made up of financial
institutions that coordinate the actions of
savers and borrowers.
Financial institutions can be grouped into
two different categories: financial markets
and financial intermediaries.
FINANCIAL INSTITUTIONS IN
THE U.S. ECONOMY
Financial Markets


Stock Market
Bond Market
Financial Intermediaries


Banks
Mutual Funds
FINANCIAL INSTITUTIONS IN
THE U.S. ECONOMY
Financial markets are the institutions
through which savers can directly provide
funds to borrowers.
Financial intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers.
Corporation:
A legal entity that can
conduct business in its
own name in the same
way that an individual
does and that is owned
by stockholders.
Financial Markets
The Stock Market



Stock represents a claim to partial ownership in a
firm and a claim to the profits that the firm makes.
The sale of stock to raise money is called equity
financing.
 Compared to bonds, stocks offer both higher
risk and potentially higher returns.
The most important stock exchanges in the United
States are the New York Stock Exchange, the
American Stock Exchange, and NASDAQ.
 Share of stock- represents ownership
in a corporation or a
claim on the assets of a
corporation.
Dividends -optional
payments of
annual profits to
stockholders.
Growth Stock -stock where the
dividends are
reinvested into the
stock.
Initial Public Offering (IPO)
--when stock is initially
offered to the public.
ADVANTAGES OF A CORPORATION
•Stockholders are not personally liable for
the debts of the corporation; they have
limited liability.
•Corporations continue to exist even if
one or more owners of the corporation
sell their shares or die.
•Corporations are usually able to raise
large sums of money by selling stock.
DISADVANTAGES OF CORPORATIONS
•Corporations are subject to double
taxation. (corporate income tax and
personal income tax)
•Corporations are difficult to set up.
What do the following companies
have in common?
Kraft Foods
Lender’s Bagels
County Line
Tang
Cool Whip
Oscar Mayer
Jell-O
Minute Rice
Stove Top
Breyers Ice
Cream
Breakstone Sour
Cream
Philadelphia Cream
Cheese
Cracker Barrel
Maxwell House
Crystal Light
Caprice
Tombstone Pizza
Toasties
Del Monte
Light-n-Lively
Sanka
Kool-Aid
Raisin Bran
Louis Rich
Miracle Whip
Log Cabin
Lowenbrau
Miller Beer
Shake-n-Bake
ANSWER:
ALTRIA
(PHILIP MORRIS)
Stock Symbol: MO
More than 10% of the food items that tumble down
the world’s supermarket check-out lines carry the
Philip Morris seal. Formally, Philip Morris is a
holding company whose principal wholly owned
subsidiaries are: Philip Morris USA, Philip Morris
International, Kraft Foods, Miller Brewing, and Philip
Morris Capital.
CABLE HOLDINGS OF THE BIG NETWORKS
VIACOM <VIA> (CBS)
MTV
VH1
BET
Nickelodeon
TV Land
DISNEY <DIS> (ABC)
ESPN
ESPN2
ESPN Classic
Disney Channel
Family Channel
Showtime
Movie Channel
Country Music TV
Comedy Central (50%)
UPN
Soapnet
Toon Disney
TimeWarner <TWX>
Liberty Media <L>
Cox Commun. <COX>
DSC
Animal Planet
DSC Health
Travel Channel
DSC Kids
BBC America
TLC
USA
TNT
CNN
HBO
TBS
America Online
WB
GE <GE> (NBC)
CNBC
MSNBC (50%)
A & E (partial)
History Channel
National Geographic
(partial)
Bravo
Liberty Media (part)
NEWS CORP <NWS> (FOX)
Fox Movie Channel
Fox News
Fox Sports
FX
National Geographic
(partial)
STAR
FUEL
DirectTV
Stock split -- when a stock’s
high price is discouraging
new investors, the company
splits the stock to a lower
price; thus creating more
shares at a lower price.
For example:
100 shares at $50 per
share equals
200 shares at $25 per
share
Would you invest in this company?
Microsoft Corporation 1978
History of Microsoft Stock Splits
Symbol: MSFT
IPO: March 13, 1986
Last updated: August 18, 1998
First
Sep 21, 1987
2 for 1
Second
Apr 16, 1990
2 for 1
Third
Jun 27,1991
3 for 2
Fourth
Jun 15, 1992
3 for 2
Fifth
May 23, 1994
2 for 1
Sixth
Dec 9, 1996
2 for 1
Seventh
Feb 23, 1998
2 for 1
Sep 18 = 114.50
Sep 21 = 53.50
Apr 12 = 120.75
Apr 16 = 60.75
Jun 26 = 100.75
Jun 27 = 68.00
Jun 12 = 112.50
Jun 15 = 75.75
May 20 = 97.75
May 23 = 50.63
Dec 6 = 152.875
Dec 9 = 81.75
Feb 20 = 155.13
Feb 23 = 81.63
History of Microsoft Stock Splits
IPO: March 13, 1986
First
Last updated:
Sep 21, 1987
2 for 1
Second Apr 16, 1990
2 for 1
Third
Jun 27,1991
3 for 2
Fourth Jun 15, 1992
3 for 2
Fifth
May 23, 1994
2 for 1
Sixth
Dec 9, 1996
2 for 1
SeventhFeb 23, 1998 2 for 1
Symbol: MSFT
August 18, 1998
Sep 18 = 114.50
Sep 21 = 53.50
Apr 12 = 120.75
Apr 16 = 60.75
Jun 26 = 100.75
Jun 27 = 68.00
Jun 12 = 112.50
Jun 15 = 75.75
May 20 = 97.75
May 23 = 50.63
Dec 6 = 152.875
Dec 9 = 81.75
Feb 20 = 155.13
Feb 23 = 81.63
2 shares =
$107.00
4 shares =
$243.00
6 shares =
$408.00
9 shares =
$681.75
18 shares =
$910.74
36 shares =
$2943.00
72 shares =
$5877.36
What does it
mean to SHORT
the stock?
Shorting stocks is a method of
gambling on a stock whose price
you think will decline.
Instead of purchasing shares of a
stock you think is going up in
price, you instead borrow shares,
sell them immediately, wait for the
price to go down, and then buy
them back at the lower price and
return the shares to the broker.
The advantage of shorting stocks
is that you can make a profit
without an initial cash investment.
For example, suppose you think
the price of NOPE stock is going
down from its current price of
$32.
You tell your broker that you
want to short 200 shares of
NOPE stock. (You must have a
margin account to short stocks.)
Your broker then borrows 200
shares of NOPE and sells them
for you, depositing $6400 in your
account.
Now you hope the price goes
down because eventually, you
need to return the 200 borrowed
shares to your broker.
Suppose the price goes down to
$25. You can now buy the 200
shares of NOPE for $5000, return
the 200 shares to your broker, and
pocket the $1400 profit.
($6400 - $5000) minus the commission.
You have now made money
without an initial cash investment.
However, shorting stocks is
considered riskier than buying
stocks because the price of the
stock could go UP an unlimited
amount, resulting in unlimited
losses.
At some point you need to buy
the shares you borrowed to short
the stock.
For example, if the price of NOPE
goes up to $40, you would have to
pay $8000 to buy the 200 shares
owed to your broker.
In this case, you would lose $1600
($8000 - $6400) plus the commission
Buying your shares back and returning
them to the broker is called covering a
short.
When an investor sells a stock for
profit, it is called a CAPITAL GAIN.
A capital gain is the difference
between an asset’s purchase
price and its’ selling price
when the amount is positive.
Because shorting stocks
involves unlimited risk, the SEC
has special regulations requiring
brokers to issue a margin call
when an investor’s losses reach
a certain point.
MARGIN is the amount of money a
customer deposits with a broker when
borrowing from the broker for securities.
Example: If a broker has a 50%
margin requirement and the customer
sells short 100 shares of XYZ at $50 a
share, how much equity must be
maintained in the margin account?
ANSWER: $2500
Reading Stock
Indexes
Originally, prices were read in fraction
form per share of stock:
Historical Note:
The Spanish
practice of
dividing the
silver dollar into
eighths was
largely
responsible for
the prevalence
of fractions when
describing stock
values.










1/64= .0156
1/32 = .03
1/16 = .06
1/8 = .125
1/4 = .25
3/8 = .38
1/2 = .50
5/8 = .63
3/4 = .75
7/8 = .88
However, since
September
2000, all stock
exchanges
converted
stock prices to
decimal format.

The stocks listed are common stocks
unless indicated otherwise. For
example “pf” indicates a preferred
stock.

The numbers to the left of the name of the
corporation show the highest and lowest price
at which the stock has traded during the
previous 52 weeks.

The symbol column lists the stock’s
ticker symbol.

The dividend column shows the current level
of dividends that will be paid over one year to
the owner of one share of stock. A dividend is
the annual payment per share of a stock
designated by a company for its stockholders.

The dividend yield shows the dividend
as a percentage of stock closing price.

The PE column lists the price/earnings ratio, which is
the price of a share of stock divided by the
company’s earnings (profits) per share of stock for
the last 12-month period.

The column marked volume lists
the number of shares traded (in
hundreds) during that day.

The hi, lo, and close columns show the
range of prices at which the stock
traded during the day. The closing price
is the price for the last transaction of the
day.

The net change column shows the
change between this closing price
and the closing price the previous
trading day.
STOCK
EXCHANGES
Three U.S. stock exchanges are:
1) NYSE --The New York Stock Exchange.



Started with “Buttonwood Agreement” in 1792
Founded in 1817
Home to Dow Jones Industrial Average
2) AMEX --The American Exchange.
Founded in 1920s
3) NASDAQ --National Assn. Of Security
Dealers Automated Quotation
•Founded in 1976
•Completely computerized quotations--no
exchange floor
Regional Stock Exchanges
San Francisco
Los Angeles
Chicago *
Cincinnati
Boston
Philadelphia
*
The term "seat" is now
synonymous with a membership
on the NYSE.
NYSE memberships can be
purchased and sold. The all time
high price paid for an NYSE
membership was $2,650,000 on
August 23, 1999. The lowest price
ever paid was $4,000 in 1876 and
again in 1878.
What is the origin of the term "Blue
Chip Stock"?
This phrase first dates back to 1904 and has
its origin from the blue, i.e., highest
denomination chips used in gambling. Today,
Blue Chip stocks are thought of as being the
most stable and safe investments available.
However, when the expression was first used,
investors were evidently aware of the
similarities between gambling and investing.
The Dow Jones Average
was started by Charles H.
Dow and Edward Jones at
a time when the stock
market was not highly
regarded. He began
testing his Average in
1884 with 11 stocks, most
of them railroads, which
were the first great
national corporations. In
the spring of 1896, he
introduced the 12-stock
average to the nation.
Charles Dow
1852-1902
The original 12 stocks on the Dow Jones
Average were:
American Cotton Oil
American Sugar
American Tobacco
Chicago Gas
Distilling & Cattle
Feeding
General Electric
Laclede Gas
National Lead
North American
Tennessee Coal & Iron
US Leather preferred
US Rubber
In the autumn of 1896, he
dropped the last non-railroad
stock from the original average
and made the 20-stock railroad
average. Today, this is called
the TRANSPORTATION
AVERAGE.
In 1916, the Dow Jones
industrial average was
increased to 20 stocks and on
October 1, 1928, it was
expanded to 30--the number of
stocks comprising the average
ever since.
Currently, the 30 stocks on the Dow
Jones Industrial Average are:
3M
Exxon/Mobil
Alcoa
General Electric
Altria (MO)
General Motors
Merck & Co.
American Express
Hewlett Packard
Microsoft Corp
American Int’l Group
Home Depot
Pfizer
Proctor & Gamble
Boeing
Honeywell
International
Caterpillar
IBM
Citigroup
Intel
Verizon
Communications
Coca-Cola
Johnson & Johnson
Wal Mart
Disney
JP Morgan Chase
Dupont
McDonalds
AT & T
United Technologies
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
1884
The Dow Jones Industrial
Average opened at 40 in the
year 1884
By 1920, the index had
reached 100
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
On September 3, 1929, the
index reached a high of 381.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
October 28, 1929, the Dow fell 38
points (down 12.8%) and on
October 29, 1929, it fell 30 points
(down 11.7%) to close at 230. This
was a 2-day percentage loss of
24.5%
By July 8, 1932, the Dow
closed at 41.
So…………..
11000
10000
9000
How long did it take the Dow to
reclaim it’s all time high of 381 ??
8000
7000
6000
5000
The answer : 1954
(22 years)
4000
3000
2000
1000
WHY?
What year did it reach 1000?
11000
10000
9000
8000
The answer : 1972
(18 years)
7000
6000
5000
4000
3000
2000
1000
WHY?
By January of 1987, the Dow
reached 2000.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
Then on October 19, 1987, the
Dow went from 2240 to 1738. It
lost 507 points in its largest
EVER one day percentage loss
of 22.6%.
In 1991, the Dow reached 3000.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
In 1995, it hit 4000 in February
and 5000 in November.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
In 1996, the Dow reached 6000.
In 1997, it hit 7000 in February
and 8000 in July.
In 1998, the Dow reached 9000.
In 1999, it hit 10000 in March and 11000 in May.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
It finally reached a high of 11,722 in January 2000.
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
Can you see why Alan Greenspan called the
ninties a period of “irrational exuberance?”
11000
10000
9000
8000
7000
6000
5000
4000
3000
2000
1000
The following is a chart of the Dow (1900-present) as compared to
the inflation adjusted Dow (1925-present).
A
prolonged
period of
rising
stock
prices is
called a
BULL
MARKET.
A
prolonged
period of
falling
stock
prices is
called a
BEAR
MARKET.
How many stock
market crashes
have there been?
The largest single day market sell-off
occurred on October 19, 1987 (Black
Monday) when the Dow Jones Industrial
Average fell 22.6%.
The 1929 market crash actually occurred
over a two-day period, when the Dow
Jones Industrial Average fell 12.8% on
October 28, 1929 and 11.7% on October
29, 1929.
The largest one-day point drop occurred
on October 27, 1997 when the Dow lost
554.26 points (7.18%).
A BEAR MARKET is defined as a prolonged
decline in stock prices, e.g., greater than a 30%
decline over a 50-day trading period.
There were 30 bear markets in the 20th century.
The worst ran from September 3, 1929 to July 8,
1932, when the Dow lost 89.1%. It took over 20
years for the Dow to trade above its pre-crash
levels.
The worst bear market in the 21st century ran
from March 10, 2000 to October 9, 2002. During
this period, the Nasdaq Composite Index lost
77.9%. At current levels, the Nasdaq Composite
is trading 70% below its all-time high.
THE GREAT CRASH:
What Happened?
1925: value of all stocks= $27b
1929: value of all stocks= $87b
(rising $11.4b in 1928 alone)
*relatively small number of companies and people held
much of the nation’s wealth
**farmers and workers were suffering
***ordinary people went into debt buying consumer goods
such as refrigerators and radios on credit.
****industries were producing more goods than consumers
could buy, developing large surpluses. (ie, Autos)
Additionally, investors were going into debt
investing in the stock market. The incredible
climb of the stock market encouraged
SPECULATION, the practice of borrowing
money to invest in high-risk investments hoping
for a big return.
Small investors began using life savings to buy
stocks. To encourage the less-wealthy,
stockbrokers invented the practice of BUYING
ON MARGIN, which allowed people to buy
stocks for a fraction of the cost and borrow the
rest from the brokerage.
*On September 3, 1929, the
Dow reached an all time high of
381. After the prices began to
fall, some brokers demanded
repayment of loans.
*When the market opened on
October 23, 1929, the Dow had
dropped 21 points in an hour.
*Worried investors began to sell and prices fell further.
*By Monday, October 28, 1929, stocks were selling for a fraction of what
people had paid for them.
*On October 29, 1929, known as BLACK TUESDAY, a record 16.4 million
shares were sold.
The GREAT CRASH had begun. . . . . .
In 1932, President Roosevelt
created reform measures in
response to the crash of 1929. He
formed the
SECURITIES AND
EXCHANGE COMMISSION
to regulate the stock market.
In charge of the SEC, he placed
Joseph Patrick Kennedy, the father
of President John F. Kennedy.
WORLD
STOCK
MARKETS
World Stock Markets
 Stock
trading goes on
around the world, around
the clock, in an electronic
global marketplace.
Indexes --major stock exchanges
around the globe express stock
performance as indexes, which
are statistical composits.





U.S. Dow Jones Industrial Average
Tokyo Average
London FT 30-share
Frankfurt FAZ
Paris Cac-40
BONDS and other
FINANCIAL
MARKETS
Financial Markets
The Bond Market
 A bond is a certificate of indebtedness that
IOU
specifies obligations of the borrower to
the holder of the bond.
 Characteristics of a Bond
 Term: The length of time until the bond
matures.
 Credit Risk: The probability that the borrower
will fail to pay some of the interest or principal.
 Tax Treatment: The way in which the tax laws
treat the interest on the bond.
 Municipal bonds are federal tax exempt.
Bonds
 Investor
loans money to a
government, municipality or
corporation (borrower gets
needed cash and lender
earns interest)
Bonds allow expansion
and help create jobs.
Maturity -- time when loan expires or is
due.
Coupon Rate -- percentage of par value paid in interest
to bondholder on a regular basis.
Par Value -- amount that an investor
pays to purchase the bond and that will
be replaced to the investor at maturity.
WHO ISSUES
BONDS?
Who issues bonds?
Corporations
-- to raise
money for
expansion
and
operations.
Who issues bonds?
Municipalities
and local
governments
-- for schools,
highways,
stadiums, etc.
Who issues bonds?
Government agencies -- for
home mortgage
associations, Federal
Housing Administration
(FHA)
Who issues bonds?
Foreign governments and
corporations -- as a primary way to
raise capital.
Who issues bonds?
Federal Government -in the form of SAVINGS
BONDS, which are lowdenomination bonds in
amounts of $50 to $10,000.
Who issues bonds?
and the
United States Treasury
Department -- for federally
funded programs. These are
issued in the form of
Treasury Bills, Treasury
Notes, and Treasury Bonds.
What is the difference between the
Treasury Bill, Treasury Bond and
Treasury Note?
Treasury Bond
Treasury Note
Term
long-term
intermediate
Maturity
10 to 30 years
2 to 10 years
Liquidity &
Safety
safe
safe
Minimum
purchase
$1,000
$1,000
Denomination
$1,000
$1,000
Treasury Bill
short-term
3, 6, or 12 months
liquid & safe
$1,000
$1,000
BOND RATINGS
B
o
n
d
R
a
t
i
n
g
s
Moody’s
Aaa
Aa
A
Baa
Ba
B
Caa
Ca
Standard
& Poors
AAA
AA
A
BBB
BB
B
CCC
CC
C
C
__
D
Meaning
Best qualit y, with the smallest
risk, issuers are exceptionally
stable and dependable.
High qualit y, with a sligh tly
higher degree of lon g-term ri sk.
High-to-medium qualit y, with
many strong attributes but
somewh at vulnerable to
changing economic con ditions
Medium qualit y, currently
adequate but perhaps un relia ble
over the lon g term.
INVESTMENT
GRADE
BONDS
Some speculative element with
moderate security, but not well
safeguarded.
Able to pay now but at ris k of
default in t he fu ture.
Poo r quality, clear danger of
default .
Highly speculative qualit y, often
in default.
Lowest rated, poor prospect of
repayment, though m ay still be
paying.
In default.
JUNK
BONDS
B
O
N
D
S
NOTE: Junk Bonds have been known to have interest rates as high
as 12% at a time when government bonds were only 8%.
BUYING BONDS AT A DISCOUNT
Suppose Al buys a $1000 bond with a coupon rate of
5 percent. The person who buys the bond (Al) is
called the “holder,” while the seller of the bond is
called the “issuer.”
Interest rates go up to 6 percent, and Al needs to sell
the bond. (noone wants to buy a 5 percent bond
when the interest rate is 6 percent)
Al offers to sell the bond to Patsy “at a discount” for
$950--taking $50 off the $1000 value of the bond.
Patsy now owns a par value $1000 bond for $950.
FINANCIAL MARKETS
Markets in which money is lent for periods
longer than one year are called CAPITAL
MARKETS.
When money is lent for less than one year, it
is called a MONEY MARKET. Money market
investments are NOT insured by FDIC
(Federal Deposit Insurance Corporation).
FINANCIAL MARKETS
Financial assets that can only be redeemed
by the original holder are sold on a PRIMARY
MARKET. (ex: savings bonds, small CDs)
Financial assets that can be resold are sold
on SECONDARY MARKET. This option for
resale provides liquidity to investors.
**For example: if the mortgage on a house does not meet
the banks’ criteria for sale on the secondary market, the
borrower may have to pay a higher interest rate for their
mortgage.
MUTUAL
FUNDS
What Is A Mutual Fund?
Company “A”
$
$
Company “B”
Company “C”
A mutual fund is a professionally managed pool of money.
Mutual Funds –
A collection of stocks,
bonds, or other securities
bought by a group of investors
and managed by a professional
investment company.
Why Own One?
•Money is
Professionally
Managed.
•Diversified.
•Flexible.
•Marketable.
•You Have
Control.
Open-end funds –(most common)
the fund will sell as many shares as investors want.
Cannot trade in stock market, only buy or sell through
mutual fund company.
Closed-end funds -- have a limited number of
shares for trading on an exchange or OTC.
Load funds -- includes a sales charge
(usually 5%), + fees. Purchased
through a broker.
No-load funds -- charge a
management fee, not a commission.
Net Asset Value (NAV) –
The total value of the fund’s holdings
divided by the number of shares. (=
price per share)
A Hypothetical Example
Investing $100 per month with different rates of return
$1,188,240
12%
10%
8%
$637,680
$351,430
$200,140
6%
10 years
20 years
30 years
40 years
$100 Investment Per Month
Assumed Rates
6%
8%
10%
12%
10 Years
$16,470
$18,420
$20,660
$23,230
20 Years
$46,440
$59,290
$76,570
$99,910
30 Years
$100,950
$150,030
$227,930
$352,990
40 Years
$200,140
$351,430
$637,680
$1,188,240
The hypothetical illustration and the 6%, 8%, 10% and 12% nominal rates compounded monthly, are not guaranteed or
intended to demonstrate the performance of any actual investment and assumes $100/month investment. Assumes payments
are made at the beginning of the compounding period and are rounded to the nearest $10.
When
You Become
Financially
Independent Depends
on How Much Money
You Can Invest.
At age 65, could you live
on $140,000 / Year?
To do that, you need to accumulate $1,400,000
@ 12% Average Rate of Return
40 Year Plan -- Invest $120/Mo.
• 30 Year Plan -- Invest $400/Mo.


• 20 Year Plan -- Invest $1,400/Mo.
• 10 Year Plan -- Invest $6,025/Mo.
The High Cost of Waiting
Saving $100 per month at 10% return
Begin Saving
Now
In One Year
In Five Years
Total in 40 Years
$637,680
$576,090
$382,830
Cost to Wait
$ 61,590
$254,850
Don’t Procrastinate!
Cost to wait includes monthly contributions. This hypothetical example demonstrates compounding at specified rate and not
the performance of any actual program. No allowance for taxes, applicable fees or inflation. Rate of return is nominal,
compounded monthly.
The Best IRA Option for you
Contributions
Traditional IRA
Roth IRA
Up to $4,000
Tax Deductible
Up to $4,000
Non-deductible
No age limit
Contribution
70 1/2
/Distribution age limit
Earnings
Tax-deferred
Tax-deferred
Taxes before
59 1/2
Money taken will be
taxable w/10% penalty
Earnings tax-free if Roth
IRA account has been
open at least 5 years
Withdrawals
after age 591/2
All of the money will
be taxable upon
withdrawal
TAX FREE MONEY
no matter how much
is withdrawn!
Comparing IRA
Income Participation Limits
Full Eligibility
Roth IRA
Traditional IRA

Full eligibility income limits for
retirement plan participants
Married
Single
2006
$80,000
$50,000

Full eligibility income limits
(regardless of retirement
plan participation)
Married
Single
2006 and on
$150,000
$95,000
OPTIONS
Options
The right, but not the obligation, to
buy or sell a stock for a specified
price on or before a specific date.
Options
Strike price -- selling price
Expiration date -- deadline to
exercise the right to buy or sell.
This occurs on the THIRD
FRIDAY of each month.
Call: normally represents 100
shares of underlying stock.
 Buy
-- right to buy a stock at a
fixed price in the future.
The buyer of an equity call option has
purchased the right to buy 100 shares of the
underlying stock at the stated exercised price.
Thus, the buyer of one XYZ June 110 call
option has the right to purchase 100 shares of
XYZ stock at $110 up until the June expiration
(the third Friday in June).
Therefore, if XYZ stock increases in price to
$120 per share, the value would increase $10
per share x 100 shares or $1000, minus the
premium.
Put: normally represents 100
shares of underlying stock.
 Buy
-- right to sell a stock
at a fixed price in the future.
The buyer of a put option has purchased the
right to sell 100 shares of underlying stock at
the contracted exercise price.
Thus, the buyer of one ZXY June 50 put option
has the right to sell 100 shares of ZYX at $50
any time prior to the third Friday in June.
Therefore, if the price of ZXY decreases to $40
per share, the value would increase $10 per
share x 100 shares, or $1000, minus the
premium.
The largest exchange for
trading options is the
CBOE, the Chicago
Board of Options
Exchange.
FINANCIAL
INTERMEDIARIES

Financial intermediaries are financial
institutions through which savers can
indirectly provide funds to borrowers.
Financial Intermediaries
Banks
 take deposits from people who want to
save and use the deposits to make
loans to people who want to borrow.
 pay depositors interest on their deposits
and charge borrowers slightly higher
interest on their loans.
Financial Intermediaries

Banks

Banks help create a medium of exchange by
allowing people to write checks against their
deposits.


A medium of exchanges is an item that people can
easily use to engage in transactions.
This facilitates the purchases of goods and
services.
Financial Intermediaries

Mutual Funds

A mutual fund is an institution that sells
shares to the public and uses the proceeds
to buy a portfolio, of various types of
stocks, bonds, or both.

They allow people with small amounts of
money to easily diversify.
Financial Intermediaries

Other Financial Institutions




Credit unions
Pension funds
Insurance companies
Loan sharks
CONSIDERATIONS
FOR SELECTING A
STOCK
ANALYSIS
TERMS
MARKET CAPITALIZATION
Value of a corporation valued by
the market price of its issued and
outstanding stock.
price of stock x outstanding
shares = market cap
EARNINGS PER SHARE
Portion of a company’s profit
allocated to each share
Actual earnings / outstanding
shares = EPS
BOOK VALUE
Value at which an asset is carried
on a Balance Sheet. (also called
net asset value when applied per
bond or per share)
cost of asset - depreciation = BV
DEBT TO EQUITY RATIO
This shows to what extent
owner’s equity can cushion
creditor’s claims in the event of
liquidation.
Total liabilities / total shareholders
equity = d/e ratio
Over the Counter (OTC)
-- an electronic
marketplace regulated by
the NASD (National
Association of Securities
Dealers).
NASDAQ -- where OTC
companies are listed
(National Association of
Securities Dealers
Automated Quotation)
FIRM NUMBERS
PRICE/EARNINGS RATIO
(PE): A calculation that evaluates a
stock’s relative performance and value.
•Higher PE multiples suggest that investors are
more optimistic about a stock’s prospects than
comparable lower PE stocks.
•Reason for high/low PE ratios also include the
company’s growth outlook, the company’s
industry, the company’s accounting policies, and
whether the company is a start-up firm or more
established.
PE is calculated by dividing the
stock’s price by the company’s
earnings per share (EPS) for the
most recent 4 quarters.
Stock price compared to “company’s
earnings” (EPS) reported in ratio.
This would indicate that a
LOW PE = better return on
investment
Example:
Stock A
Stock B
Price
$10
$20
EPS
$2.00
$2.00
PE Ratio
5
10
Which is a better investment?
The answer is Stock A.
Stock B is more expensive than
Stock A in terms of earnings. For
Stock B, you must pay $20 to earn
$2, but for Stock A, you pay only
$10 to earn $2.
The ratio is the number of times greater
the stock price is as compared to the
corporate earnings.
P $1.00 =
1
PE
10
PE
E $1.00
P $1.00 =
E
.10
When a market tends toward rapid
and extreme fluctuations, it is said to
be VOLATILE.
BETA:
refers to risk
management or volatility of a stock
(I.e. the percentage change for the
stock’s return compared to the
change in the return of the market)
If the returns are the same, the ratio is
1.0.
A beta of 1.00 means that the stock
has the same percentage of change
as the market.
Thus, if you want to perform better
than the market, a beta greater than
1.0 would be desired.
A high beta # would indicate more
volatility than the current market.
A high beta # would indicate more
volatility than the current market.
When market indicators shift, the
high beta stock will move more in
the direction that the stock is
presently headed.
For example, if a stock has a beta
of 1.35 and the market has
changed 10%, how much has the
stock changed in return?
1.35 = X/10 percent
X = 13.5 percent
* the 13.5% stock return change
indicates that this stock has a
greater risk of change than the
market.
DIVIDEND:
indicates the annual
payment per share of a stock
designated by the company for
stockholders. COMMON shares
dividends vary with the business
condition of the company and are
evaluated regularly by a firm’s
directors. PREFERRED
stockholders are the first to get paid.
%YIELD:
represents the dividend
return an investor can expect on each
share of stock purchased.
It is calculated by dividing the dividend that
each share pays by its current market
value, expressed as a percentage.
$1 dividend / $10 price = 10% yield
$1 dividend / $5 price = 20% yield
NEWS:
Strikes/scandals,
accidents/hazards, research &
development, safety issues, new
technology, management/labor,
takeover bids, et. al. can all lead to
the price of a stock going up or down.
TRADING VOLUME:
shows
the total number of shares traded for
the day (listed in hundreds); thus 363
would mean 36,300.
When a “z” precedes the volume
number, it refers to the actual number.
For example, “z20” means 20 shares
not 2000.
CURRENT DEBT RATIO:
A
BALANCE SHEET sets forth the various
types of assets and liabilities of the firm.
An excess of current assets (cash,
inventory, accounts receivable) over
current liabilities (accounts payable, shortterm debt, etc.) is viewed as favorable.
This information is expressed in a ratio.
A ratio of 1.0 means that assets are
equal to liabilities.
A ratio greater than 1.0 means that
assets are greater than liabilities.
A ratio less than 1.0 means that assets
are less than liabilities.
BROKER
RECOMMENDATION:
Financial ideas or suggestions are
offered by brokerage firms or brokers
who act as intermediaries between a
buyer and a seller.
FACTORS OF
PRODUCTION:
what a firm uses
as resources to produce their goods
should be considered when investing in a
company.
BOOK
VALUE/OVERPRICED?:
The difference between the firm’s
assets and liabilities which determines
what the stockholder owns after all
debts are paid.
To calculate book value use the
following equation:
P = PE x EPS
P = 15 x 3
P = $45
If the current price of the stock is
over $45 per share, it is overpriced.
INDUSTRY
CONSIDERATIONS
INDUSTRY TYPE:
A
group of companies that
produce or sell the same kind of
product or service is called an
industry.
GROWTH PROSPECTS:
A common stock that has increased
in earnings, year-after-year, would
indicate that the company is growing.
One hopes that the company will
continue to grow so that the earnings
will increase.
GOVERNMENT POLICIES
AND REGULATIONS: these may
encourage or discourage corporate
expansion and growth.
For example: if the government decides to
spend money on defense items, those
companies that produce defense-related
goods are guaranteed work and usually
long-term profits.
LIFE CYCLE:
The firm may be
young, growing, maturing or failing.
Management may use a merger,
acquisition, new technology, human
resource development and
diversification to revive and renew the
firm if it is in a mature or failing state.
THE ECONOMY
INTEREST RATE:
the
amount paid for borrowing
someone else’s money. It is
usually expressed as an Annual
Percentage Rate (APR)
INFLATION (CPI):
an
increase in the amount of money in
circulation that lowers the value of
money. Inflation results in higher
prices paid for goods and services.
The CONSUMER PRICE INDEX
(CPI) is used to measure the current
inflation rate.
UNEMPLOYMENT:
Failure of the
economy to fully employ its labor force.
The unemployed are people in the civilian
labor force who do not have jobs but are
actively seeking work.
It is important to note whether
unemployment is cyclical, frictional or
structural.
BUSINESS CYCLE (GDP):
the business cycle is divided into four
phases of the economy (peak,
recession, trough, recovery). The
GROSS DOMESTIC PRODUCT (GDP)
is a good reference of measurement.
MONETARY POLICY:
considers
whether the current monetary policy favors
contraction or expansion of the money
supply.
A CONTRACTIONARY policy is when the discount
rate goes up, when the reserve requirement goes
up, or the Fed sells government securities.
An EXPANSIONARY policy is when the discount
rate goes down, when the reserve requirement
goes down, or the Fed buys government securities.
FISCAL POLICY:
consider
whether the current fiscal policy favors
contraction or expansion.
A CONTRACTIONARY policy is when tax
rate goes up and/or federal government
spending goes down.
An EXPANSIONARY policy is when tax rates
go up and/or federal government spending
goes up.
THE END
Compiled by:
Virginia Meachum, Economics Teacher
Coral Springs High School
Broward County, Florida