Savings and Investment

Savings and
Investment
Should you Invest?
Why do you come to school today?
Besides having a burning desire to learn economics,
you expect to get some benefit (or return) for your
investment of time and energy.
Return is the money an investor receives above and
beyond the sum of money initially invested.
You came to school because you know that graduating
significantly increased the chances of getting a wellpaying job .
People invest their money for similar reasons
Example: If you invest $10 a week at 15% rate of return,
you would have $100,000 by the time you are 40
Why are some investments
more profitable?
Return and Liquidity
• Savings accounts have greater liquidity, but in
general have a lower rate of return.
• Certificates of deposit usually have a greater return
but liquidity is reduced.
Return and Risk
• Investing in a friend’s Internet company could double
your money, but there is the risk of the company
failing.
• There is a clear relationship between risk and
return…
Risks vs. Rate of Return
Nearly all investments share one characteristic…
…the less risk, the less return.
…the greater the risk, the greater the return.
Types of Investments
Types of Investments
Let’s use an example to demonstrate three
types of investments.
Pretend you are going to start a lemonade
stand. You need some money to get your stand
started. What do you do?
You ask your grandmother to lend you $100 and write this
down on a piece of paper: "I owe you (IOU) $100, and I will pay
you back in a year plus 5% interest."
Your grandmother just bought a bond (IOU) by lending money to
your "company" named Lemo. Now you need more money…
To get more money, you sell half of your company for $50 to your
brother Tom. You put this transaction in writing: "Lemo will issue
100 shares of stock. Tom will buy 50 shares for $50." Tom has just
bought 50% of the shares of stock from Lemo.
You sell $500 worth of lemonade. Business is good. Your costs
for setting up the stand are $150, plus you pay yourself $100 for
the hours you work. The company makes a profit of…
Revenue – Costs = Profit
$500 - $250 = $250
After one year, from the $250 profits, you pay back your
grandmother $100 plus $5 interest. You pay $20 to Tom and
yourself, shareholders. This $20 paid to the owners is called a
dividend.
You decide to put the dividend money in the bank. Banking the
money is a short-term investment.
We just covered three types of investments: Bonds,
Stocks, and Short-term Investments.
What are Bonds?
Bonds are basically loans, or IOUs, that represent debt
that the government or a corporation must repay to
an investor.
Ex: War Bonds During World War II
The person who writes the IOU is the issuer
The person who gets the IOU is the holder
Most bonds are low risk, which means…
…low returns (4-5% Returns)
How do bonds work?
Bonds have three basic components:
1. The coupon rate is the interest rate that the bond issuer will
pay to the bondholder.
2. A bond’s maturity is the time at which payment to the
bondholder is due.
3. A bond’s par value is the amount that an investor pays to
purchase the bond and that will be repaid to the investor at
maturity.
Example:
A company called Callahan Auto wants to create a new break
pads division so they sell bonds to get money.
You buy a bond for $500
Example
The Par Value=
$500
Coupon Rate= 10% annually
Maturity= 5 Years
How much would you earn from the bond in 5 Years?
10% of $500 = ____ is paid each year
$50 x 5 = ____
$250 (a 50 % return)
What happens when the bond reaches maturity?
The firm pays you back the par value.
Advantages and Disadvantages to
Bond Issuers
Bonds are desirable from the issuer’s point of view
for two main reasons:
1. Once the bond is sold, the coupon rate for that bond will
not go up or down.
2. Unlike stock, bonds are not shares of ownership in a
company.
Bonds also have two main disadvantages to the issuer:
1. The company must make fixed interest payments, even in
bad years when it does not make money.
2. If the issuer does not maintain financial health, its bonds
may get a lower bond rating. This makes it harder to sell
future bonds.
Types of Bonds
There are several different types of bonds (pg 280)
Savings Bonds
Savings bonds are low-denomination ($50 to $10,000) bonds issued by
the United States government. Savings bonds are purchased below par
value (a $100 savings bond costs $50 to buy) and interest is paid only
when the bond matures.
Treasury Bonds, Bills, and Notes
Municipal Bonds
These investments are issued by the
Municipal bonds are issued by
United States Treasury Department. state or local governments to finance
such improvements as highways,
High or Lowstate
Risk?
buildings, libraries, and
schools.
High
or
Low
Returns?
Corporate Bonds
Junk Bonds
A corporate bond is a bond that a
Junk bonds are lower-rated,
corporation issues to raise money to
potentially higher-paying bonds.
expand its business.
Types of Bonds
There are several different types of bonds (pg 280)
Savings Bonds
Savings bonds are low-denomination ($50 to $10,000) bonds issued by
the United States government. Savings bonds are purchased below par
value (a $100 savings bond costs $50 to buy) and interest is paid only
when the bond matures.
Treasury Bonds, Bills, and Notes
Municipal Bonds
These investments are issued by the
Municipal bonds are issued by
United States Treasury Department. state or local governments to finance
such improvements as highways,
state buildings, libraries, and
High or Low Risk?schools.
Corporate
Bondsor Low Returns?
Junk Bonds
High
A corporate bond is a bond that a
Junk bonds are lower-rated,
corporation issues to raise money to
potentially higher-paying bonds.
expand its business.
Types of Bonds
There are several different types of bonds (pg 280)
Savings Bonds
Savings bonds are low-denomination ($50 to $10,000) bonds issued by
the United States government. Savings bonds are purchased below par
value (a $100 savings bond costs $50 to buy) and interest is paid only
when the bond matures.
Treasury Bonds, Bills, and Notes
Municipal Bonds
These investments are issued by the
Municipal bonds are issued by
United States Treasury Department. state or local governments to finance
such improvements as highways,
state buildings, libraries, and
schools.
Corporate Bonds
Junk Bonds
A corporate bond is a High
bond thator
a Low
Risk?
Junk
bonds are lower-rated,
corporation issues to raise money to
potentially higher-paying bonds.
High
or
Low
Returns?
expand its business.
Types of Bonds
There are several different types of bonds (pg 280)
Savings Bonds
Savings bonds are low-denomination ($50 to $10,000) bonds issued by
the United States government. Savings bonds are purchased below par
value (a $100 savings bond costs $50 to buy) and interest is paid only
when the bond matures.
Treasury Bonds, Bills, and Notes
Municipal Bonds
These investments are issued by the
Municipal bonds are issued by
United States Treasury Department. state or local governments to finance
such improvements as highways,
state buildings, libraries, and
schools.
Corporate Bonds
Junk Bonds
A corporate bond is a bond that a
Junk bonds are lower-rated,
High
or Low Risk?
corporation issues to raise money to
potentially higher-paying bonds.
expand its business.
High or Low Returns?
Types of Bonds
There are several different types of bonds (pg 280)
Savings Bonds
Savings bonds are low-denomination ($50 to $10,000) bonds issued by
the United States government. Savings bonds are purchased below par
value (a $100 savings bond costs $50 to buy) and interest is paid only
when the bond matures.
Treasury Bonds, Bills, and Notes
Municipal Bonds
These investments are issued by the
Municipal bonds are issued by
United States Treasury Department. state or local governments to finance
such improvements as highways,
state buildings, libraries, and
schools.
Corporate Bonds
Junk Bonds
High
or bond
Low
A
is aRisk?
bond that a
corporate
Junk bonds are lower-rated,
corporation
issues toReturns?
raise money to
potentially higher-paying bonds.
High
or Low
expand its business.
Short-Term Investments
Certificates of Deposit
•
•
•
•
Money Market Mutual Funds
Certificates of deposit (CDs) • Money market mutual funds
pool the money of many people
are funds that are deposited
to buy stocks and bonds.
for a fixed amount of time (6
• Investors receive higher interest
months -3 Years).
on a money market mutual fund
CDs have low liquidity but
than they would receive from a
various terms of maturity,
savings account or a CD.
This allows investors to plan
• However, assets in money
for future financial needs.
market mutual funds have more
Ex: If you inherited $3000
risk
that will go toward college.
Instead of leaving it in the
bank, put it in a CD.
The Stock Market
Buying Stock
Corporations can raise money by issuing stock, which
represents ownership in the corporation.
A portion of stock is called a share (aka: equities)
Stockowners can earn a profit in two ways:
1. Dividends, which are portions of a corporation’s
profits, are paid out to stockholders of many
corporations.
The higher the corporate profit, the higher the
dividend.
2. A capital gain is earned when a stockholder sells
stock for more than he or she paid for it. A
stockholder that sells stock at a lower price than the
purchase price suffers a capital loss.
Types of Stock
Stocks may be classified by…
1) whether or not they pay dividends
2) whether or not the stockholder has a say in the
corporation’s affairs.
Dividend Differences
• Income stock pays dividends
at regular times during the
year.
• Growth stock pays few or no
dividends. Instead, the issuing
company reinvests earnings
into its business.
Decision-Making Differences
• Investors who buy common
stock are voting owners of the
company.
• Preferred stock owners are
nonvoting owners of the
company, but receive
dividends before the owners
of common stock.
Stock Splits and Stock Risks
Stock Splits
• A stock split is the division of a single share of stock
into more than one share.
• Stock splits occur when the price of a stock becomes
so high that it discourages potential investors from
buying it.
Risks of Buying Stock
• Purchasing stock is risky because the firm selling the
stock may encounter economic downturns
• That force dividends down or reduce the stock’s
value. It is considered a riskier investment than
bonds.
How are stocks traded?
What is a stockbroker?
a person who links buyers and sellers of stock.
• Stockbrokers work for brokerage firms, or
businesses that specialize in trading stock.
• Some stock is bought and sold on stock
exchanges, or markets for buying and selling
stock.
Stock Exchanges
The New York Stock Exchange (NYSE)
– The NYSE is the country’s largest stock exchange. Only
stocks for the largest and most established companies are
traded on the NYSE.
NASDAQ-AMEX
– NASDAQ-AMEX is an exchange that specializes in high-tech
and energy stock.
The OTC Market
– The OTC market (over-the-counter) is an electronic
marketplace for stock that is not listed or traded on an
organized exchange.
Daytrading
– Daytraders use computer programs to try and predict minuteby-minute price changes in hopes of earning a profit.
The ups and downs of daytrading…
Measuring Stock Performance
Bull and Bear Markets
• When the stock market rises steadily over time, a
bull market exists.
• Conversely, when the stock market falls over a
period of time, it’s called a bear market.
Stock Performance Indexes
The Dow Jones Industrial Average
• The Dow is an index that shows how stocks of 30
companies in various industries have changed in value.
The S & P 500
• The S & P 500 is an index that tracks the performance
of 500 different stocks.
The Great Crash
The collapse of the stock market in 1929 is
called the Great Crash.
Causes of the Crash
Effects of the Great Crash
• Many ordinary Americans were •
struggling financially: many
purchased new consumer goods
by borrowing money.
The Crash contributed to a
much wider, long-term crisis
(the Great Depression) during
which many people lost their
jobs, homes, and farms.
• Speculation, or the practice of
making high-risk investments • Depression lead to more
with borrowed money in hopes
government involvement in the
of getting a big return, was
economy
common.
• Now Americans are wary of
buying stock.