FIN 200: Personal Finance

1. FIN 200: Personal Finance Topic 18–Stocks Lawrence Schrenk, Instructor

2. Learning Objectives • Describe the risk-return trade-off in the case of stocks. ▪ • Explain how stocks are valued. • Discuss how stock markets work and how you buy stocks. ▪

3. Buy High, Sell Low?! • It is obvious that investors should buy low and sell high in order to build wealth over time. • The investment process involves analytical analysis of investment alternatives that are filtered through a decision process that is fraught with psychological biases.

4. Investment Objectives • Why are you investing? • Retirement, vacation, … • Investment objectives are important. • Matching goal characteristics with investment characteristics. • Risk, Return, Time

5. Key Investment Concepts • Portfolio • Diversified collection of stocks, bonds, etc. • Individual investments are often evaluated on how they change the characteristics of the portfolio. • Risk • Chance of economic loss; variation in return. • Expected Return • Anticipated gain of a specific period of time. • Often evaluated as compensation for taking certain types of risks. • NOTE: Future-Oriented

6. The Risk-Return Trade-Off, Revisited

7. Stock Risk

8. Risk-Return Trade-Off Stocks ER Bonds Risk-Free Rate Risk

9. Return Comparisons (1976-2000) Investment Average Annual Return S&P 500 11% Small-Company Stocks 12% U.S. Treasury Bonds (short-term)4% U.S. Treasury Bonds (long-term) 5% Savings Interest Rate 1-3% Inflation2-3%

10. The Pyramid

11. Stock Valuation

12. Dividends versus Capital Gains • Dividends • Quarterly • Paid by Corporation • Capital Gains • Increase in value relative to the purchase price. • Paid by Buyer

13. Example • You bought General Motors at $50 per share in 1998 and sold it at $74 in 2000. For each share, you received $2 in dividends in 1998 and 1999. • You bought Ford at $25 per share in 1998 and sold it at $29 in 2000. For each share, you received $1.07 in 1998 and $1.17 in1999 in dividends.

14. Why Do Prices Change? • Supply and Demand • Earnings (expectations) • Sentiments, attitudes, & sense of greed • Economic Indicators • Follow the leader • Manipulation • LOTS of different theories

15. Financial Analysis • Fundamental Analysis • Macroeconomic Factors • Individual Firm Factors • Technical Analysis • Price Trends • Price Patterns

16. Head & Shoulder Pattern

17. Efficient Market Hypothesis (EMH) • Every security at every point in time is fairly priced. • Stock prices accurately reflect publicly available information • Competition assures prices reflect information • Controversial • Market bubbles • Most professional investors don’t beat the market • Investment superstars • Hard to predict the direction of stock prices

18. Stock Exchanges

19. Some History • 1602 Amsterdam Stock Exchange • 1730 Dojima Rice Exchange • 1792 New York Stock Exchange • 1973 Chicago Board Options Exchange

20. Stock Exchanges • New York Stock Exchange (NYSE) • Founded in 1792, this by far, the largest exchange in the world with the most stringent requirements for listing • Large corporations • minimum earnings of $2.5 million before taxes, • net assets of at least $16 million, etc. • Foreign Corporations • NASDAQ • Provides prices on securities offered by more than 4000 small domestic and foreign companies. • Technology

21. NYSE Volume

22. Ticker Symbols • Mnemonic used to uniquely identify publicly-traded shares of a corporation. Examples: KO Coca-Cola Company MSFT Microsoft F Ford Motor Company WMT Wal-Mart T AT&T HPQ Hewlett-Packard TXN Texas Instruments

23. Buying Stocks • General brokerage firm offers a full rage of services to customers. • Discount brokers charge commissions to execute trades that are about 40 to 80 percent less than the fees charged by full-service brokers. • Online brokers

24. Order Types • Market order instructs the stockbroker to execute an order at the prevailing market price. • Limit order instructs the stockbroker to buy or sell a stock at a specific price. • Stop order instructs a stockbroker to sell your shares of stock at the market price if a stock declines to or goes below a specified price.

25. Reading Newspaper Price Quotations

26. Bulls versus Bears • Bull Market • Upward • Optimistic • Bear Market • Downward • Pessimistic

27. Stock Market Indices • 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) • S&P 500

28. Dow Jones Industrial Average (DJIA) • The arithmetic average of the price of 30 large NYSE stocks (~ 20% of NYSE value) • Represents the return (not including dividends) from a strategy of holding one share of each stock

29. Standard & Poor’s 500 • A market value weighted index of 500 large company stocks • Represents the return (not including dividends) from the strategy of holding a portfolio of the 500 firms in proportion to their market values

30. Other Indices • New York Composite • NASDAQ Composite • Russell 2000 • Wilshire 5000

31. Stock Information

32. A Firm’s Financial Statements • Two Main Statements • Income Statement • How much cash flow it produces. • Balance Sheet • How much it is worth • ‘Market’ versus ‘Book’ Value • Analysis of Financial Statements • Financials Ratios (not individually required) • Price/Earnings (P/E) Ratio

33. Media and Web • Wall Street Journal, Financial Times • Websites • The Motley Fool • Morningstar • Bloomberg • Standard & Poor’s Financial Information Services • Value Line

35. Ethical Dilemma Nick buys four stocks based on his broker's advice and is surprised that the broker recommended the same four stocks to both his father and grandfather. Nick's father defends the broker by saying that if it's a good stock for Nick, why isn't it a good stock for all of them? Besides, his father says, since the broker's company does all of the investment banking work for the four stocks that he recommended, they undoubtedly know everything there is to know about these four firms. a. Discuss the ethical issues of the broker's recommending the same four stocks to Nick, his father, and his grandfather. b. Why could these four stocks be a good investment for Nick, but not his father or grandfather?