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Lecture Focus on personal finance: An active approach to help you develop successful financial skills (2e) - Chapter 11B

Chapter 11B - Investing basics and evaluating bonds. In this chapter, you will learn to: Explain why you should establish an investment program; describe how safety, risk, income, growth, and liquidity affect your investment program; identify the factors that can reduce investment risk; understand why investors purchase government bonds. | 11B Investing Basics and Evaluating Bonds #2 Recall the concept of asset allocation 11- One Effect of Asset Allocation: A Weighted Total Return Ultraconservative “Investors” Are Really Just “Savers” People who invest very conservatively They do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings Remember “The Rule of 72”? 72/4% = 18 years 72/8% = 9 years (money doubles much faster) Identify the Types of Investments You Want to Make Do You Want to Lend Your Money or Own an Asset? Debts – “loanership” (lending) investments. Fixed Maturity – the borrower agrees to repay the principal to the investor on a specific date. Fixed Income – the borrower agrees to pay the investor a specific rate of return for use of the principal. Equities – “ownership” investments. Potential for a higher return by sharing in profits The Risk Pyramid Reveals the Trade-offs Between Investment Risk and Return Inflation To beat inflation, one must invest money so that it earns a higher after-tax return than the inflation rate Real Rate of Return – the return after subtracting the effects of both inflation and income taxes. Example: 10% return, 7.5% after taxes (25% tax bracket), 4% inflation, real rate of return of 3.5% after taxes and inflation Objective 5 Recognize Why Investors Purchase Corporate Bonds Corporate Bonds A corporation’s written pledge to repay a specified amount of money with interest An interest-only loan Considered safer than co. stocks A “fixed-income” security A form of debt financing (bond owners repaid in future) 11- Corporate Bonds Face Value Dollar amount bondholder receives at bond’s maturity date Usually $1,000 Coupon rate Stated interest rate Interest payments made every six months Example: $1,000 x 5.8% = $58 (in two $29 payments) Maturity Date = date on which face value repaid; generally 1 to 30 years 11- Corporate Bonds Bond Indenture Legal document describing conditions of the bond issue . | 11B Investing Basics and Evaluating Bonds #2 Recall the concept of asset allocation 11- One Effect of Asset Allocation: A Weighted Total Return Ultraconservative “Investors” Are Really Just “Savers” People who invest very conservatively They do not get ahead financially over the long term because taxes and inflation offset most of their interest earnings Remember “The Rule of 72”? 72/4% = 18 years 72/8% = 9 years (money doubles much faster) Identify the Types of Investments You Want to Make Do You Want to Lend Your Money or Own an Asset? Debts – “loanership” (lending) investments. Fixed Maturity – the borrower agrees to repay the principal to the investor on a specific date. Fixed Income – the borrower agrees to pay the investor a specific rate of return for use of the principal. Equities – “ownership” investments. Potential for a higher return by sharing in profits The Risk Pyramid Reveals the Trade-offs Between Investment Risk and Return Inflation To beat inflation, one must .