*The Wall Street Journal, Sept. 10-11, 2011 pg B7.

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Understand the characteristics and the reasons for investing in various securities.
Understand the relationship between risk and return when investing.
Understand the role of diversification in successful investing.
Be familiar with financial considerations important to those nearing retirement or currently retired.
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Become familiar with characteristics of popular financial securities commonly used by individual and institutional investors and how these instruments are traded on organized security exchanges.
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Basic Types
Interest-bearing
Equities
Derivatives
Major Subtypes
Money market instruments
Fixed-income securities
Common stock
Preferred stock
Futures
Options
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Money market instruments are short-term debt obligations of large corporations and governments.
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These securities promise to make one future payment.
When they are issued, their lives are less than one year.
Fixed-income securities (a bond) are longer-term debt obligations of corporations or governments.
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The typical bond promise to make fixed payments according to a pre-set schedule. At maturity you received the principal (par value) back.
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A “zero coupon” bond pays no annual interest. It is bought at a discount price that reflects the current interest rate. At maturity pays the par value (typically stated as 100).
When they are issued, their maturity exceeds one year.
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Examples : U.S. Treasury bills (T-bills), bank certificates of deposit (CDs), corporate and municipal money market instruments.
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Potential gains/losses : A known future payment/except when the borrower defaults (i.e., does not pay).
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Price quotations : Usually, the instruments are sold on a discount basis , and only the interest rates are quoted, not the prices.
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A safe place to store cash balances and earn interest on the proceeds.
Provides liquidity for your portfolio.
Most money market instruments have a very low probability of default.
Price risk is low because of short time to maturity.
However, the interest earned will be the lowest of all fixed income assets.
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Examples : U.S. Treasury notes, corporate bonds, municipal bonds.
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Bond Quality is rated by three private companies:
Standard & Poor’s (AAA), Moody’s (Aaa) and Fitch’s.
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Rating ranges from “AAA” (best) to “D” (in default)
Investment grades are AAA, AA, A and BBB-.
Like grades, “+” and “-” may be used, eg. AA-
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Price quotations from www.wsj.com
—the online version of
The Wall Street Journal (some columns are self-explanatory) :
You will receive 6.875% of the bond’s face value each year in 2 semi-annual payments.
The price (per $100 face) of the bond when it last traded.
The Yield to Maturity (YTM) of the bond.
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Pros - Include Bonds in a portfolio to:
1.
2.
3.
Reduce risk. Bonds are more stable in value than stocks or many other assets.
Provide income. They provide consistent payments every six months(the interest).
Provide some liquidity. U.S. Treasury Bonds are highly liquid, however, many others are not.
 Cons - Risk of Bonds include:
1. Prices vary with interest rates. Up and down.
2. Can be highly volatile. Like the last three years.
3. Many bonds are highly illiquid. Eg. Municipals and some corporates.
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Represents ownership in a company. You are an equity owner and typically have voting rights in the company.
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May be publicly traded, (eg. Williams Companies) or privately held, (Koch Industries).
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Typically you get two things of value when you buy a stock: (1) The price rises over time and (2) dividends.
Stocks that pay no dividends but have a good business are typically called “growth stocks”.
Stocks that pay a relatively large dividend (eg. 3+%) are typically called “value stocks”.
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Common Stock Price Quotes Online at http://finance.yahoo.com
*
*From Monday, Sep 12, 2011
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Stocks provide the growth factor in a portfolio
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Stock prices tend to rise over time as the economy grows.
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Dividends tend to rise over time reflecting inflation and growth in the economy.
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See the S&P Dividends Aristocrats list of 42 stocks that have raised their dividends every year for the past 25 years. Most are household names : Johnson & Johnson; Emerson Electric; Pepsico; Proctor and
Gamble, etc.
Exxon Mobil has increased dividends an average of 5.7% a year for 27 years.
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Most portfolios should have some common stock exposure
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Stocks are more “risky” than the other assets we have discussed.
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That is, they tend to vary more in price.
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They go to zero if the company goes bankrupt.
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There is a wide variety of stocks that you can own, ranging from very safe to very risky.
Thus, more time is needed to research individual stocks.
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Dow Jones Industrials – 30 large blue chip companies
(DJIA).
Standard and Poor’s –
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S&P 500 Index
S&P 400 Midcap Index
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S&P 600 Small cap index
Russell 2000 – small cap firms
NASDAQ Composite – stocks listed on the National
Assoc. of Securities Dealers Automated Quote
System.
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Yields on Dow Jones Industrial Average Component
Stocks
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Indexes can be distinguished in four ways:
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The market covered,
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The types of stocks included,
How many stocks are included, and
How the index is calculated
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 price-weighted , e.g. DJIA, versus value-weighted , e.g. S&P 500.
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For a value-weighted index (i.e., the S&P 500), companies with larger market values have higher weights.
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For a price-weighted index (i.e., the DJIA), higher priced stocks receive higher weights.
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This means stock splits cause issues.
But, stock splits can be addressed by adjusting the index divisor.
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Note: As of March 8, 2008, the DJIA divisor was a nice “round”
0.122834016!
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Many are based on something called market capitalization or market cap for short.
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Market cap is the $ value of the equity of the firm that is in the hands of the shareholders:
Market cap = shares outstanding x $ price per share
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It varies daily because the price of the stock changes
Shares outstanding change gradually, usually at most at each quarter.
Others are based on the geographical region or company characteristics.
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By Market Cap
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All Cap – Russell 3000; Wilshire 5000
Large Cap – S&P 500; Russell 1000
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Mid Cap/Small Cap – S&P 400/600;
Russell 2000 and 2500
By Firm Objective
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Growth
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Value
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By Geographical Area;
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EAFE (Europe, Australia, Far East)
BRIC (Brazil, Russian, India, China)
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MSCI ACWI (Morgan Stanley Capital International
World Index)
By type of market
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Emerging Markets
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Frontier Markets
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 www.nasdbondinfo.com
(current corporate bond prices) www.investinginbonds.com
(bond basics) www.finra.com
(learn more about TRACE) www.fool.com
(Are you a “Foolish investor”?) finance.yahoo.com
(prices for option chains) www.wsj.com
(online version of The Wall Street Journal ) www.morningstar.com
(Morningstar’s information on stocks and mutual funds)

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An idea leads to starting a small business, financed by the owner’s own money – equity.
A bank may provide initial financing – debt.
A Private equity or Venture Capitalist investor may provide additional capital to finance growth – equity financing.
Ultimately, the successful firm decides to “go public” and sell its common stock on the open market. This is called an Initial Public Offering (IPO).
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Private Equity is the used for the rapidly growing area of equity financing for nonpublic companies.
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Because banks generally are not interested in making loans to start-up companies, especially small ones.
Firms often seek equity financing from a venture capital (VC) firm , an important part of the private equity markets.
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Venture Capital refers to financing new, often high-risk, start-ups .
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Individual venture capitalists invest their own money.
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Venture capital firms pool funds from various sources, like
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Individuals
Pension funds
Insurance companies
Large corporations
University endowments
Venture capitalists know that many new companies will fail, but the companies that succeed can provide enormous profits.
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To limit their risk:
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Venture capitalists generally provide financing in stages.
Venture capitalists actively help run the company.
At each stage, enough money is invested to reach the next stage.
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Ground-floor financing
Mezzanine Level financing
At each stage of financing, the value of the founder’s stake grows and the probability of success rises.
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If goals are not met, the venture capitalists withhold further financing.
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If a start-up succeeds:
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The big payoff frequently comes when the company is sold to another company or goes public.
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The primary market is the market where investors purchase newly issued securities.
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Initial public offering (IPO): An IPO occurs when a company offers stock for sale to the public for the first time.
Seasoned equity offering (SEO): If a company already has public shares, an SEO occurs when a company raises more equity.
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The secondary market is the market where investors trade previously issued securities. An investor can trade:
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Directly with other investors.
Indirectly through a broker who arranges transactions for others.
Directly with a dealer who buys and sells securities from inventory.
The NYSE is an example of a secondary market for securities.
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The issuing firm hires an investment banking firm that performs the following functions:
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Development of the prospectus:
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Red Herring; Official
Origination
Underwriting arrangement – “best efforts”, “all or none”, “firm purchase”, etc.
Syndication – the group of investment banks that will help sell the issue
Distribution – Through the syndicate
Market Stabilization
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Most common stock trading is directed through an organized stock exchange or trading network.
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Whether a stock exchange or trading network, the goal is to match investors wishing to buy stocks with investors wishing to sell stocks.
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The market maker function is key to providing a liquid and fair market for any financial asset. They are ready to take the other side of your order.
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The New York Stock Exchange (NYSE), popularly known as the Big Board , celebrated its bicentennial in 1992.
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The NYSE has occupied its current building on Wall Street since the early
1900’s.
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For 200 years, the NYSE was a not-for-profit New York State corporation.
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The NYSE went public in 2006
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(NYSE Group, Inc., ticker: NYX)
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Naturally, NYX stock is listed on the NYSE
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In 2007, NYSE Group merged with Euronext to form NYSE Euronext, the world’s largest exchange.
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Historically, the NYSE had 1,366 exchange members. These members:
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Were said to own “seats” on the exchange.
Collectively owned the exchange, although professionals managed the exchange.
Regularly bought and sold seats (Record seat price: $3 million in 2005)
Seat holders could buy and sell securities on the exchange floor without paying commissions.
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In 2006, all of this changed when the NYSE went public.
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Instead of purchasing seats, exchange members purchase trading licenses:
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 number limited to 1,500
In 2007, a license would set you back a cool $55,000—per year.
Having a license entitles the holder to buy and sell securities on the floor of the exchange.
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The largest number of NYSE members are registered as commission brokers .
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Commission brokers execute customer orders to buy and sell stocks.
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Second in number of NYSE members are specialists , or market makers .
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Market makers are obligated to maintain a “fair and orderly market” for the securities assigned to them.
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In 2006, the total number of companies listed on the NYSE represented a total global market value of about $25 trillion.
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Initial and annual listing fees are charged based on the number of shares.
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To apply for listing, companies have to meet certain minimum requirements with respect to
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The number of shareholders
Trading activity
The number and value of shares held in public hands
Annual earnings
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The fundamental business of the NYSE is to attract and process order flow .
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In 2007, the average trading volume on the NYSE was over
2 billion shares a day.
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Volume breakdown:
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About one-third from individual investors.
Almost half from institutional investors.
The remainder represents NYSE-member trading, mostly from specialists acting as market makers.
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