Common Stock and Derivatives

• Common Stock is equity or ownership in a

corporation.
– Payments to stockholders are not fixed, but depend
on the success of the firm
• Derivatives
– Value derives from prices of other securities, such as
stocks and bonds
– Used to transfer risk
Stocks- An investment that represents
ownership in a company or corporation.
Bonds- A security representing a loan of
money from a lender to a borrower for a set
time period, which pays a fixed rate of
interest.
Mutual Fund- An investment that pools
money from several investors to buy a
particular type of investment, such as stocks.
Real Estate- An investor buys pieces of
property, such as land or a building, in hopes
of generating a profit.
 Savings/Certificates of Deposits
• A deposit that earns a fixed interest rate for a
specified length of time.
– The longer the time period the greater the rate of
return.
– There is a substantial penalty for early withdrawal.
 Collectibles

• Unique items that are relatively rare or highly

valued.
– Art work
– Baseball trading cards
– Coins
– Automobiles
– Antiques
 Risk vs. Return
• On average, stocks have a high rate of return
– The increase or decrease in the original purchase price of
an investment
• Higher rate of return = greater risk
– Uncertainty about the outcome of an investment
• Stocks provide portfolio diversification
– Money invested in a variety of investment tools
 Financial Assets
• Three types:

1. Fixed income or debt

2. Common stock or equity
3. Derivative securities
 Fixed Income
• Payments fixed or determined by a formula

• Money market debt: short term, highly

marketable, usually low credit risk

• Capital market debt: long term bonds, can be

safe or risky
 Principles for Successful Investing
• Watch overconfidence
– Men trade 45% more than women
• Their annualized returns were 2.7% less
– Single men trade 67% more than single women
• Their annualized returns were 1.4% less
– Most investors have significantly (> 5% a year)
underperformed the market over the last 20 years
• Watch on-line trading
– Before on-line, investors beat the market by 1.9%
• Afterwards, they underperformed by 3.6%
Carla Fried, “The Problem with your Investment Approach,” Business 2.0, November 2003,
p. 146
 Principles for Successful Investing
2. Understand Risk
– Risk is inherent in all investing activities
• There are lots of different types of risk
– Inflation, business, interest rate, financial, market, political
and regulatory, exchange rate, call, and liquidity risk
– Invest at a risk level you are comfortable with
• Find that risk level
– Taking a risk tolerance test may help. Take TT16 – A Risk
Tolerance Test to get a sense on how much risk you can
tolerate
 Principles for Successful Investing
3. Stay diversified
– Always invest in different asset classes and assets
• Diversification is your key defense against risk
– Make sure you understand the risks of each and every asset
class you invest in
• It’s a risky place out there. Be prepared!
– Remember that the numbers you see for specific asset class
performance are from diversified portfolios, not single assets!
– Use TT23 – Return Simulation Worksheet to see the effects of
diversification
4. Invest low cost and tax-efficiently
– Control what you can.
• You cannot control returns, but you can control your
costs, fees, and taxes
– A $1 saved is more than a $1 earned because:
» You pay taxes, charitable contributions and savings on
every new dollar earned, and a dollar saved can earn
income and income on income (compound interest)
• Realize that frequent trading incurs significant costs,
both in terms of transactions costs and taxes
5. Invest long-term
– Avoid short-term and day trading
• Its expensive and generates transactions costs and
taxes
– Invest wisely
• There are no get-rich-quick schemes that work.
– Stay at least partly in the market
• Taking money out of the market or not continuing to
save and invest stops your progress
6. If you must invest in individual assets, know
what you invest in and who you invest with
– When investing in individual assets, do your
homework
• Know what you are investing in
• Know who you are investing with
• Be aware of the environment in which the company
operates
• Be very careful and invest wisely
7. Monitor portfolio performance
– Measure performance. President Thomas S. Monson
stated:
When performance is measured, performance improves.
Where performance is measured and reported, the rate of
improvement accelerates (General Conference reports,
1970).
– How can you know how you are doing if you don’t check your
performance against some benchmark?
– Interestingly, most investors have underperformed the
market benchmarks over the last 20 years
• (DALBAR’s Annual Quantitative Analysis of Investor Behavior 2014)
8. Don’t waste too much time, money, and
energy trying to beat the market, unless you
have a lot of time, money, and energy
– It is very difficult, expensive, and time consuming
to try and beat the market
• If you want to trade, trade tax-efficiently and in tax-
deferred accounts
– If your actively managed funds under-perform, look to index
funds as inexpensive, tax efficient and very viable alternatives
to actively managed funds
9. Invest only with high quality, licensed, and
reputable people and institutions
– When help is needed, don’t be afraid to get help.
• But get good help from good people consistent with the
principles discussed
• And compare the performance of that help to your
benchmarks after taxes (and to a passive portfolio)
– Use the best resources available
• Know how those resources are compensated
• Work only with licensed and registered advisors
• Get references for any resources
10. Develop a good investment plan consistent
with your goals, budget, and these principles,
and follow it closely
– Think it through and write it wisely
• It’s your roadmap to success
– If you write it wisely and invest accordingly, it will
save you much heartache in the future
• And you will likely achieve your personal goals
• Understand key investment basics:
– What is investing?
• The giving up of something important to us now in order to
get something better in the future
– What is sacrifice?
• The giving up of something important to us now in order to
get something better in the future
– Are they similar?
• Yes
– Do we all invest?
• Definitely yes
 Investment Basics (continued)
• Why do we invest?
– From our view:
• To accomplish our personal and family goals
• To have resources for retirement, education, etc.
• To grow our financial assets to serve and bless our families
and others
– From the Lord’s view:
• To bring us to Christ
• To help us achieve our divine missions
• To help us return with our families with honor
• To teach us to be “wise stewards”
• The difference between investing and gambling?
Investing: The odds are in your favor
• There is a favorable risk-return tradeoff
• It is part of a long-term plan
• You have done your homework
• It involves the creation of wealth
Gambling: The odds are in another’s favor
• There is no favorable risk-return tradeoff
• There is no long-term plan
• There is no homework, only chance
• It is a zero-sum game—no wealth is created
– Principle: Know the difference
• Are there things you should do before you
start investing?
– Is there a priority to paying bills?
– Are there certain things you should never do
without?
– Are their other bills more important than
investing?
– Is there a purpose to investing?
• Money market securities
• Stocks
– Primary and secondary stock markets
– Primary market: a market where newly issued
securities are traded
• Initial public offering (IPO): the first offering
of a firm’s stock to the public
– Secondary market: a market where existing stocks
are traded
 Types of Investment
• Types of stock investors
– Institutional investors: professionals who are
responsible for investing the money
of a financial institution on behalf of their clients
– Portfolio managers: employees of financial
institutions who make investment decisions
– Individual investors: individuals who invest a
portion of their own money
• Return from investing in stock
– Returns come through dividends and price
appreciation
– Growth stocks: stocks of firms with substantial
growth opportunities
– Income stocks: stocks that provide investors with
periodic income in the form of large dividends
• Common versus preferred stock
– Common stock: a certificate issued by a firm to
raise funds that represents partial ownership in
the firm
– Preferred stock: a certificate issued by a firm to
raise funds that entitles shareholders to first
priority to receive dividends
• Less risky than common stock
• Bonds
– Return from investing in bonds is in the form of
coupon payments and price appreciation
• Mutual Funds
– Return from investing in mutual funds comes from
coupon or dividend payments generated by the
portfolio of the fund
• Publicly traded indexes: securities whose
values move in tandem with a particular stock
index representing a set of stocks
– One of the most popular is the Standard & Poor’s
Depository Receipt (S.P.D.R, also called Spider)
• Real estate
– Buying a home or purchasing rental property or
land
– Return from investing in real estate comes in the
form of rent payments and selling the property for
a higher price than paid for it
 Investment Return and Risk
• Real estate
Buying a home or purchasing rental property
or land
Return from investing in real estate comes in
the form of rent payments and selling the
property for a higher price than paid for it
• Risk from investing
– Returns are uncertain
– Future values of investments are dependent on
demand by investors
– Before you select an investment, you should
assess the risk
 Investment Return and Risk
– Measuring an investment’s risk
• Range of returns: returns of a specific investment over
a given period
• Standard deviation of returns: the degree of volatility in
the stock’s return over time
• A risky stock will normally have a relatively wide range
of returns and a high standard deviation of returns
• There are other subjective measures of risk
 Investment Return and Risk
• Return-risk tradeoff among stocks
– Small firms tend to have more growth potential,
but higher risk
– IPOs may offer high returns, but also have high
risk, especially for individual investors
• Return-risk tradeoff among bonds
– Large, well-known firms have low return, low risk
– High risk bonds offer higher payments
• Risk-return tradeoff among mutual funds
– Mutual funds containing small stocks are more
risky than those containing large stocks
– Mutual funds containing bonds of weak
corporations are more risky than those with bonds
of creditworthy corporations
• Risk-return tradeoff among mutual funds
– Mutual funds containing small stocks are more
risky than those containing large stocks
– Mutual funds containing bonds of weak
corporations are more risky than those with bonds
of creditworthy corporations
 Learning From the Investment
Mistakes of Others
• Making decisions based on unrealistic goals
• Borrowing to invest
• Taking risks to recover losses from previous
investments
• Focus on Ethics: Falling prey to online
investment fraud
– Avoid making decisions without facts
• Key decisions about investments that should
be included in your financial plan are:
– What are your investment goals?
– Given your existing budget, should you make
investments?
– Based on your risk tolerance, how should you
invest funds?