CH-13 Investing Fundamentals – Personal Finance : Chapter Notes

13 INVESTING FUNDAMENTALS CHAPTER OVERVIEW This chapter is the first chapter in Part Five—Investing Your Financial Resources. We begin our discussion by stressing the importance of preparing for an investment program and managing your credit card debt. Then, we provide an overview of how the factors of safety, risk, income, growth, and liquidity affect investment programs. Next, we examine asset allocation and the different investment alternatives available to individuals. We also study methods that investors can use to reduce investment risk. Included in this section on reducing risks is a discussion on the importance of the individual’s role in the investment process. Finally, we discuss sources of investment information which include the Internet, newspapers, news programs, business periodicals and government publications, corporate reports, investor services and newsletters. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO13-1 Describe why you should establish an investment program. As pointed out in the My Personal Finance Life opening scenario for this chapter, there is no better time for college students to begin planning for retirement than now. The reason is quite simple: If you start an investment program when you are young, let the time value of money work for you, and make sound investments, you won’t have to worry about finances when you reach retirement age. It all begins with creating the investment goals that are right for you. Investment goals must be written, specific, and measurable and should be classified as short term, intermediate, and long term. Before beginning an investment program, you must then make sure your personal financial affairs are in order. This process begins with learning to live within your means including managing your credit card debt. The next step is the accumulation of an emergency fund equal to three to six months’ living expenses or more. Then, and only then, is it time to save the money needed to establish an investment program. Because of the time value of money, even small investments can grow to substantial amounts over a long period of time. LO 13-2 Assess how safety, risk, income, growth, and liquidity affect your investment decisions. All investors must consider the factors of safety, risk, income, growth, and liquidity. Especially important is the relationship between safety and risk. Keep in mind that there is risk associated with all investments. Often, investors may experience two types of risk: a risk you will not receive periodic income payments; and a risk that an investment will decrease in value. As a result, all investors must evaluate their tolerance for risk. Basically, this concept can be summarized as follows: The potential return for any investment should be directly related to 13-1 the risk the investor assumes. In fact, some investors base their investment decisions on projections for rate of return. You can also use the same calculation to determine how much you actually earn on an investment over a specific period of time. The risk factor can be broken down into five components: inflation risk, interest rate risk, business failure risk, market risk, and global investment risk. Income, growth and liquidity may also affect your choice of investments. LO 13-3 Explain how asset allocation and different investment alternatives affect your investment plan. Asset allocation is the process of spreading your assets among several different types of investments to lessen risk. Typical asset classes include large-cap stocks, mid-cap stocks, small-cap stocks, foreign stocks, bonds, and cash. The percentage of your investments that should be invested in each asset class is determined by your age, investment objectives, your ability to tolerate risk, how much you can save and invest each year, the dollar value of your current investments, the economic outlook for the economy, and several other factors. Typical long-term investment alternatives include stocks, bonds, mutual funds, and real estate. More speculative investment alternatives include options, commodities, derivatives, precious metals, gemstones, and collectibles. Before choosing a specific investment, all potential investments should be evaluated on the basis of safety, risk, income, growth, and liquidity. With all of these factors in mind, the next step is to develop a specific, personal investment plan. LO 13-4 Recognize the importance of your role in a personal investment program. It is your responsibility to monitor the value of your investments. Accurate recordkeeping can also help you spot opportunities to maximize profits or reduce losses when you sell your investment. These same detailed records can help you decide whether you want to invest additional funds in a particular investment. To achieve their financial goals, many people seek professional help. In many cases, they turn to stockbrokers, lawyers, accountants, bankers, insurance agents, or financial planners. If you choose to use a financial planner or other professional, keep in mind, you are the one who must make the final decisions with the help of the professionals. Finally, it is your responsibility to determine how taxes affect your investments. LO 13-5 Use the various sources of financial information to reduce investment risks and increase investment return. Since there is more information on investments than most investors can read and comprehend, investors must be selective in the type of information that they use for evaluation purposes. Sources of information include: the Internet, newspapers and news programs, business periodicals, government publications, corporate reports, and investor services and newsletters. 13-2 INTRODUCTORY ACTIVITIES • Point out the learning objectives (p. 443) in an effort to highlight key points in the chapter. • Discuss the information presented in the My Life feature: Why Invest? (p. 443). • Ask students to share experiences about investments they or their family have had. • Point out the benefits of investing for long-term personal financial security. WHAT’S NEW Selected Topics Benefits for the Teaching and Learning Environment New content: Why you should pay your bills on time Updated coverage: The need to manage credit card debt New content: Basic information on economics New Did You Know New content: Priority of investment goals Revised content: The time value of money New examples: Real- world examples Updated statistics: Value of long-term investments Updated Did You Know New Dashboard feature Provides information about why an individual should pay recurring bills on time and what happens if bills aren’t paid. Includes revised statistics about how many Americans use credit cards and how much they owe. Defines economics and the business cycle and how the economy can affect an individual’s personal finances and investment activities. Points out trends for American consumer debt. Describes how many employers have eliminated or reduced their matching provisions in a 401(k) or 403(b) retirement plans during the recent economic crisis. Includes more streamlined coverage of how to calculate the time value of money. Uses real-world companies including Apple, J.M. Smuckers, Border’s Books, Shutterfly, and Biogen Idec to illustrate key topics in the chapter., Provides updated statistics about the performance of stocks and bonds for the period 1926 to 2013. Gives updated information for different income levels for people in the United States. Explains the importance of developing measurable investment goals and performing a financial checkup. 13-3 CHAPTER 13 OUTLINE I. Preparing for an Investment Program A. Establishing Investment Goals B. Performing a Financial Checkup 1. Ethical Concerns: Paying Your Bills on Time 2. Work to Balance Your Budget 3. Manage Your Credit Card Debt 4. Start an Emergency Fund 5. Have Access to Other Sources of Cash for Emergency Needs C. Managing a Financial Crisis D. Getting the Money Needed to Start an Investment Program 1. Priority of Investment Goals E. How the Time Value of Money Affects Your Investments II. Factors Affecting the Choice of Investments A. Safety and Risk B. The Risk-Return Tradeoff 1. Evaluating Your Tolerance for Risk 2. Calculating Return on Investment C. Components of the Risk Factor 1. Inflation Risk 2. Interest Rate Risk 3. Business Failure Risk 4. Market Risk 5. Global Investment Risk D. Investment Income E. Investment Growth F. Investment Liquidity III. Asset Allocation and Investment Alternatives A. Asset Allocation and Diversification 1. The Time Factor 2. Your Age B. An Overview of Investment Alternatives C. Stock or Equity Financing D. Corporate and Government Bonds E. Mutual Funds F. Real Estate G. Other Investment Alternatives H. A Personal Plan for Investing IV. Factors That Reduce Investment Risk A. Your Role in the Investment Process 1. Evaluate Potential Investments 2. Monitor the Value of Your Investment 3. Keep Accurate and Current Records B. Other Factors that Improve Investment Decisions V. Sources of Investment Information A. The Internet B. Newspapers and News Programs C. Business Periodicals and Government Publications D. Corporate Reports E. Investor Services and Newsletters 13-4 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions I. PREPARING FOR AN INVESTMENT PROGRAM (p. 444) • By studying the basic investment principles presented in this chapter, along with the information on stocks, bonds, mutual funds, real estate, and other alternatives in the remaining investment chapters, you can create an investment plan that is custom-made for you. Establishing Investment Goals (p.444) • To be useful, investment goals must be written, specific, and measurable. • Investment goals must be tailored to your particular financial needs. • Investment goals must always be oriented toward the future. Performing a Financial Checkup (p. 444) • Before beginning an investment program, you must make sure your personal financial affairs are in order. To be successful, you must: 1. Pay your bills on time. 2. Work to balance your budget. 3. Manage your credit card debt 4. Start an emergency fund equal to at least three to six months’ living expenses. 5. Have access to other sources of cash for emergency needs. Managing a Financial Crisis (p. 446) • While the typical personal finance course is not an economics course, it does help to have a basic understanding of how the nation’s economy affects your personal financial situation. • Economics is the study of how wealth is created and distributed. • A nation’s business cycle also affects your personal finances. Many economists define a business cycle as the increase and decrease in a nation’s economic activity. • The recent economic crisis underscores the importance of managing your personal finances and your investment program. • To manage a financial crisis, many experts recommend that you take action to make sure your financial affairs are in order. Specific steps include: 1. Establish a larger than usual emergency fund. 2. Know what you owe. • Use PPT slides 13-1 and 13-2. • Text Reference: There are eight specific questions included in this section that may help students establish valid investment goals. • Use PPT slides 13-3 and 13-4. • Current Example: Many financial planners stress the importance of home equity as part of an investment plan. Not only does home ownership provide for a possible increase in equity, it also has definite tax advantages. Under current tax laws, interest on homes and real estate property taxes are deductible for federal tax purposes. • Use PPT slide 13-5. • Discussion Question: When you decide to start an investment program, where does the money come from? • Discussion Questions: What are the ethical implications of not paying your bills on time? What could happen if you don’t pay your bills on time? • Discussion Question: How did the recent economic crisis affect you or someone you know? • Text Reference: You may want to discuss the “Did You Know” feature about the amount of consumer debt on p. 446 at this point in your lecture and how it relates to the business cycle. • Discussion Questions: How would you rate the health of the nation’s economy now? What problems could affect your personal financial planning? • Use PPT slide 13-6. 13-5 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions 3. Reduce spending. 4. Notify credit card companies and lenders if you are unable to make payments. 5. Monitor the value of your investment and retirement accounts. 6. Consider converting investments to cash to preserve value. Getting the Money Needed to Start an Investment Program (p. 447) • Once you have established your investment goals and completed your personal financial checkup, it’s time to start investing—assuming that you have enough money to finance your investments. • Priority of Investment Goals • What is important to you? And the you may be the most important part of a successful investment program. • What do you value? • Use PPT slide 13-7. • The How To . . . Obtain the Money Needed to Establish an Investment Program can provide useful tips to help your students obtain the money to begin investing--see p. 448. How the Time Value of Money Affects Your Investments (p. 448) • If you start an investment program when you are young, let the time value of money work for you, and make sound investments, you won’t have to worry about finances when you reach retirement age. • Many individuals never start an investment program because they only have a small sum of money. But even small sums of money grow over a long period of time. • The Financial Planning Calculations feature on p. 450 illustrates how much you’re a $2,000 investment would be worth if the money is invested at 4 percent for 40 years. • The actual calculation can be completed by using a financial calculator or by using the information in the table. In this feature a table is used to calculate the dollar amount at the end of 40 years. You can use the three specific steps provided in the feature to calculate how different investment amounts, interest rates, and the time factor affect the total value of your investments • Text Highlight: Use the Financial Planning Calculations feature on p. 450 to illustrate the growth for $2,000 for 5, 10, 20, 30, and 40 year periods at different rates of return. Also, there is a student tryout problem. • Practice Quiz 13-1 (p. 449) II. FACTORS AFFECTING THE CHOICE OF INVESTMENTS (p. 450) • Although each investor may have specific individual reasons for investing, there are a number of factors • Use PPT slide 13-8. 13-6 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions that all investors must consider. Safety and Risk (p. 450) • The safety and risk factors are two sides of the same coin. Safety in an investment means minimal risk of loss. On the other hand, risk in an investment means a measure of uncertainty about the income. • Investments range from very safe to very risky. At one end of the investment spectrum are very safe investments that attract conservative investors. Investors pick such investments because they know there is very little chance that investments will become worthless. • At the other end of the investment spectrum are very risky investments. A speculative investment is high- risk investment that is made in the hope of earning a relative large profit in a short time. Such investments offer the possibility of a larger dollar return, but if they are unsuccessful, the investor may lose most or all of the initial investment. The Risk-Return Tradeoff (p. 451) • You may experience two types of risks with most investments. 1. Investors often choose some investments because they provide a predictable source of income. In reality, there is a risk that you will not receive periodic income payments. 2. A second type of risk with many investments is that an investment will decrease in value. • Evaluating your tolerance for risk. When investing, not everyone has the same tolerance for risk. In fact, some people will seek investments that offer the least risk. 1. When people choose investments that have a higher degree of risk, they expect larger returns. 2. One basic rule sums up the relationship between the factors of safety and risk: The potential return on any investment should be directly related to the risk the investor assumes. • Calculating return on investment. The rate of return you receive is often determined by the amount of risk you are willing to take. 1. To determine how much you actually earn on an investment over a specific period of time, you can calculate your rate of return. 2. To calculate rate of return, the total income you receive on an investment over a specific period of time is divided by the original investment • Text Highlight: You may want your students to take the risk tolerance test included in the “Financial Planning for Life’s Situations” boxed feature on p. 454. • Use PPT slide 13-9. • Text Highlight: Use Exhibit 13-1 to help your students determine if they are comfortable with the risk associated with conservative and speculative investments (p. 451). • Discussion Question: Have your students discuss the following statement: The potential return on any investment should be directly related to the risk that the investor assumes. • Use PPT slide 13-10. • Text Reference: You may want to review the example for rate of return on p. 452 in the text. 13-7 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions amount. 3. With this information, it is also possible to compare the projected rate of return for different investment alternatives that offer more or less risk. Components of the Risk Factor (p. 453) • The factor of risk associated with a specific investment does change from time to time. In fact, the overall risk factor can be broken down into the following five components. 1. Inflation risk 2. Interest rate risk 3. Business failure risk 4. Market risk 5. Global Investment Risk • You may want to discuss the My Life feature (p.453) on the importance of understanding the relationship between safety and risk at this point in your class presentation. • Use PPT slides 13-11 and 13-12. • Text Highlight: You may want to review the bond interest calculation and the approximate market value calculations on pp.453 and 454. Investment Income (p. 456) • Investors sometimes purchase certain investments because they want a predictable source of income from their investment. The safest investments are passbook savings accounts, certificates of deposit, and securities issued by the U.S. government are also the most predictable sources of income. • If income is a primary objective, most investors choose municipal bonds, corporate bonds, preferred stock, utility stocks, or selected common stocks. Other investments that provide income potential are mutual funds and real estate rental property. • When purchasing investments for income, you should be concerned about the issuer’s ability to make periodic income or dividend payments. • Use PPT slides 13-13 and 13-14. • Discussion Question: How can a CD provide both income and growth? Investment Growth (p. 456) • To investors, growth means that their investment will increase in value. • Companies with better than average earnings potential, sales revenues that are increasing, and managers who can solve the problems associated with rapid expansion are often consider to be growth companies. • Stocks, mutual funds, and real estate may offer growth possibilities. • Use PPT slide 13-15. • Discussion Question: For someone just beginning an investment program, why is growth important? Investment Liquidity (p. 456) • Liquidity is the ease with which an asset can be converted to cash without a substantial loss in dollar value. • Practice Quiz 13-2 (p. 457) 13-8 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions III. ASSET ALLOCATION AND INVESTMENT ALTERNATIVES (p. 457) • By now, you are probably thinking, how can I choose the right investment for me? To help answer that question, consider the following: 1. Since 1926, stocks, as measured by the Standard and Poor’s 500 stock index, have returned 9.8 percent a year and outperformed other investment alternatives on average. 2. By comparison, long-term government bonds have return just over 5 percent during the same period. 3. Since 1926, stocks had positive gains in 63 years. 4. Since 1926, stocks lost money in 25 years. 5. In reality, stocks have a place in every investment portfolio, but there is more to establishing a long-term investment program than just picking a bunch of stocks. • Asset Allocation and Diversification. (p. 457) Asset allocation is the process of spreading your assets among several different types of investments (sometimes referred to as asset classes). 1. Simply put, asset allocation really means that you need to diversify and avoid the pitfall of putting all your eggs in one basket—a common mistake made by investors. 2. Typical asset classes include stocks issued by large corporations (large cap), stocks issued by medium size corporations (mid cap), stocks issued by small, rapidly growing companies (small cap), foreign stocks, bonds, and cash. 3. Many financial experts argue that asset allocation is the most important factor when establishing a long-term investment program because choosing the “right mix” of assets will outperform the investment selections that individual investors make over a long period of time. 4. The percentage of your investment that should be invested in each asset class is determined by your age, investment goals, your ability to tolerate risk, how much you can save and invest each year, the dollar value of your current investments, the economic outlook for the economy, and several other factors. 5. To help you decide how much risk is appropriate for your investment program, many financial • Discussion Questions: Why do investors choose to invest in stocks? Why would they choose other investment alternatives? • Use PPT slide 13-16. • Text Highlight: The Did You Know feature on page 458 describes how income is related to an individual’s investment goals and investment program. • Current Example: Eager to drum up new business, the people on Wall Street are encouraging investors to use asset allocation. • Text Reference: You may want to discuss the My Life feature on page 458 on the importance of Asset Allocation at this point in your class discussion. • Text Reference: To illustrate how asset allocation can be used for a 31-year old investor, see Exhibit 13.2 on page 458. 13-9 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions planners suggest that you think of your investment program as a pyramid consisting of four levels, as illustrated in Exhibit 13-3. • The Time Factor. The amount of time your investments have to work for you is an important factor when managing your investment portfolio. 1. If you can leave your investments alone and let them work for 5 to 10 years or more, then you can invest in stocks and mutual funds. 2. On the other hand, if you need your investment money in two years, you should probably invest in short-term government bonds, highly rated corporate bonds, or certificates of deposit. • Your Age. A final factor to consider when choosing an investment is your age. 1. Younger investors tend to invest a large percentage of their assets in growth-oriented investments. 2. Older investors tend to be more conservative. 3. Financial expert, Suze Orman, suggests that you subtract your age from the number 110. The difference is the percentage of your assets that should be invested in growth investments. • An Overview of Investment Alternatives (p.460) • Once you have considered the risks involved, asset allocation, the time factor your investments can work for you, and your age, it’s time to consider which investment alternative is right for you. • Exhibit 13-3 illustrates the investment pyramid with four levels of investments ranging from low risk to high risk. • Current Example: Based on their current age, you may want to have students calculate the percentage of their investments that should be growth- oriented—see page 459. Stock or Equity Financing (p. 460) • Equity capital is money that a business obtains from its owners. • Investors should consider at least two factors before investing in stock. First, a corporation is not obligated to repay the money obtained from the sale of stock or to repurchase the stock at a later date. Second, a corporation is under no legal obligation to pay dividends. • A dividend is a distribution of money, stock, or other property that a corporation pays to stockholders. • There are two types of stock—common stock and preferred stock. • People often purchase stock because of (1) dividend income, (2) the possibility of increased value, and (3) the possibility of increased value caused by stock splits. Corporate and Government Bonds (p. 460) • There are two types of bonds that an investor should • Use PPT slide 13-17. • Discussion Question: When compared to other investments, stocks have higher returns over a long period of time. Do you think the higher returns are worth the increased risk? • Use PPT slide 13-18. 13-10 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions consider. A corporate bond is a corporation’s written pledge that it will repay a specified amount of money with interest. A government bond is the written pledge of a government or a municipality to repay a specified sum of money with interest. • The maturity dates for most bonds range between 1 and 30 years. • The value of a bond is closely tied to the ability of the corporation or government entity to repay the bond at maturity and pay interest payments until maturity. • Also keep in mind that the value of a bond may increase or decrease in value before it reaches maturity because of changes in interest rates in the economy. • Interest payments on bonds are made every six months. Mutual Funds (p. 461) • A mutual fund pools the money of many investors— its shareholders—to invest in a variety of securities. • Professional management is an especially important factor. • Another reason why investors choose mutual funds is because of diversification. • The goals of one investor may differ from those of another investor. The managers of mutual funds realize this and tailor programs to meet individual needs and objectives. • In many cases, mutual funds can also be used for retirement accounts, including traditional individual retirement accounts, Roth IRAs, and retirement plans sponsored by your employer. Real Estate (p. 461) • As a rule, real estate increases in value and eventually sells for a profit, but there are no guarantees. • Any investment has its disadvantages, and real estate is no exception. Like any other investment, real estate must be evaluated. • Use PPT slide 13-19. • Discussion Question: Why would an investor purchase a mutual fund? • Use PPT slides 13-20 and 13-21. • Discussion Question: What are some of the disadvantages of owning real estate investments? What are some of the advantages? Other Investment Alternatives (p. 462) • Speculative investments include: options, commodities, derivatives, precious metals, gemstones, coins, stamps, and antiques and collectibles. • Without exception, investments of this kind are normally referred to as speculative for one reason or another. • More detailed information about the investment alternatives is provided in later chapters. • Use PPT slide 13-22. 13-11 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions A Personal Investment Plan for Investing (p. 462) • Earlier in this chapter we examined how the factors of safety, risk, income, growth, and liquidity affect investments. Now it is possible to compare the different investment alternatives to those factors. (See Exhibit 13-4.) • To be successful, you must develop a plan and then implement it. • Individuals begin investment planning by establishing realistic goals. • The eight steps required for an effective personal plan of action are presented in Exhibit 13-5. • Use PPT slide 13-23. • Text Highlight: Use the Did You Know feature on page 462 to stress the importance of asking questions when choosing an investment. • Use Transparency Masters 13-1 and 13- 2. • Practice Quiz 13-3 (p. 464) IV. FACTORS THAT REDUCE INVESTMENT RISK (p. 464) Your Role in the Investment Process (p. 464) • An informed investor has a much better chance of choosing the types of investments that will increase in value. But you have to be willing to work and learn if you want to be an informed investor. • Factors that can spell the difference between success and failure include: 1. Evaluating potential investments. 2. Monitoring the value of your investment. 3. Keeping accurate and current records. • Other Factors to Consider. To achieve their financial goals, many people seek professional help. 1. Often investors turn to stockbrokers, lawyers, accountants, bankers, or insurance agents. However, these professionals are specialists in one field and may not be qualified to develop a thorough financial plan. 2. Another source of help is a financial planner who has had training in securities, insurance, taxes, real estate, and estate planning. 3. You must also consider the tax consequences of selling your investments. • Use PPT slide 13-24. • Use the My Life feature on page 465 to reinforce the fact that successful investors are involved in their investment program. • Text Highlight: You may want to discuss the Financial Planning Calculations feature “Monitoring the Value of Your Investment” feature on p. 465. Also, there is a student tryout problem. • Practice Quiz 13-4 (p. 466) V. SOURCES OF INVESTMENT INFORMATION (p. 466) • With most investments, there is more information than an investor can read and comprehend. Therefore, you must be selective in the type of information that you use for evaluation purposes. The following sources may be of value: • Use PPT slide 13-25. • You may want to discuss the sources of information described in Exhibit 13-6 and 13-7 at this point in your class discussion. • Text Highlight: You may want to mention the My Life feature that stresses the importance of evaluating investments. 13-12 CHAPTER 13 LECTURE OUTLINE Instructional Suggestions 1. The Internet 2. Newspapers and news programs 3. Business periodicals and government publications 4. Corporate reports 5. Investor services and newsletters • Use PPT slide 13-26. • Practice Quiz 13-5 (p. 470) CONCLUDING ACTIVITIES • Point out the Dashboard and My Life Stages for Investing features, chapter summary, and key terms at the end of the chapter. (p. 470). • Discuss selected end-of-chapter Key Formulas, Self-Test Problems, Financial Planning Problems, Financial Planning Activities, and Financial Planning Case. • Use the Chapter Quiz in the Instructor’s Manual. • Refer students to the Student Web site for Chapter 13. WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 13 Sheet 55 Investment Objectives Sheet 56 Investment Risk Sheet 57 Investment Information Sources CHAPTER 13 QUIZ ANSWERS True-False Multiple Choice 1. F (p. 444) 6. B (p. 461) 2. T (p. 445) 7. A (p. 461) 3. T (p. 446) 8. C (p. 462) 4. F (p. 450) 9. B (p. 457) 5. T (p. 451) 10. A (p. 469) 13-13 Name ________________________________________ Date ____________________________ CHAPTER 13 QUIZ TRUE-FALSE _____1. Long-term objectives are defined as objectives that can be accomplished within one year. _____2. An emergency fund is an amount of money that can be obtained quickly in case of immediate needs. _____3. A line of credit is a short-term loan that is approved before the money is actually needed. _____4. There is no relationship between safety and risk when choosing an investment. _____5. A speculative investment is usually defined as one that is made in the hope of earning a relatively large profit in a short time. MULTIPLE CHOICE _____6. Corporate bonds a. are tax exempt from federal taxation. b. must be repaid at maturity. c. pay dividends on a quarterly basis. d. are debt obligations, and, therefore, risk free. _____7. Which of the following investments would have the greatest potential for safety? a. Government bonds b. Stocks c. Commodities d. Options _____8. Which of the following investments would have the greatest potential for risk? a. Preferred stock b. Corporate bonds c. Options d. Bank accounts _____9. Which of the following statements is false? a. Asset allocation is the process of spreading your assets among several different types of investments. b. Asset allocation eliminates the risk associated with an investment program. c. The time your investments can work for you is a major factor to consider when choosing investment alternatives. d. Your age is a factor that should be considered when establishing an investment program. _____10. Standard & Poor’s is an example of a(n) a. investor service. b. corporate report. c. government publication. d. newspaper. 13-14 SUPPLEMENTARY LECTURE You may want to review the time value of money concept as part of your discussion of Chapter 13. Sometimes students forget that any investment program is based, to some extent, on this important concept. The material below will help reinforce the time value of money concept. The Problem The old saying goes: “I’ve been rich and I’ve been poor, but believe me, rich is better.” While being rich doesn’t guarantee happiness, the accumulation of money does provide financial security and is a goal worthy of pursuit. Regardless of how much money you want or what you want to use the money for, the time value of money concept can help you obtain your financial goals. The Solution The time value of money is a concept that recognizes that money can be invested, earn interest and dividends, and increase in value over a period of time. For example, assume you invest $10,000 in a certificate of deposit that pays 4 percent interest. If you let your interest accumulate, your initial $10,000 investment is worth $10,400 at the end of one year. At the end of five years, your investment is worth $12,170. At the end of ten years, your investment has increased to $14,800. In this example, you have received $4,800 in interest over a ten-year period of time as a result of letting your interest compound and grow. How You Can Become a Millionaire Today, there are many millionaires in the United States, and you, too, can become a millionaire. Here’s a plan guaranteed to work. Let’s assume you are 25 years old and invest $4,000 each year in an investment that provides an 8 percent return each year for the next forty years. When you reach age 65, your investment will be worth $1,036,240. Over a forty-year period of time, you have invested a total of $160,000 ($4,000 x 40 = $160,000. The remainder ($876,240) is the result of letting your investment accumulate and compound for forty years. As part of your discussion, you may want to discuss how people can “find” the $4,000 needed to fund this type of investment program each year. You may also want to discuss what happens if the investor earns a higher or lower rate of return or invests different amounts of money for a longer or shorter period of time. (Note: The table in the Financial Planning feature on page 450 in this chapter can be used to determine the effect of different rates of return and different time periods.) Finally, you may want to discuss the types of investments (and the risk associated with these investments) that will generate an 8 percent or higher return. 13-15 ANSWERS TO PRACTICE QUIZ QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE PRACTICE QUIZZES Practice Quiz 13-1 (p. 449) 1. Why should an investor develop specific investment goals? The goal setting process is important because it forces investors to consider what they want to accomplish in the future. You may want to remind students that these goals are not set in concrete, but can be changed if necessary. (p. 444) 2. What factors should you consider when performing a financial checkup? A financial checkup allows investors to determine if they are ready to invest. The five factors to consider are: (1) make sure your bills are paid on time; (2) work to balance your budget; (3) manage your credit card debt; (4) start an emergency fund; and (5) have access to other sources of cash for emergency needs. (pp. 444-446) 3. Explain the time value of money concept and how it affects your investment programs. The time value of money concept allows people to invest money over a period of time. At the end of the investment period, people receive not only what they have invested, but also the earnings (dividends and interest) the investment has earned. The investment may (hopefully) increase in value. For most people, an investment program is built on the principle of investing small sums of money over a long period of time. Thus, the time value of money can really help people accumulate wealth. (pp. 448-449) 4. Using the information in the Financial Planning Calculations feature, calculate the future value of your investments if you invest $3,000 each year for 20 years. Assume your investments earn 5 percent each year. Three thousand dollars invested for 20 years that earns 5 percent each year would be worth $99,198, as shown below. $3,000 (Annual Investment) x 33.066 (Table Factor from p. 450) = $99,198. Practice Quiz 13-2 (p. 457) 1. In your own words, describe the risk-return tradeoff. Simply put, one basic rule sums up the relationship between the factors of safety and risk (and the risk-return tradeoff): The potential return on any investment should be directly related to the risk the investor assumes. When investing, not everyone has the same tolerance for risk. In fact, some people may actually be risk averse. Typically, a risk averse investor will seek investment alternatives that offer the least risk. When people choose investments that have a higher degree of risk, they expect larger returns. (p. 450) 2. What are the five components of the risk factor? The five components of the risk factor are: (1) inflation risk; (2) interest rate risk; (3) business failure risk; (4) market risk; and (5) global investment risk. (p. 453-455) 3. How do income, growth, and liquidity affect the choice of an investment? 13-16 Each of these factors can affect the choice of investments. Investors purchase certain investments because they want a predictable return or distribution of income from the investment. Growth means that their investment will increase in value. Liquidity is the ability to buy or sell an investment quickly without substantially affecting the investment’s value. Usually, investors must give up some of one factor to get more of another factor. (p. 456) Practice Quiz 13-3 (p. 464) 1. How can asset allocation help you build an investment program to reach your financial goals? Many financial planners suggest that you use asset allocation to avoid the mistake of putting all your eggs in one basket. Asset allocation stresses the importance of diversification and is the process of spreading your assets among several types of investments (asset classes) to reduce risk. (pp. 457-459) 2. How do the time your investments have to work for you and your age affect your investment program? The amount of time your investments have to work for you and your age are important factors when managing your investment portfolio. If you can leave your investments alone and let them work for 5 to 10 years or more, then you can invest in stocks and mutual funds. On the other hand, if you need your investment money in two years, you should probably invest in short-term government bonds, highly rated corporate bonds, or certificates of deposit. Another factor to consider when choosing an investment is your age. Younger investors tend to invest a large percentage of their assets in growth- oriented investments. Older investors tend to be more conservative. (p. 459) 3. Of all the investment alternatives presented in this chapter, which one do you think would help you obtain your investment goals? Explain your answer. While individual student answer may vary, you may want to use this question to review each of the investment alternatives described in this chapter. You may also want to review Exhibit 13-4 on page 463, which summarizes how different investment alternatives relate to the factors of safety, risk, income, growth, and liquidity (pp. 460-462) 4. Using the Suze Orman method described on page 459, determine how much of your investments should be growth oriented. Does this seem like a reasonable amount? While student answers will vary depending on how old they are and their individual financial situation when they answer this question, you may want to review the calculations that can be used to determine what percentage of investments should be growth oriented. As a reminder, financial expert, Suze Orman, suggests that you subtract your age from the number 110. The difference is the percentage of your assets that should be invested in growth investments. (p. 459) Practice Quiz 13-4 (p. 466) 1. What is your role in the investment process? Your role is to evaluate potential investments, monitor the value of your investments, and keep current records. (pp. 464-465) 2. Why should you monitor the value of your investment? Without monitoring the value of investments, it is impossible to know if the investments are increasing or decreasing in value. It should also be pointed out that this information can help investors decide to hold specific investments, invest additional money in the investments, or sell the investments. (pp. 464-465) 3. Assume you have $10,000 that can be invested. Would you make your own decisions or seek professional help? Explain your answer. While students must answer this question, you may want to discuss the importance of obtaining accurate information regardless if it comes from a professional or from the investor’s own efforts. The key point is to obtain accurate information that helps the investor develop a high quality investment program. (p. 466) 13-17 Practice Quiz 13-5 (p. 470) 1. What do you think is the most readily available source of information for the average investor? Explain your answer. While answers may vary, most investors would consider the Internet or newspapers as the most available. (p. 466-467) 2. What type of information can you obtain using the Internet? There is a wealth of information that can be obtained by using the Internet. Some types of information include information on interest rates, current price information for stocks, bonds, and mutual funds, and broker’s recommendations. It is also possible to do financial planning on the Internet. Finally, many personal finance web sites have financial calculators that can help you plan for retirement. (p. 466) 3. Briefly describe the additional sources of information that can be used to evaluate a potential investment. Other sources of information described in this section include: newspaper and news programs, business periodicals and government publications, corporate reports, and investor services and newsletters. Each of these sources can be useful depending on the particular investment under consideration. (pp. 467-469) FINANCIAL PLANNING PROBLEMS 1. Calculating the Amount for an Emergency Fund. Beth and Bob Martin have a total take-home pay of $4,000 a month. Their monthly expenses total $2,900. Calculate the amount the couple needs to establish an emergency fund. How did you calculate this amount? (LO13-1) The minimum amount for an emergency fund for the Martin’s is $8,700, as illustrated below. $2,900  3 months (minimum) = $8,700 Emergency Fund Learning Objective: 13-1 Topic: Preparing for an Investment Program Level of Difficulty: Easy Bloom’s Tag: Application 2. Planning for an Investment Program. Assume you are 29 years old, your take-home pay totals $2,400 a month, your monthly living expenses total $1,400, your monthly car payment is $400, and your credit card debts total $3,500. Using the information presented in this chapter, develop a three-part plan to (a) reduce your monthly expense, (b) establish an emergency fund, and (c) save $6,000 to establish an investment program. (LO13-1) While student answers may vary, they must deal with the credit card debt. This has to be a high priority because of the finance charges that are associated with the credit card. Once that has been paid off, then they can take the next steps. Possible next steps would include paying off the car loan and establishing an emergency fund that is equal to at least 3 month’s living expenses. Once the emergency fund is established, the final step would be to save the money needed to fund their investment program. Learning Objective: 13-1 Topic: Preparing for an Investment Program Level of Difficulty: Medium 13-18 Bloom’s Tag: Analysis; Synthesis 3. Determining Profit or Loss from an Investment. Three years ago, you purchased 150 shares of IBM stock for $92 a share. Today, you sold your IBM stock for $183 a share. For this problem, ignore commissions that would be charged to buy and sell your IBM shares and dividends you might have received as a shareholder. (LO13-1) a. What is the amount of profit you earned on each share of IBM stock? The profit for each share of IBM stock was $91, as illustrated below $183 price when each share was sold - $92 price when each share was purchased = $91. b. What is the total amount of profit for your IBM investment? The total profit for the IBM transaction was $13,650, as illustrated below. $91 profit per share x 150 shares = $13,650. Learning Objective: 13-1 Topic: Preparing for an Investment Program Level of Difficulty: Medium Bloom’s Tag: Application 4. Determining the Time Value of Money. Using the table in the Financial Planning Calculations feature on page 450, complete the following table. Then answer the questions that follow the table. Hint: To calculate the total amount of interest or earnings, subtract the amount of your total investment from the value at the end of the time period. (LO13-1) Annual Deposit Rate of Return Number of Years Investment Value at the End of Time Period Total Amount of Investment Total Amount of Interest or Earnings $2,000 5% 10 $25,156 $20,000 $ 5,156 $2,000 9% 10 $30,386 $20,000 $10,386 $2,000 5% 20 $66,132 $40,000 $26,132 $2,000 9% 20 $102,320 $40,000 $62,320 a. In the above situations, describe the effect that the rate of return has on the investment value at the end of the selected time period. Simply put, the higher the rate of return, the larger the amount of total investment at the end of the investment period and the larger the amount of interest or earnings. Caution: You may want to review the risk-return tradeoff while discussing this question. b. In the above situations, describe the effect that the number of years has on the investment value at the end of the selected time period. Simply put, the longer monies are invested, the larger the amount of total investment at the end of the investment period and the larger the amount of interest or earnings. 13-19 Learning Objective: 13-1 Topic: Preparing for an Investment Program Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 5. Calculating Rate of Return. Assume that at the beginning of the year, you purchase an investment for $5,500 that pays $110 annual income. Also assume the investment’s value has increased to $6,400 by the end of the year. (LO13-2) a. What is the rate of return for this investment? Step 1: Subtract the investment’s initial value from the investment’s value at the end of the year. $6,400 – $5,500 = $900 Step 2: Add the annual income and the amount from Step 1. $900 + $110 = $1,010 Step 3: Divide the total dollar amount of return (Step 2) by the original investment. $1,010 ÷ $5,500 = .1836 = 18.36% b. Is the rate of return a positive or negative number? The rate of return is a positive number. Note: If an investment decreases in value, the steps used to calculate the rate of return are the same, but the answer is a negative number. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 6. Calculating Rate of Return. Assume that at the beginning of the year, you purchase an investment for $7,100 that pays $80 annual income. Also assume that the investment’s value has increased to $7,590 at the end of the year. (LO13-2) a. What is the rate of return for this investment? Step 1: Subtract the investment’s initial value from the investment’s value at the end of the year. $7,590 – $7,100 = $490 Step 2: Add the annual income and the amount from Step 1. $490 + $80 = $570 Step 3: Divide the total dollar amount of return (Step 2) by the original investment. $570 ÷ $7,100 = .0803 = 8.03% 13-20 b. Is the rate of return a positive or negative number? The rate of return is a positive number. Note: If an investment decreases in value, the steps used to calculate the rate of return are the same, but the answer is a negative number. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 7. Calculating Rate of Return. Assume that at the beginning of the year, you purchase an investment for $7,000 that pays $100 annual income. Also assume the investment’s value has decreased to $6,600 by the end of the year. (LO13-2) a. What is the rate of return for this investment? Step 1: Subtract the investment’s initial value from the investment’s value at the end of the year. $6,600 – $7,000 = $400 (negative) Step 2: Add the annual income and the amounts from Step 1. $400 (negative) + $100 = $300 (negative) Step 3: Divide the total dollar amount of return (Step 2) by the original investment $300 (negative) ÷ $7,000 = .0429 (negative) = 4.29% (negative) b. Is the rate of return a positive or negative number? The rate of return is a negative number and a loss on the investment. Note: If an investment increases in value, the steps used to calculate the rate of return are the same, but the answer is a positive number. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 8. Determining Interest. Assume that you purchased a corporate bond with a face value of $1,000. The interest rate is 4.10 percent. What is the dollar amount of annual interest you will receive each year? (LO13-2) The annual interest rate is $41, as calculated below. $1,000 x 0.0410 = $41. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Easy Bloom’s Tag: Application 13-21 9. Determining Interest. Three years ago you purchased a Heinz corporate bond that pays 3.125 percent annual interest. The face value of the bond is $1,000. What is the total dollar amount of interest that you received from your bond investment over the three-year period? (LO13-2) Step 1: The annual interest amount is $31.25, as calculated below. $1,000 x 0.03125 = $31.25. Step 2: The total interest for 3 years is $93.75, as calculated below. $31.25 annual interest x 3 years = $93.75 Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Medium Bloom’s Tag: Application 10. Determining Interest. Jackie Martin purchased three $1,000 corporate bonds issued by J. C. Penney. The bonds pay 5.65 percent and mature in 2020. What is the total dollar amount of interest Jackie will receive for her three bonds each year? (LO13-2) The total amount of interest for the three bonds is $169.50, as calculated below. Step 1: $1,000 x .0565 = $56.50 interest per bond. Step 2: $56.50 interest per bond x 3 bonds = $169.50. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Medium Bloom’s Tag: Application 11. Determining Interest and Approximate Bond Value. Assume that three years ago, you purchased a corporate bond that pays 6.10 percent. The purchase price was $1,000. Also assume that three years after your bond investment, comparable bonds are paying 7.20 percent. (LO13-2) a. What is the annual dollar amount of interest that you will receive from your bond investment? The annual interest is $61.00 as calculated below, as calculated below. $1,000  .0610 = $61.00 annual dollar amount of interest. b. Assuming that comparable bonds are paying 7.20 percent, what is the approximate dollar price for which you could sell your bond? The approximate dollar price would be $847.22, as calculated below. $61.00 annual interest ÷ .0720 = $847.22 approximate market value c. In your own words, explain why your bond increased or decreased in value. 13-22 This bond decreased in value because you owned a bond with a fixed interest rate of 6.10 percent during a time period when interest rates in the economy were increasing. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 12. Determining Interest and Approximate Bond Value. Eight years ago, Burt Brownlee purchased a U.S. government bond that pays 3.80 percent interest. The face value of the bond was $1,000. (LO13-2) a. What is the dollar amount of annual interest that Burt received from his bond investment each year? The annual interest is $38 as calculated below, as calculated below. $1,000  .038. = $38 annual dollar amount of interest b. Assume that comparable bonds are paying 2.9 percent, what is the approximate dollar price for which Burt could sell his bond? The approximate dollar price would be $1,310.34, as calculated below. $38 annual interest ÷ .029 = $1,310.34 approximate market value c. In your own words, explain why Burt’s bond increased or decreased in value. This bond increased in value because Burt owned a bond with a fixed interest rate of 3.80 percent during a time period when interest rates in the economy were decreasing. Learning Objective: 13-2 Topic: Factors Affecting the Choice of Investments Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 13. Using Asset Allocation to Diversify Risk. Assume you are 59 years old, want to retire in 6 years, and currently have an investment portfolio valued at $550,000 invested in technology stocks. After talking with friends and relatives, you have decided that you have “too many eggs in one basket.” Based on this information, use the asset allocation method described in this chapter and the table below to diversify your investment portfolio. Then answer the questions below. (LO1-3) Investment Alternative Percentage You Would Like in this Category Large-Cap Stocks Mid-Cap Stocks Small-Cap Stocks Foreign Stocks Government Bonds 13-23 Corporate Bonds Cash Other Investment 100% Actual percentages will vary because of several factors. For example, the student’s tolerance for risk and the state of the economy may affect the percentages that each student chooses. a. What are the advantages of asset allocation? Asset allocation is the process of spreading your assets among several different types of investments (sometimes referred to as asset classes) to lessen risk. b. How could the time your investments have to work for you and your age impact your asset allocation? Assuming the investor chooses quality investments, generally time works to smooth out unexpected ups and downs in the market. The fact that this investor is 59 and wants to retire in six years shortens the window of opportunity. The time factor should be reflected in the asset allocations chosen when answering this question. Learning Objective: 13-3 Topic: Asset Allocation and Investment Alternatives Level of Difficulty: Medium Bloom’s Tag: Analysis; Synthesis 14. Monitoring an Investment’s Financial Performance. Based on the following information, construct a graph that illustrates price movement for a share of the Davis New York Venture Mutual Fund. Note: you may want to review the material presented in the Financial Planning Calculations boxed feature (p.465) in this chapter. (LO1-4) January $28.70 July $26.10 February 28.00 August 25.50 March 30.30 September 26.40 April 31.35 October 26.90 May 29.50 November 28.40 June 27.80 December 27.20 13-24 Learning Objective: 13-4 Topic: Factors that Reduce Investment Risk Level of Difficulty: Easy Bloom’s Tag: Application FINANCIAL PLANNING ACTIVITIES 1. Using Investment Information. Choose a current issue of Kiplinger’s Personal Finance Magazine or Money and summarize an article that provides suggestions on how you could use your money more effectively. (LO 13-1) Student answers will vary, but you may want to use this question to reinforce the importance of effective money management. 2. Using the Internet to Obtain Information about Money Management. As pointed out in the beginning of this chapter, it doesn’t make a lot sense to establish an investment program until credit card and installment purchases are reduced or eliminated. While most people are responsible and make payments when they’re supposed to, some people do get in trouble. To help avoid this problem, each of the following organizations has a home page on the Internet. Consumer Credit Counseling Services provides information about how to manage consumer debt (cccs.net). Green Path Debt Solutions provides counseling for people with debt problems (http://www.greenpath.com). Choose one of the above organizations and visit its home page. Then, prepare a report that summarizes the information provided by the organization. Finally, indicate if this information could help you manage your consumer debt. (LO 13-1) Although student answers will vary depending on which Internet site they visit, you may want to use this opportunity to discuss the issue of how consumers can get in trouble by using credit cards and 13-25 installment debt. (Another option would be to ask all students to view just one of the above Internet sites and prepare a report based on the information obtained from that website.) 3. Choosing Investment Alternatives. From the investment alternatives described in this chapter, choose two specific investments that you feel would help an individual who is 35 years old, divorced, and earns $27,000 a year begin an investment program. Assume that this individual has $30,000 that can be invested at this time. As part of your recommendation, compare each of your investment suggestions on the factors of safety, risk, income, growth, and liquidity. (LO 13-2) Although the specific investment alternatives chosen by students may be different, the ideal investment would have some capacity for growth. This investor—an individual who is 35 and divorced—should develop a long-term investment program. The $30,000 should be seed money to obtain long-term goals in the future. 4. Developing a Financial Plan. Assume you are single and have graduated from college. Your monthly take-home pay is $2,500 and your monthly expenses total $2,300, leaving you with a monthly surplus of $200. Develop a personal plan of action for investing using the steps listed in Exhibit 13.5. (LO13.3) While student answers may vary, you may want to use this question to reinforce a number of concepts when you discuss this activity. For example, you may want to talk about performing a financial checkup before beginning an investment program. You may also want to talk about asset allocation, the time factor, and their age when establishing an investment program. You can also use this activity to discuss the various investment alternatives and the risk involved with each alternative. (LO13-3) 5. Using Financial Information to Track the Value of an Investment. Choose one stock and one mutual fund investment. Using the Internet, the Wall Street Journal, or your local newspaper, track the value of both investments on a daily basis for a two-week period. Then construct a graph that illustrates the changes in each investment’s value over the two-week period. In a one-page report indicate if either of the two investments would have been a good investment over the two-week time period. Explain your answer. (LO 13-5) Student answers will vary depending on which stock and mutual fund they choose. You may want to use this assignment to reinforce the value of maintaining accurate records for all investments and monitoring the value of all investments. 6. Using Investment Information. Assume you have established an emergency fund and that you have saved an additional $12,000 that could fund an investment in common stock issued by the AT&T Corporation. Using the sources of information discussed in this chapter, go to the library or use the Internet to obtain information about this company. Summarize your findings in a three-page report that describes AT&T’s current operations and the firm’s past and present financial performance. Finally, indicate if you would still purchase AT&T common stock based on the information contained in your report. (LO 13-5) While student reports will vary, they should contain the type of information contained in reports published by Standard & Poor’s Value Line, and Mergent’s Investment Service. Some students may have access to a current annual report or business periodicals. And, some information may be obtained by looking in the financial pages of the newspaper. It would also be possible to obtain a great deal of financial information about AT&T by accessing the Internet. 13-26 FINANCIAL PLANNNING CASE First Budget, Then Invest for Success! (p. 476) 1. How would you rate the financial status of the Garners before the air conditioner broke down? The Garners could be in better financial shape. The fact that they had to use part of the money they were saving for a vacation to fix a broken air conditioner is evidence that their financial affairs could be better. In reality, this means that they have no emergency fund, no investment program, and no money to fund their child’s college education. Fortunately, they are in their thirties, and they realize that they have a problem. Realization of a financial problem may be the first step. 2. The Garners take-home pay is over $4,500 a month. Yet, after all expenses are paid, there is only $220 surplus each month. Based on the information presented in this case, what expenses, if any, seem out of line and could be reduced in order to increase the surplus at the end of each month? A first step in increasing the amount of surplus might be to concentrate on paying off the automobile loan. While variable expenses seem reasonable, they may be able to reduce the $700 allotted for recreation and entertainment. Also, they should work to reduce the amount of credit card debt and the resulting monthly credit card payments. 3. Given that both Joe and Mary Garner are in their mid-thirties and want to retire when they reach age 65, what type of investment goals would be most appropriate for this couple? Their window of opportunity is approximately 30 years. Therefore, they should begin an investment program that stresses long-term growth. Ideally, common stocks and mutual funds that invest in stocks that have the potential for long-term growth seem appropriate for this couple in their mid- thirties. 4. How does the time value of money and the asset allocation concept affect the type of long-term goals and the investments that a couple like the Garners might use to build their financial nest egg? The time value of money is the foundation for a long-term investment program. If they will start saving a little money each month and then investing that money in quality stocks, mutual funds, and other asset classes used in asset allocation models, their nest egg will grow over the next 30 years. Naturally, they must be disciplined and continue to invest money on a regular basis. And they must realize that their earnings on their investments must be reinvested to accumulate the amount of money they need for their retirement and their daughter’s college education. 5. Based on the different investments described in this chapter, what specific types of investments (stocks, mutual funds, real estate, etc.) would you recommend for the Garners? Why? The Garners should concentrate on long-term investments that include quality common stocks and mutual funds. If they are uncomfortable with the risk associated with these investments, they could choose more conservative investments that include certificates of deposits or certain corporate or government bonds. Unfortunately, these more secure investments will not provide the type of return the Garners need to obtain their long-term financial goals. 13-27 Comments on the Continuing Case – Chapter 13 (p. 478) 1. What are the steps that Shelby and Mark should take to prepare for an Investment Program? Shelby and Mark should begin by performing a financial checkup. Specific steps include balancing their budget, managing their credit card debt, starting an emergency fund, and having access to other sources of cash for emergency needs—all topics discussed at the beginning of Chapter 13. Other factors that could help Shelby and Mark are making investment goals a high priority and recognizing the importance of the time value of money. 2. Explain how Shelby and Mark might obtain money to start an Investment Program. Shelby and Mark could use the suggestions in the How To . . . Obtain the Money Needed to Establish an Investment Program feature on page 448. In addition to these four suggestions, they should make sure their investment goals are a high priority and build a long-term investment program on the time value of money concept—see the material in the Financial Planning Calculations feature on page 450. 3. Explain how the Brocks might use Personal Financial Planner sheets Investment Objectives and Investment Information Sources? The Brocks can use Personal Financial Planner sheet 55 (Investment Objectives) to establish specific objectives they believe are important. Personal Financial Planner sheet 57 (Investment Information Sources) can help the Brocks evaluate different sources of investment information. 13-28 TM 13-1 A Personal Plan for Investment Step 3 I have $_______________ available for investment purposes. Date __________________ Step 4 Possible investment alternatives a. ____________________ b. ____________________ c. ____________________ d. ____________________ e. ____________________ Step 5B Projected return for each investment alternative a. ___________________ b. ___________________ c. ___________________ d. ___________________ e. ___________________ Step 5A Examination of risk factor for each alternative a. ____________________ b. ____________________ c. ____________________ d. ____________________ e. ____________________ Step 2 By ___________, 20____, I will have obtained $ ____________________ Signed _______________ Step 1 My investment goals are _____________________ _____________________ _____________________ Step 8 Continued evaluation of your investment choices Step 7 Final decision based on reevaluation of top 3 _____________________ Step 6 Investment decision based on the top 3 a. ___________________ b. ___________________ c. ___________________ 13-29 TM 13-2 The Risks Involved in Typical Investment Alternatives Factors to Be Evaluated Type of Investment Safety Risk Income Growth Liquidity Common stock Average Average Average High Average Preferred stock Average Average High Average Average Corporate bonds Average Average High Low Average Government bonds High Low Low Low High Mutual funds Average Average Average Average Average Real Estate Average Average Average Average Low Options Derivatives Low Low High High N/A N/A Low Low Average Average Commodities Low High N/A Low Average Precious metals, gemstones, Low High N/A Low Low antiques, and collectibles N/A = Not applicable 13-30 Name ______________________________________ Cha pt er 13: I nv est ing F unda m ent a ls 3. The written pledge of a government or a municipality to repay a specified sum of money, along with interest. 5. An investment alternative chosen by people who pool their money to buy stocks, bonds, and other securities selected by professional managers employed by an investment company. 9. A high-risk investment made in the hope of earning a relatively large profit in a short time. 10. A corporation's written pledge to repay a specified amount of money, along with interest. 1. The process of spreading your assets among several different types of investments to lessen risk. 2. Money that a business obtains from its owners. 4. A distribution of money, stock, or other property that a corporation pays to its stockholders. 6. A short-term loan that is approved before the money is actually needed. 7. An amount of money you can obtain quickly in case of immediate need. 8. The ability to buy or sell an investment quickly without substantially affecting the investment's value. Across Down L I Q U I D I T Y C O R P O R A T E B O N D S P E C U L A T I V E I N V E S T M E N T A S S E T A L L O C A T I O N L I N E O F C R E D I T E M E R G E N C Y F U N D D I V I D E N D E G O V E R N M E N T B O N D Q U I T Y C A P I T A L M U T U A L F U N D 1 2 3 4 5 6 7 8 9 10 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993