5.10: Bonds, Stocks, Mutual Funds, Risk and Diversification

Bonds, Stocks, Mutual Funds, Risk & Diversification

Investing money for your future is very important in your life. Not everybody invests as they should. People should begin investing their money as soon as they begin to work. It makes for a brighter future. Stocks, bonds, and mutual funds are all good ways to invest your money beyond the everyday savings account. In this chapter, we will explore how to calculate these investments and see how they work.

Universal Generalizations

• One way to increase the amount of interest earned on one’s money is to “lend” it to the government or business in the form of a bond purchase.
• Governments and companies offer people the opportunity to invest in a variety of ways.
• Risks vary depending on the types of stocks and bonds you invest in.
• There are always risks and benefits associated with investing in the stock market.
• Investors should know how much they can afford to risk and what types of investments pose low, medium, and higher risks.

Guiding Questions

1. Why would people want to invest in the stock market?
2. How can stocks and bonds benefit both the buyer and the seller?
3. Why would the local government want to sell municipal bonds?
4. What are the safest investments a person can make, with the highest return for the lowest risk?

When someone buys stock, they buy a small part of a company. They earn the right to share in a company’s profits and losses. They can make money if the value of the company goes up. Then they sell their stock for more than they paid. There is another way that people earn money from stocks. Some people own shares of stocks that pay dividends.

Percent of the Profits

When a company pays a dividend, it gives some of its profits directly to the stock owners. The more shares of stock a person owns, the more money they’ll receive. For instance, if a stock pays a dividend of 75 cents a share, someone who owns 85 shares will receive. Stable companies such as Coca-Cola and electric companies offer dividends on their stocks. People hold these stocks for years at a time.

Elderly people often use dividends from stocks to supplement their income from Social Security. While dividends don’t offer the huge profits that can come from buying and selling stocks, they also carry fewer risks. They’re a good investment for people looking for steady, reliable income.

Example A

Buying and Selling Stocks

Randy just bought 800 shares of stock in Facebook at $19.50 per share. A stock company that you have been working with charges $10 per transaction and you want to sell because the current rate for your shares skyrocketed and is at $34.50 per share. What will be your profit from this stock?

Solution

Sell: 800 * $34.50 = $27,600.00

Your cost: 800 * $19.50 = $15,600.00

Since you have basically made two transactions, the buying and selling of your stock, your company charges you $20.00 so your net profit will be:

$27,600 - $15,600 = $12,000.00

$12,000.00 - $20.00 = $11,980.00

Example B

Mutual funds are investment programs paid for by shareholders and is usually professionally managed. One advantage to having mutual funds is that the assets are liquid, which means that converting from assets to cash money is really easy. Since these funds in the market are in high demand, these mutual funds become liquid assets and investors can convert the asset to cash easily by selling them to other investors. Another good thing is that these funds are professionally managed by professional companies and don't require a lot of time or knowledge from the investors themselves. Diversified portfolios, which don't carry lots of risk, are very costly. The good thing about having a portfolio is the increased expected returns without the risk factors involved. The bad thing is that they are very expensive in price.

Example C

Bonds are debt, securities, under which the issuer owes the holders a debt, and depending on the terms, is obligated to pay them interest. This interest is commonly known as the coupon and they need to repay the debt at a later date, which is called the maturity date. When companies want to raise money for new projects, they issue bonds directly to investors instead of going to banks for loans. An example of this is when a bond is issued when interest rates are at 5% at $1,000 per value with an annual coupon of 5%, it will create $50 annually to the bondholder. If rates drop to 3.5% then the bond still pays out at 5 % which makes the bond very attractive to investors who will buy it until the rates of the bond equal 4%, but if the rates go up to 6.5% then the bond becomes unattractive to investors. Interest rates determine the value of bonds to investors.

Complete the practice problems below.

Practice Problems

Use the information to answer these questions about buying and selling of stocks.

1. Purchased shares of stock: 1000 shares of Nike at $24.50 per share

   Current price of stock: $39.75 per share

   Stock companies price per transaction: $9.99

   What is your net profit from each stock transaction?

2. Purchased shares of stock: 800 shares of Panda Express at $13.50 per share

   Current price of stock: $23.25 per share

   Stock companies price per transaction: $10

   What is your net profit from each stock transaction?

3. Purchased shares of stock: 1200 shares of Wal Mart at $35.50 per share

   Current price of stock: $58.75 per share

   Stock companies price per transaction: $12.99

   What is your net profit from each stock transaction?