Slides_Fundamentals of Investments - Chapter 2 doc

2 2 C h a p t e r Buying and Selling SecuritiesBuying and Selling Securities second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 2 First you buy a stock. First you buy a stock. If it goes up, sell it. If it doesn’t go up, don’t buy it. – Will Rogers © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 3 Buying and Selling Securities This chapter covers the basics of the investing process. Goal  We begin by describing how you go about buying and selling securities such as stocks and bonds.  Then we outline some important considerations and constraints to keep in mind as you get more involved in the investing process. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 4 Close account Close account Buy securities Buy securities Sell securities Sell securities Withdraw money from account Withdraw money from account Deposit money into account Deposit money into account Getting Started Open a brokerage or trading account Open a brokerage or trading account © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 5 Choosing a Broker  Brokers are traditionally divided into three groups. c full-service brokers d discount brokers e deep-discount brokers  These three groups can be distinguished by the level of service provided, as well as the resulting commissions charged. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 6 Choosing a Broker Commissions # of shares ($50/share) 200 500 1000 Full-Service Brokers A.G. Edwards $150 $200 $300 Merrill Lynch Discount Brokers Charles Schwab $100 $125 $150 Fidelity Brokerage Deep-Discount Brokers Olde Discount $50 $75 $100 Quick & Reilly Provides extensive investment advice Maintains account and executes buy/sell orders only Level of Service © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 7 Choosing a Broker  However, as the brokerage industry becomes more competitive, the differences among the broker types seem to be blurring.  Another important change is the rapid growth of online brokers, also known as e-brokers or cyberbrokers.  Online investing has fundamentally changed the discount and deep-discount brokerage industry by slashing costs dramatically. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 8 Choosing a Broker Broker Commission for Simple Trade Charles Schwab $29.95, up to 1000 shares  http://www.schwab.com Fidelity Investments $25, up to 1000 shares  http://www.fidelity.com CSFBdirect $20, up to 1000 shares  http://www.csfbdirect.com E*Trade $14.95, up to 5000 shares  http://www.etrade.com TD Waterhouse $12, up to 5000 shares  http://www.tdwaterhouse.com Ameritrade $8, no share limits  http://www.ameritrade.com © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 9 Work the Web  Which online broker is the best? See ratings at: http://www.gomez.com © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 10 Security Investors Protection Corporation  Most brokerage firms belong to the SIPC, which insures each account for up to $500,000 in cash and securities, with a $100,000 cash maximum.  Note that SIPC does not guarantee the value of any security. Security Investors Protection Corporation (SIPC) Insurance fund covering investors’ brokerage accounts with member firms. [...]... Account equity Total $20 ,000 20 ,000 $40,000 © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 18 Margin Accounts Example: Margin Requirements After your purchase, the share price of stock A falls to $35 per share Assets 800 A shares Total Liabilities & Account Equity $28 ,000 $28 ,000 Margin loan Account equity Total $20 ,000 8,000 $28 ,000 New margin = $8,000 / $28 ,000 = 28 .6% < 30% Therefore,... call McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 19 Margin Accounts Margin is a form of financial leverage When you borrow money to make an investment, the impact is to magnify both your gains and your losses McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 20 A Note on Annualizing Returns To compare investments, we will usually... position McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 25 Short Sales An investor with a long position benefits from price increases On the other hand, an investor with a short position benefits from price decreases McGraw Hill / Irwin Buy sell low, hig h! Sel buy l high low , ! © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 26 Short Sales Example:... Proceeds from sale $3,000 Short position Initial margin deposit 1,500 Account equity Total $4,500 Total $ 2, 000 2, 500 $4,500 New margin = $2, 500 / $2, 000 = 125 % McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 28 Short Sales Example: Short Sales …continued Scenario 2: The stock price rises to $40 per share Assets Liabilities & Account Equity Proceeds from sale $3,000... individual must balance return objectives with risk tolerance McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 32 Work the Web How risk-averse are you? Take a test at: http://www.investorama.com/calc McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 33 Investor Constraints Resources What is the minimum sum needed? What are the associated... call McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 17 Margin Accounts Example: Margin Requirements Your account requires an initial margin of 50% and a maintenance margin of 30% Stock A is selling at $50 per share You have $20 ,000, and you want to buy as much of stock A as you possibly can You may buy up to $20 ,000 / 0.5 = $40,000 worth of shares Assets Liabilities... no limit to how high the stock price may rise McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 30 Work the Web There are many sites devoted to the fine art of short selling Try: http://www.bearmarketcentral.com McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 31 Risk and Return In formulating investment objectives, the individual... settled by arbitration and that the arbitration is final and binding McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 12 Work the Web To learn more about dispute resolution, visit: http://www.nasd.com McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 13 Brokerage Accounts Cash account A brokerage account in which all transactions are... Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 34 Work the Web Can you open a brokerage account with no money? See: http://www.sharebuilder.com http://www.buyandhold.com McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 35 Strategies and Policies Be e! ctiv A B Pas e sive ! Investment management Should you manage your investments yourself?... broker is the registered owner of a security The account holder is the “beneficial owner.” McGraw Hill / Irwin © 20 02 by The McGraw-Hill Companies, Inc All rights reserved 2 - 22 Other Account Issues Trading accounts can also be differentiated by the ways they are managed Advisory account - You pay someone else to make buy and sell decisions on your behalf Wrap account - All the expenses associated . loan $20 ,000 Account equity 8,000 Total $28 ,000 Total $28 ,000 © 20 02 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 19 Margin Accounts  Margin is a form of financial. Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu © 20 02 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 2 - 2 First you buy a stock. First you buy. / Irwin 2 - 6 Choosing a Broker Commissions # of shares ($50/share) 20 0 500 1000 Full-Service Brokers A.G. Edwards $150 $20 0 $300 Merrill Lynch Discount Brokers Charles Schwab $100 $ 125 $150 Fidelity