Solution Manual for Fundamentals of Investing Essay Example for Free

Solution Manual for Fundamentals of Investing EssayKey Concepts1.The meaning of the termination enthronisation and the implications it has for individual embellishors2.Review the factors recitationd to differentiate between different character references of enthronizations3.The importance of and basic steps involved in the enthronisation process4.Popular types of enthronement vehicles, including short vehicles, common stock, rough-cut silver and exchange-traded currency, fixedincome securities such as bonds, preferred stock, and convertibles5.Derivative securities such as options and futures6.Other popular investments such as real estate, tangibles, and tax-advantaged investments7.Investment goals including income, major expenditures, seclusion, and sheltering income from taxes the last mentioned includes analysis of tax-advantaged retirement vehicles8.Building a diversified portfolio logical with investment goals9.Sources of taxation, types of taxable income, and the effect of taxes on the investor 10.Developing an investment program that considers differing scotch environments and the life cycle11.The use of short-term securities in meeting liquidity needs12.The merits and suit strength of various popular shortterm investments, including deposit accounts and notes market securitiesOverviewThis chapter provides an everyplaceview of the scope and contentedness of the text.1.The term investment is defined, and the alternative investment opportunities purchasable to investors argon classified by types.2.The structure of the investment process is examined. This sectionexplains how the marketplace brings together suppliers and pick outers of investment funds.3.The key participants in the investment processgovernment, business, and individualsargon described, as atomic number 18 institutional and individual investors.4.Returns atomic number 18 defined as rewards for investiture. Returns to an investor take two forms range of flow inc ome and increased value of the investment over duration. In this section, the instructor need only(prenominal) define spend, since there go away be another opportunity to father the impression of return in Chapter 4 also, providing information somewhat recent investment returns always engages students attention.5.Next, the following investment vehicles available to individual investors ar discussed short-term vehicles, common stock, fixedincome securities, mutual funds, exchange-traded funds, hedge funds, real estate, tangibles, tax-advantaged investments, and options and futures. The text describes their stake-return characteristics in a general way. The instructor may want to expand on the advantages and disadvantages of investing in each, although they will be treated in greater detail in subsequent chapters. It is vital for any investor to establish investment goals that be consistent with his or her overall financial objectives.6.Once the investment goals ask been w ell specified, the investor stick out adopt an investment plan consistent with these goals, select suitable investments, and build a diversified portfolio and act it.7.Personal taxes are discussed in terms of types of income and tax rates. The investment process is affected by current tax laws. Examples of tax shelters, especially tax-advantaged retirement vehicles, and tax supplying are provided.8.Once investment goals are established, it is important to understand how the investment process is affected by different economic environments. The chapter talks about types of investments such as stocks, bonds, and tangibles as they are affected by business cycles, saki rates, and inflation.9.Liquidity is defined, and short-term securities that apprize be utilise to meet liquidity requirements are described. The discussion includes a look at short-term evoke rates and the risk characteristics of various short-term securities. 10.The next section covers the various types of short- term vehicles available to todays investor. The text provides enough detail about everything from passbook accounts to money market funds to commercial paper that students should get a reliable grasp of the differences between the vehicles. Information on current rates brings realism into the classroom and enhances student perception of the lecturer as a knowledgeable instructor.Answers to Concepts in Review1.An investment is any asset into which funds can be placed with the expectation of preserving or increasing value and sucking a positive rate of return. An investment can be a tribute or a place. Individuals invest because an investment has the potential to preserve or increase value and to achieve income. It is important to stress that this does not imply that an investment will in fact preserve value or earn income.Bad investments do exist.2.(a)Securities and post are simply two classes of investments. Securities are investments, commonly evidenced by certificates, that represent a legal select. For example, a bond represents a legal claim on debt, and a stock represents a proportionate ownership in a unwaveringly. An option, on the other hand, represents the legal dear to either buy or sell an asset at a predetermined wrong within a specified time period. Property constitutes investments in either real property (land and buildings) or tangible personal property (Rembrandt paintings, Ming vases, or antique cars). (b)With a estimate investment, an individual acquires a direct claim on a security or property. For example, an investment in one share of IBM stock right away provides the stockholder a proportionate ownership in IBM. An verifying investment provides an indirect claim on a security or property. For example, if you bought one share of Fidelity Growth Fund (a mutual fund), you are in effect buying a portion of a portfolio of securities owned by the fund.Thus, you will have a claim on a fraction of an entireportfolio of securities. (c )An investment in debt represents funds loaned in exchange for the receipt of pastime income and repayment of the loan at a given future date. The bond, a common debt instrument, pays specified interest over a specified time period, then repays the face value of the loan. (Chapters 10 and 11 cover bonds in detail.) An right investment provides an investor an ongoing incomplete ownership interest in a firm. The nigh common example is an investment in a companys common stock. We will field of study equity instruments in greater detail in Chapters 6 through 8.Derivative securities are securities derived from debt or equity securities and structured to exhibit characteristics different from the be securities. Options are derivative securities that allow an investor to sell or buy another security or asset at a special(prenominal) price over a given time period. For example, an investor might purchase an option to buy Company X stock for $50 within nine months. (d)Short-term inves tments typically vaned within one year while long-term investments have longer maturities, including common stock, which has no maturity at all. However, long-term investments can be used to satisfy short-term financial goals.3.In finance, risk refers to the chance that the return from an investment will differ from its expected value. The broader the range of possible values (dispersion), the greater is the risk of the investment. Low-risk investments are those considered safe with respect to the return of funds invested and the receipt of a positive rate of return. High-risk investments are those that have more uncertain future values and levels of boodle.4.Foreign investments are investments in the debt, equity, derivative securities of foreign-based companies, and property in a foreign country. Both direct and indirect foreign investments provide investors more winsome returns or lower-risk investments compared to purely domestic investments. They are useful instruments to d iversify a purely domestic portfolio.5.The investment process brings together suppliers and demanders of funds. This may drop dead directly (as with property investments). More often the investment process is aided by a financial institution (such as a bank,savings and loan, savings bank, cite union, insurance company, or pension fund) that channels funds to investments and/or a financial market (either the money market or the groovy market) where transactions come in between suppliers and demanders of funds.6.(a)The various levels of government (federal, state, and local) require more funds for projects and debt repayment than they dumbfound in revenues. Thus, governments are net demanders of funds. Governments also demand funds when the measure of their revenues does not match their expenditures. The term net refers to the fact that, while governments both supply and demand funds in the investment process, on balance they demand more than they supply.(b)Businesses are also n et demanders, requiring funds to cover short and longterm operating needs. musical composition business firms often supply funds, on balance they also demand more than they supply. (c)Individuals are the net suppliers of funds to the investment process. They put more funds into the investment process than they take out. Individuals map an important role in the investment processsupplying the funds demand to finance economic growth and development.7.Institutional investors are investment professionals who are paying to manage other peoples money. They are employed by financial institutions like banks and insurance companies, by nonfinancial businesses, and by individuals. Individual investors manage their own personal funds in order to meet their financial goals. Generally, institutional investors tend to be more sophisticated because they handle more than big amounts of money, and they tend to have a broader knowledge of the investment process and available investment technique s and vehicles.8.Shortterm investments usually have lives of less than one year. These vehicles may be used to warehouse temporarily idle funds until suitable longterm vehicles are found. Due to their safety and convenience, they are popular with those who wish to earn a return on temporarily idle funds or with the very conservative investor who may use these shortterm vehicles as a primary investment outlet. In addition to their warehousing function, short-term vehicles provide liquiditythey can be converted into cashquickly and with secondary or no disadvantage in value. This characteristic is very useful when investors need to meet unexpected expenses or take advantage of attractive opportunities.9.Common stock is an equity investment that represents a fractional ownership interest in a corporation. The return on a common stock investment derives from two sources dividends, which are periodic payments made by the firm to its shareholders from current and past earnings, and capi tal gains, which result from selling the stock at a price above the pilot light purchase price. Because common stock offers a broad range of return-risk combinations, it is one of the nearly popular investment vehicles. 10.a.Bonds are debt obligations of corporations or governments. A bondholder receives a know interest return, typically semi-annually, plus the face value at maturity. Bonds are usually issued in $1,000 denominations, pay semi-annual interest, and have 20- to 40-year maturities.Bonds offer fixed/certain returns, if held until maturity. b.A convertible security is a fixed-income security, either a bond or preferred stock, which has a conversion feature. Typically, it can be converted into a specified arrive of shares of common stock. Convertible securities are quasi-derivative securities, as their market value would depend on the price of the common stock and the conversion ratio. c.Preferred stock is very much like common stock in that it represents an ownership i nterest in a corporation. But preferred stock pays only a fixed say dividend, which has precedence over common stock dividends, and does not share in other earnings of the firm. d.A mutual fund is a company that invests in a large portfolio of securities, whereas a money market mutual fund is a mutual fund that solely invests in short-term investment vehicles. Investors might flummox mutual funds appealing because a large portfolio may be more consistent with their investment goals in terms of risk and return. As we will see later, a mutual fund offers the investor the benefits of diversification and professional management.Mutual funds do not offer fixed/certain returns. Mutual funds are quasi-derivative securities, as their market value would depend on the price of the assets that make up the funds portfolio. Exchange-traded funds are similar to mutual funds but are traded throughout the day on exchanges and priced continuously. e.Similar to mutual funds,hedge funds pool the inv estors funds to invest in securities but are open to a narrower group of investor than mutual funds and may employ high-risk strategies. They do not offer a fixed return and are most often not based on derivatives. Hedge funds usually employ a professional manager.f.Options are derivative securities that provide holders the right to buy or sell another security (typically stock) or property at a specified price over a given time period. Factors like the time until expiration, the underlying stock price behavior, and supply and demand conditions affect the returns. g.Futures represent contr unfeigned arrangements in which a seller will shake or a buyer will take delivery of a specified quantity of a commodity at a given price by a certain date.Unlike an option, which gives the investor the right to purchase or sell another security, futures contracts obligate the investor to deliver or take delivery. Factors affecting returns on commodity contracts include changes in government pol icy, unpredictable weather, trade embargoes, and other events. 11.Before developing and executing an investment program, an investor must ensure the following Necessities of life such as funds for housing, food, transportation, taxes, etc. are fully provided for.The investor is adequately insured against the losses resulting from death, illness or disability, property damage, etc.Retirement goals are established.The seven steps in investing are as follows(1)Meet investment prerequisites. Provide for the necessities of life, adequate protection against losses, and setting retirement goals. (2)Establish investment goals. Investment goals are the financial objectives that one wishes to achieve by investing. Common investment goals areAccumulate retirement fundsEnhance current income through interest income and dividendsSave for major expenditures like home, education, etc.Shelter income from taxes(3)Adopt an investment plan. An investment plan is a written document describing how fund s will be invested. The more specific your investment goal, the easier it will be to establish an investment plan consistent withyour goals. (4)Evaluate investment vehicles. In this step, the measures of risk and return are used to estimate the perceived charge of an investment vehicle. This process is called valuation. (5)Select suitable investments. This step involves careful selection of investments that are consistent with established goals and offer acceptable levels of return, risk, and value. (6)Construct a diversified portfolio. Diversification is the concept of forming a portfolio using different investments to reduce risk and increase return. This concept is central to constructing an effective portfolio.(7)Manage the portfolio. Portfolio management involves monitoring the portfolio and restructuring it as dictated by the actual behavior of the investments. 12.Investment goals are the financial objectives you wish to achieve by investing in any of a wide range of investme nt vehicles. Common investment goals are as follows (1)Enhancing current income means choosing investment vehicles that regularly pay dividends and interest that can provide all or some of the money needed to meet living expenses. This is a common goal of retired persons and sometimes an important part of a normal family budget. (2)Saving for major expenditures includes money set aside for such things as the down payment on a home, college tuition, and even an expensive vacation. The amount of money needed and the time period over which one can save will determine the amount set aside and, frequently, the investment vehicle employed.(3)The single most important reason for investing is to accumulate retirement funds. The amount that must be set aside is determined by the level of expected expenditures, expected income from Social Security and other sources, and the amount of interest expected to be get on savings. (4)Sheltering income from taxes involves taking advantage of certain tax provisions that permit reduction of the income reported to the government or direct reductions in taxes. Investments in certain assets, such as real estate, may be attractive due to their tax advantages. 13.Federal income taxes are charged against all income individuals receive from all sources (with the exception of interest received on some bonds issued by state and local governments). a.Active (ordinary earned) income is the broadest category and includes income from wages, salaries, bonuses, tips, pension income, and alimony.It is made up of income earned on the job as well as most other forms of noninvestment income. b.Portfolio (investment) income is earnings generated from varioustypes of investment holdings. For the most part, it consists of interest, dividends, and capital gains earned on most types of investments. Passive income is a special category that consists of income derived chiefly from real estate, limited partnerships, and other forms of tax shelters. c.Capit al gains are the profits earned on the sale of capital assetspleasure or investment. They are measured by the amount by which the proceeds from the sale of the capital asset exceed its original purchase price. Currently, long-term capital gains are taxed at preferential rates to ordinary income. Capital gains are appealing to investors because they are not taxed until they are actually realized. d.A capital loss is the amount by which the proceeds from the sale of a capital asset are less than its original purchase price.Up to $3,000 of net losses can be applied against ordinary income in any one year, with the unused portion carried forward to offset future income. e.Due to the opportunities and challenges created by the tax laws, tax planning is an important part of the investment process. Tax planning involves looking at an individuals current and projected earnings and developing strategies that will put back or minimize the level of his or her taxes. Tax plans involve current i ncome, capital gains, or tax-sheltered investments. For example, one strategy is to take losses as they occur and to delay taking profits in order to minimize current taxable income. f.In general, tax-advantaged retirement plans allow individuals to defer taxes on the contribution and/or portfolio earnings until some future date when retirement withdrawals take place.There are employer-sponsored plans (such as 401(k) accounts), individual-created plans (such as Keogh plans), and individual retirement accounts (IRAs). 14.Investors tend to follow different investment strategies as they move through different stages of their life cycle. a.Young investors, ages 20 to 45, tend to prefer growth-oriented investments that stress capital gains rather than income. These investors have little investable funds, and capital gains are seen as the quickest way to build up investment capital. b.By middle age, ages 45 to 60, there is a consolidation taking place as family demands and responsibilitie s change.While growth-oriented securities are still used, investing becomes less speculative. Quality-growth vehicles are employed, and more attention is given to current income. The foundation is being set for retirement. c.As the investor moves into the retirement years, age 60on, preservation of capital and current income become the principal concerns. High-quality stocks and bonds and money market instruments are used as the investors objective is to live as well as possible from the investment income. During retirement, one tries to reap the rewards of a lifetime of saving and investing.15.Stocks and equity-related securities (such as mutual funds and convertibles) are highly responsive to the economic cycle. During recovery and expansion, stock prices are up. As the decline approaches, stock prices begin to decline as well. Growth-oriented and speculative stocks tend to do especially well in an expanding economy. Bonds and other fixed-income securities are sensitive to movemen ts in interest rates. Bond prices also move in the opposite direction of interest rate changes. This means that if interest rates are expected to rise, bond prices would fall, and bonds would not be a good place to hold investment funds. Interest rates generally shift with the economic cycle. Rates rise during normal recovery and fall during economic declines. 16.An asset is liquid if it can be converted to cash (sold) easily and quickly, with little or no loss in value. You would want to hold liquid assets as emergency funds or to accumulate funds for some specific purpose.IBM stock is not considered a liquid investment even though it can be easily sold. As with stocks in general, you can never be sure that, when funds are needed, you can quickly sell the stock without taking a loss. 17.Purchasing power risk for short-term investments occurs when the rate of return on these investments falls short of the inflation rate. This generally happens to fixed-rate investments such as passb ook savings accounts. Most other short-term investments have managed to provide rates of return about equal to the inflation rate when one looks at these short-term rates over long periods of time. Default (nonpayment) risk is very small with most short-term investments. The deposits in banks and other federally insured savings institutions are protected up to $100,000 per account by agencies of the federal government. U.S. Treasury bills are dead safe and sometimes called a risk-free investment. Commercial paper and repurchase agreements are extremely safe, based upon past experience, even though there have been rare instances of problems.These latter two instruments are also not insured. Money market mutual funds have also had anexceptionally safe history. Of course, the safest money market funds are those that invest solely in government securities and are virtually default-risk-free. 18.Passbook savings accounts and NOW accounts (a checking account), offered by banks, generally pay a low rate of interest and have no minimum balance. Passbook savings and NOW accounts are primarily used by investors as savings accounts, providing the investor with a highly liquid pool of funds. MMDAs are bank deposit accounts with limited check-writing privileges. Central asset accounts are comprehensive deposit accounts and combine checking, investing, and espousal activities. MMDAs and asset management accounts are more likely used by investors to earn a competitive short-term return while maintaining liquidity.Each type of account, except for asset management accounts, is insured. All but the passbook account typically require a minimum balance, which varies. 19.a. I bonds are savings bonds issued by the U.S. Treasury. They earn interest at a rate that varies with inflation. Interest is dislodge from state and local taxes. They are issued in denominations that make them affordable to everyone and mature in 30 years but can be redeemed after one year. b.U.S. Treasury bil ls are short-term (less than one year) debt obligations of the federal government. T-bills are exempt from state and local income taxes, and federal taxes are deferred. They are regarded as the safest but generally lowest yielding of all investments, and the secondary market for T-bills is highly liquid.c.Certificates of deposits (CDs) are savings vehicles in which funds must remain on deposit for a specified period. Premature withdrawals incur interest penalties. Because of the requirement that they remain on deposit, CDs are less liquid than T-bills, but they are convenient to buy and hold, offer highly competitive returns, and have federal insurance protection. d.Commercial paper is unfastened short-term debt issued by corporations with very high attribute standings. The secondary market for commercial paper is very limited and yields are comparable to yields on large-denomination CDs. Typically, only larger institutions deal directly in this market because the denominations ra nge from $25,000 to the more commonly issued $100,000. Commercial paper is not federally insured. e.Bankers acceptances are short-term credit arrangements between business firms and banks. Firms usebankers acceptances to finance transactions, most often involving firms in foreign countries or firms with unknown credit capacities. Bankers acceptances typically are denominated in $100,000 units, are low-risk securities, and have active secondary markets.Yields are slightly below CD yields and commercial paper and above T-bills. f.Money market mutual funds (MMMFs) pool capital of many investors and invest it exclusively in high-yielding, short-term securities, such as T-bills, large CDs, commercial paper, and other similar securities. Because these high-yielding securities are in denominations of $10,000 to $1 million, the MMMF makes them available in a format that is affordable to individual investors. MMMFs are convenient, offer check writing privileges, and yields are based on the a bility of the fund manager to invest in various short-term securities. Although they are not federally insured funds, their default risk is nearly zero because the securities they invest in are very low risk and the fund is relatively diversified. 20.The senior managers in a corporation, such as the chief financial ships officer (CFO), have the primary responsibility of managing the firms capital resources and investments. Because so much of the CFOs primary responsibilities require an understanding of investment principles, a CFO must understand market forces but more importantly communicate in such a way that investors understand the value of the firm and the securities the firm has issued. 21.Because insurance companies have large sums of investment capital under management, they require the skills of a highly trained finance person in investment principles. Since this person is asked to manage risk for individuals as well as businesses, the decisions they make and the strategie s they devise will assist the insurance companies customers in the creation of their individual prospering asset and risk management strategies.