Personal Finance- Chapter 13- Investment Fundamentals

Investing Putting saved money to work so that it makes you even more money
Securities Assets suitable for investment, including stocks, bonds, and mutual funds
Stocks Shares of ownership in cooperation
Bond A debt instrument issued by organization that promises repayment at a specific time and the right to received regular interest payments during the life of the bond
Portfolio Collection of investments assembled to meet your investment goals
Total return Income an investment generates from current income and capital gains
Current Income Money received while you own an investment; usually received regularly as interest, rent, or dividends
Interest Charge for borrowing money; investors in bonds earn interest
Capital gain Increase in the value of an initial investment (less costs) realized upon the sale of the investment
Capital loss Decrease in paper value of an initial investment; only realized if sold
Rate of return/yield Total return on an investment expressed as a percentage of its price
Speculative risk Involves the potential for either gain or loss; equity investments might do either
Investment risk The possibility that the yield on an investment will deviate from its expected return
Risk premium (or equity risk premium) The difference between a riskier investment’s expected return and the totally safe return on the T-bill
Risk tolerance An investor’s willingness to weather changes in the value of your investments, that is, to weather investment risk
Investment philosophy Investor’s general approach to tolerance for risk in investments, whether it is conservative, moderate, or aggressive, given the investor’s financial goals
Conservative investment philosophy (risk aversion) Investors with this philosophy accept very little risk and are generally rewarded with relatively low rates of return for seeking the twin goals of a moderate amount of current income and preservation of capital
Risk averse In investments, one who tends to dislike risk and is unable to put money into investments that seem risky
Moderate investment philosophy (risk indifference) Investors with this philosophy accept some risk as they seek capital gains through slow and steady growth in investment value along with current income
Aggressive investment philosophy (risk seeker) Investors with this philosophy primarily seek capital gains, often with a short time horizon
Debts Lending investments that typically offer both a fixed maturity and a fixed income
Fixed maturity Specific date on which a borrower agrees to repay the principal to the investor
Fixed income Specific rate of return that a borrower agrees to pay the investor for use of the principal (initial investment)
Equities Ownership equities such as common or preferred stocks, equity mutual funds, real estate, and so on that focus on capital gains more than on income
Real rate of return Return on a investment after subtracting the effects of inflation and income taxes
Random/unsystematic risk Risk associated with owning only one investment of a particular type (such as stock in one company) that, by chance, may do very poorly in the future due to uncontrollable or random factors that do not affect the rest of the market
Diversification Process of reducing risk by spreading investment money among several different investment opportunities
Market risk/systematic risk/undiversifiable risk The possibility for an investor to experience losses due to unknown factors that affect the overall performance of the financial markets
Financial risk Possibility that an investment will fail to pay a return to the investor
Business-cycle risk The fact that economic growth usually does not occur in a smooth and steady manner, and this impacts profits as well as investments returns
Market-volatility risk The fact that all investments are subject to occasional sharp changes in price such as result of events, affecting a particular company of the overall market for similar investments
Liquidity The speed and ease with which an asset can be converted to cash
Liquidity risk The risk that a given security or asset cannot be traded quickly enough in the market to prevent a loss (or make the required profit)
Commissions Fees or percentages of the selling price paid to salespeople, agents, and companies for their services in buying or selling an investment
Leverage Using borrowed funds to invest with the goal of earning a rate of return in excess of the after-tax costs of borrowing
Securities markets Places where stocks and bonds are traded (or in the case of electronic trading, the way in which securities are traded)
Bull market Market in which securities prices have risen 20 percent or more over time
Bear market Market in which securities prices have declined in value by 20 percent or more from previous highs, often over the course of several weeks or months
Market correction A short term price decline in the stock markets of at least 10 percent in a stock, bond, commodity or index to adjust for a recent price rises
Market volatility The likelihood of large price swings in securities due to a company’s success (or lack of it) and various market conditions
Market timers Investors who attempt to predict the short-term movements of various markets (or market segments) and, based on those predictions, move capital from one segment to another in order to capture market gains and avoid market losses
Market efficiency The speed at which new information is reflected in investment prices suggesting that security prices are reflective of their true value at all times because publicly available information has driven market prices to the correct level
Herd behavior When emotion, not logic, rules investing decisions and investors decide to copy the observed decisions of other investors or movements in the markets rather than follow their own beliefs and information
Buy and hold/buy to hold Investment strategy in which investors buy a widely diversified mix of stocks and/or mutual funds, reinvest the dividends by buying more stocks and mutual funds, and hold onto those investments almost indefinitely
Dollar-cost averaging/cost averaging Systematic program of investing equal sums of money at regular intervals, regardless of the price of the investment
Below-average costs Average costs of an investment if more shares are purchased when the price is down and fewer shares are purchased when the price is high
Average share price Calculated by dividing the share price total by the number of investment periods
Average share cost Actual cost basis of the investment used for income tax purposes, calculated by dividing the total amount investment by the total shares purchased
Portfolio diversification Practice of selecting a collection of different asset classes of investments (such as stocks, bonds, mutual funds, real estate, and cash) that are chosen not only for their potential returns but also for their dissimilar risk-return characterisitics
Asset allocation Form of diversification in which the investor decides on the proportions of an investment portfolio that will be devoted to various categories of assets
Limited managed account An account an investment firm whereby, for a fee, they sell and buy your mutual fund assets, usually quarterly, on your behalf to automatically rebalance your portfolio back to your specific standards
Monte Carlo analysis Technique that performs a large number of trial runs of a particular portfolio mix of investments, called simulations, to find an optimal allocation for a particular investor’s goals and risk tolerance
Investment plan An explanation of your investment philosophy and your logic on investing to reach specific goals
A stock or mutual fund with a__ beta means the security goes up when the market as a whole goes up average when the market is rising; a__ beta indicates the opposite. positive; negative
The firms that serve as intermediaries in selling newly issued securities are called__ firms. investment banking
Stocks with low price/earnings ratios tend to have a slower earnings growth rate
Common stock owners typically expect to make money on stocks by receiving dividends and capital gains
Companies that consistently pay out higher than average cash dividends are classified as__ stocks. income
Common stockholders elect the corporation’s board of directors.
A__ stock is one that has little or no track record but has a potential for substantial earnings at some time in the future. speculative
Most stock investors invest in public corporations
Capital gains on the sale of municipal bonds are taxable and will occur when bonds are purchased at a discount then sold at a higher price at full value at maturity
The approximate compound yield (ACY) formula provides a measure of the annualized compound growth of any long-term investment
Employees can benefit from the appreciation in the stock in their company even if they put no money down if their employer offers employee stock options
When a bond is purchased at a discount from its face value, yield to maturity will be__ the coupon rate printed on the certificate. more than
The limited liability of common stockholders refers to their losses being limited to their original amount that they invested
The average corporation pays out__ percent of its after-tax earnings in cash dividends to stockholders. 40 to 60
Which of the following statements accurately describes preferred stock investments? preferred stock is a fixed-income investment
Which of the following serve as the intermediaries between companies and investors when new issues of stocks or bonds are offered? investment banking firms
Which of the following statements regarding cash dividends is true? growth and speculative companies typically pay little or no cash dividends
The inverse of the P/E ratio is the earnings yield
You can purchase__ directly from the issuer and avoid the transaction fees. treasury securities
The type of business ownership that has the potential to raise large amounts of capital through the sale of stock is called a corporation
The after-tax earnings of a corporation that are not paid out to stockholders are called retained earnings
__would be classified as cyclical industries airlines
Owners of a corporation who want to raise more capital by issuing new securities but who also want to retain control of their company could issue either preferred stock or bonds.
__would be classified as a countercyclical industry. tobacco
A stock that tends to trade a low price relative to its company fundamentals is labeled a value stock
Tammy and Richard have $100 a month automatically transferred from their checking account to their mutual fund account. This is an example of dollar-cost averaging
Investors want to earn a__ for their willingness to make investments for which there is no absolute guarantee of future success. risk premium
A conservative investor would be least likely to invest in growth mutual funds
A bond represents a debt owed by a business or organization
Diversification__risk, and leverage__ risk. decreases; increases
Research suggests that you can eliminate random risk by holding__ or more stocks and bonds. 15
Bert has invested all of his savings in a choice piece of downtown Midland real estate. Recently he has had a personal emergency and needs money. Bert can’t sell the property because of the state of Midland’s economy. His problem is an example of__ risk. marketability
A__ in the market is a person who expects securities prices to go up; a__ expects the general market to decline. bull; bear
The real rate of return on a taxable investment yielding 8 percent annually would be__ percent if the investor were in the 15 percent marginal tax bracket and inflation were 2 percent. 4.80 percent
XZY Corporation has suffered a major downturn in business and will not be able to pay interest on its bonds. This is an example of__ risk. financial
Investing goes beyond saving in that it involves increased risk
Which of the following arises when investors decide to copy the observed decisions of other investors or movements in the markets rather than follow their own beliefs and information. herd-behavior
You put your money into a 0.05 percent savings account. After two years you take your money out of the account, only to find that your purchasing power has decreased. This is an example of__ risk. inflation
With a(n)__ investment, the borrower agrees to pay the investor a specific rate of return for use of the principal. fixed income
__is an example of a lending investment. mortgage-backed bonds
The investment strategy that requires the percentage of dollars invested in stocks, bonds, and cash to remain fixed over a long period of time is called asset allocation
Tyler is going to invest $2,000 in money market mutual fund. He has narrowed his choices to a tax-free fund currently earning 2.8 percent and a taxable fund earning 4.1 percent. If Tyler is in the 28 percent marginal tax bracket, which of these funds would give him the highest after-tax yield? the taxable fund
Securities are made up of all of these (stocks, bonds, mutual funds)
__income is NOT an example of current income from an investment. capital gains
If you time horizon is six to ten years and your asset allocation consists of 10 percent cash, 30 percent bonds, and 60 percent stocks, you would be considered to have a(n)__ investment philosophy. moderate
Portfolio diversification__ volatility while__ return. reduces; averaging out
Ownership investments generally produce capital gains
Since 1927 the worst 20-year performance for stocks was a__of__ percent. gain; 3
In an average year, the price of a typical stock fluctuates up and down by about__ percent. 50
Shares in the ownership of a corporation are called stocks
The__ strategy avoids the risks and responsibilities of investment timing because the stock purchases are made regularly regardless of the price. dollar-cost averaging
__is (are) the portion of a company’s profits that the firm pays out to its shareholders. dividends
__would be a reasonable investment for funds that could be invested less than two years. money market mutual funds
Typically the highest commissions are charged on investments in collectibles
An investment that can be sold quickly but only by making price concessions suffers from__ risk. marketability
Financial risk relates to the possibility that the investment will fail to pay a return to the investor
Which of the following would NOT be considered as securities? real estate
Joelle purchased 100 shares of PAC stock for $20 per share and sold this same stock one year later for $25 per share. She paid commissions of $60 when she purchased the stock and $70 when she sold the stock. Dividends of $2 per share were paid during the year. The total rate of return on this investment was 28.50 percent
Your collection of multiple investments in different assets chosen to meet your financial goals is your portfolio
Commissions are generally based on the value of the transaction
An explanation of your investment philosophy and your logic on investing to reach specific goals is a(n) investment plan
If you have a(n)__ investment philosophy, you accept very little risk and are generally rewarded with relatively low rates of return conservative
With a(n)__investment, the borrower agrees to pay the investor a specific rate of return for use of the principal. fixed income
The likelihood that an investment market will fluctuate up and down in its market volatility
A stock represents a share of ownership in a corporation
Market risk is also known as systematic risk
__risk represents the uncertainty that the yield on an investment will deviate from what is expected. investment
Investing goes beyond saying in that it involves increased risk
When choosing among investment alternatives you want to focus on their yields
Selling shares of stock for more than you originally paid is called capital gain
The income received in return for someone’s use of your property is called rent
Attempting to invest based on predictions of short-term fluctuations in an investment market is called market timing

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