Lesson 16 - Mr. Wilson: The Digital Classroom



AOF Principles of FinanceLesson 10Financial MarketsStudent ResourcesResourceDescription Student Resource 10.1Reading: Investment Risk Factors Student Resource 10.2Chart: Investment Risk FactorsStudent Resource 10.3Note-Taking Guide: Investment InstrumentsStudent Resource 10.4Reading: Investment InstrumentsStudent Resource 10.5Reading: Understanding Financial MarketsStudent Resource 10.6Assignment: Investment PosterStudent Resource 10.7Research Guide: Investment PosterStudent Resource 10.8Feedback Form: Investment PostersStudent Resource 10.1Reading: Investment Risk FactorsThere are certain risks associated with every choice you make in life. From the friends you choose to the sports you play to even the foods you eat, there is an element of risk involved with each decision. The same holds true with money. Whether you spend, save, donate, or invest your money, there is always an element of risk attached. For example, if you choose to spend $150 on a pair of concert tickets you are accepting a level of risk. What if you get sick on the day of the show, what if the tickets get posted on eBay for half the price, or what if your car breaks down unexpectedly and you need that money for repairs? Even if you keep your money stashed at home hidden in your dresser drawer, you risk that you could lose it or that it could be stolen. Investing is a way for you to increase the amount of money you have—it’s a way to put your hard-earned money to work for you. But there is risk involved in investing because you can never be completely sure of the return the investment will provide. This type of risk is commonly referred to as financial risk. In fact, every investment carries with it some level of risk. (There’s even risk in not investing—what if inflation goes crazy and the value of your money drops dramatically?) What’s more, the market sometimes rewards risk takers—the greater an investment’s risk, the greater the possible reward as well as the greater the chance of decline in value. Most investors decide the level of risk they’re comfortable with and invest according to that risk level.So how much risk should you take with your money? That depends on your age, financial goals, existing economic conditions, financial resources, financial responsibilities, and risk tolerance level. Risk tolerance level refers to your ability and willingness to accept risk. Most investors feel that if you are losing sleep over your investments or if your investment portfolio is causing you to feel anxious or worried, then your investments’ risk level probably exceeds your risk tolerance, and you should think about adjusting accordingly. You can evaluate the overall risk of an investment by understanding and being knowledgeable about some of the major risk components described below.Economic Risk and Market Risk Sometimes the value of an investment (stock, bond, mutual fund, real estate) can fluctuate just because of the state of the economy and/or the financial markets. Many factors can influence this type of risk such as war, inflation, political changes, and recessions, to name a few. Economic risks (the investment risk associated with the overall health of the economy) affect the entire market, whereas market risks (the risk that the value of an investment will decrease due to changes in the market) may affect just one sector of the market. Stock prices, interest rates, and exchange rates, as well as other outside forces, can affect market risk. For example, from about 1995–2001 the United States experienced a market crash in the tech industry. Because of this, the tech industry (and not the entire market) experienced a very substantial crash, which caused many investors to lose millions of dollars. The 2008 US subprime mortgage crisis is another example of a market crash. There were many factors that contributed to this crisis, which included subprime lending practices, overbuilding, risky mortgage products, and an incredibly high level of default rates among borrowers. Liquidity RiskLiquidity risk refers to the ease with which an investment can be bought and sold and/or converted to cash. Some investments are more easily converted to cash on short notice than others. These are considered liquid. Financial assets, like stocks and bonds, are generally more liquid than real assets such as collectibles—coin collections, antique cars, jewelry--or real estate. For example, let’s say that you want to buy a car for work purposes and you need access to your money quickly. If you can’t redeem your investment quickly without taking a huge loss in its value, your investment has a low liquidity. Inflation (or Price-Level) RiskSome people believe that the safest form of investing is to place their money into a savings account or a certificate of deposit because their money is “guaranteed” to be safe. However, even these forms of investing can be risky. There is a chance that your money may not be able to keep up with inflation and your dollar may actually be worth less in the future. As you have learned, when the price of goods and services goes up, the result is an increase in the cost of living, which is referred to as inflation. When this happens, your purchasing power decreases because the value of your money declines. Inflation risk refers to the uncertainty associated with the real value of the cash payments that you expect to receive from your investments.Interest Rate Risk The amount your investments earn can become uncertain because of changes in value caused by interest rate changes. Changes in interest rates can affect the price of a stock or a bond. If interest rates go up, bond prices usually go down and if interest rates go down, bond prices usually go up. In other words, bond issuers must offer higher rates on new bonds in order to entice investors when interest rates decrease. The result is that the prices of existing bonds drop because investors will choose the newer bonds that are offering the higher rate. Since stocks and bonds react differently to the changes in interest rates, investing in a variety of investment instruments can help minimize this type of risk. Business Risk Business risk refers to the risk associated with investing. The risk revolves around the soundness of the business or firm in which you are investing. Even if you do careful research on the company, you still face the risk that the company may be less profitable than you expected and may experience declining revenues or increasing costs. There is no way to predict that the company you invested in won’t be affected by the arrival of a competitor, changes in labor conditions, or poor management practices. There is also the possibility that the company you invest in could fail and/or go out of business, which would mean that you could lose all of your initial investment! Global Investment RiskGlobal investment risk affects those investors who invest their money in stocks and bonds offered by companies in other countries. There are many risks involved with investing internationally, such as the exchange rate risk, political stability of another country, or differences in regulatory agencies and standards that other countries must abide by. Minimize Your RiskThere are many different ways to invest, and every option has a different level of risk attached to it. You will learn about the variety of investment options later in this lesson, and as you’ll see there will always be the potential for loss but also for high returns. The key is to have a balanced investment portfolio so gains in one type of investment in your portfolio can offset any potential losses that may occur in another part of your portfolio. Diversifying your investments (spreading your money among different investments) is a good way to reduce investment risks. Furthermore, understanding the risks posed by certain types of investments and determining the kind of investment risks worth taking at a particular point in time should be a part of everyone’s investment strategy. One thing to remember: we all have a responsibility when it comes to the decisions we make. We need to educate ourselves and understand the potential risks involved and then make an informed decision about whether or not to accept the risk.Student Resource 10.2Chart: Investment Risk FactorsStudent Name:_______________________________________________________ Date:___________Directions: Use your knowledge of the different forms of risk to complete the table below. For each type of risk, describe some of the factors that cause it and one thing it most affects.Type of RiskWhat Causes ItOne Thing It Most AffectsEconomic RiskMarket RiskLiquidity RiskInflation RiskInterest Rate RiskBusiness RiskGlobal Investment Risk DOCPROPERTY Category DOCPROPERTY Category DOCPROPERTY Category DOCPROPERTY Category Student Resource 10.3Note-Taking Guide: Investment InstrumentsStudent Name:_______________________________________________________ Date:___________Directions: Jot down what you know about each term. Add information both during and after viewing the presentation and then write a definition of each type of investment instrument or term. common stockpreferred stockinitial public offering (IPO)primary marketcorporate bondsUS Treasury bondsmunicipal bondsmutual fundsexchange-traded funds (ETFs)optionsfuturesannuitieshedge fundsprivate equityStudent Resource 10.4Reading: Investment InstrumentsThere are many different investment instruments available that can help investors meet their financial objectives, each with its own unique characteristics. Being knowledgeable about the various instruments available should be the first part of any investment strategy. Some of the main differences between common and preferred stock include the payment of the dividends, voting rights, and the risk return trade-off. Both common stocks and preferred stocks represent ownership in a company, and both stockholders share in the profit if the stock prices go up. However, preferred stockholders will be paid dividends before common stockholders, and the dividends are generally greater than for common stockholders. Common stockholders also have voting rights, while preferred stockholders do not. Preferred stocks are more stable and are considered a safer investment; however, they do lack the potential for growth that common stocks can offer. Companies may issue different classes of stock and list them differently on the stock market. Most stocks can be placed into the following categories: blue chip stocks, income stock, growth stock, defensive stock, large and small cap stock, and penny stock. The strength of the stock market is usually related to the economy and specific factors that affect it. The price of stocks move up or down depending on consumer confidence along with how much investors are willing to pay for them at any given time.When stocks are first purchased by investors from the investment bank or directly from the founders, it is considered a primary market. After that, any shares that are sold will be on the secondary market. On the secondary market, securities may be bought and sold to many different investors and traded on securities exchanges like the NYSE or the NASDAQ. On the primary market, prices are usually set beforehand and generally the company gets the money when its stock is first issued, sold via a firm commitment deal. The investment bank makes a profit by selling the stock at a higher price than it gave the issuer. However, if an investment bank decides to facilitate the sale of a company’s IPO stock using a best-efforts basis, the investment bank reduces its risk by not committing to purchase all of the company’s stock and receives a flat fee for its services. On a secondary market, factors like supply and demand, the health of the economy, and political changes can affect the price of the security. A bond is a loan that pays interest over a specified amount of time. Bonds are usually considered fixed-income securities, because the rate of interest and the amount of each payment is fixed at the time the bond is offered. In the United States, there are three main categories that bonds fall into: corporate bonds, US Treasury bonds, and municipal bonds. Within each of these categories various types of bonds are available. Corporate bonds are bonds issued by companies to help them raise money for expansion, modernization, or other business activities. The US government offers different types of bonds; the three most common types of securities include Treasury bills (T-bills), Treasury notes, and US savings bonds. Treasury bills make up most of the money market and are used by the government to provide immediate funding. T-bills are sold in $1,000 increments. T-notes help to pay interest on national debt and are also issued in $1,000 increments. Series EE savings bonds are offered by the federal government and are an alternative to regular savings accounts. They can be purchased in amounts that range from $25 to $5,000. Series EE savings bonds earn interest for up to 30 years.Municipal bonds (or munis) allow states and cities to raise money. Municipal bonds help to finance new projects and improvements for each state, city, or county. By investing in mutual funds, investors with limited capital can create a diversified portfolio. There are many different types of mutual funds; the three main groups are stock funds, bond funds, and money market funds. Within each group, many different categories exist to meet the needs and objectives of different types of investors. Most of these funds serve to diversify an investor’s holdings by purchasing a variety of investments within their particular category. At the end of 2012 there were more than 7,000 mutual funds in the United States with nearly $12 trillion in them.Stock funds invest in stocks and can be classified by the types of stock they buy. Categories can range from (but are not limited to) global stock funds (international companies) to utility funds (companies that offer utility services) to value funds (companies that may be undervalued and pay high dividends) to growth funds (companies in a rapid expansion phase).Bond funds invest in bonds and can be classified by the types of bonds they buy. Bond funds provide income. Categories include junk bonds (high-risk companies), corporate bonds, and municipal bonds, to name a few.Money market funds usually maintain a $1-per-share value, so they can be thought of as equal to cash. The interest the investments earn is low when interest rates are low. Money market funds invest in short-term interest-paying securities. ETFs are portfolios of stocks, bonds, or other investment instruments that trade on a stock exchange similar to a regular stock. This portfolio may also have a collection of stocks that are bought and sold as a package. When you invest in an ETF, you are investing in whatever the ETF owns. ETFs are categorized by their investment target. For example, some ETFs track a specific market within the stock exchange, such as the pharmaceutical industry or financial companies. Other ETFs track a market index. A market index is a method for measuring a section of the stock market and is used as a benchmark to gauge the performance of a specific investment. The Dow Jones Industrial Average and the Standard & Poor’s 500 Index are the best-known US indicators. Other ETFs track a certain investment style (such as growth funds). Like stocks and traditional mutual funds, ETFs are listed on an exchange (NYSE Euronext) so they can be bought and sold at the price at which they happen to be trading. Investors like the flexibility that this provides. One of the disadvantages of ETFs is that you have to buy them through a broker. Because of this, individuals pay commission fees when they buy and sell. Once bundled and traded on the exchange, the ETFs are not actively managed by a fund manager, and therefore they have lower costs.Futures and options are both considered derivatives. Derivatives are financial instruments whose value depends on the value of something else, like an asset or an index. Options give the owner the right, but not the obligation, to buy or sell a specific item at a specific price over a specific time. If the owner chooses not to buy or sell, the option will expire and the investor’s only loss is the price at the time of purchase. A future is a contract that says that the buyer will purchase a financial instrument for a specific price at a specific time in the future. Futures contracts hold considerable risk because they involve a considerable degree of speculation. Futures require that investors only put up a fraction of the contract’s value. Investing in futures can be dangerous for corporations as well as for individuals.Annuities are sold by life insurance companies and provide a regular series of payments that continue for a set period of time. Investors can purchase annuities with a single payment or a series of payments. Annuities are often used to fund a person’s retirement. There are fixed annuities that pay a set amount (usually monthly) and variable annuities in which the payments change based on how well the investments are doing. A hedge fund is an investment fund that is lightly regulated. With hedge funds, investors can participate in a range of investment and trading activities. Hedge funds invest in stocks, bonds, and more and use a variety of investment strategies to enhance returns. Currently hedge funds do not have to register with the SEC.Real estate investment trusts (REITs) are established to make money in real estate. REITs are also similar to mutual funds in that they use funds pooled from a group of investors to buy buildings or mortgages on buildings. Most REITs will specialize in a specific type of building such as hotels, hospitals, apartments, and/or shopping centers. REITs are similar to stock in that they trade on the major exchanges. REITs are considered a highly liquid method of investing in real estate. There are many different forms of REITs; for example, there are equity REITs, mortgage REITs, and hybrid REITs. Private equity consists of securities of companies that are not openly traded on stock exchanges. Very wealthy investors are often interested in private equity investments. Their money goes into pools and is used as a source of funding for high-risk ventures, including new start-ups that are predicted to have significant growth possibilities or firms in need of restructuring. Many well-known companies have had their beginnings with private equity funding. Federal Express and Intel are two well-known examples. Student Resource 10.5Reading: Understanding Financial MarketsWhen you think of a market, your mind probably thinks of a specific location, such as a grocery store or a department store where products can be bought and sold. But what do you think of when you hear the term financial markets? Financial markets offer products that are a bit different from the products you would find at a grocery store or a department store. For example, financial markets won’t supply you with food items or cleaning supplies; however, you could buy stocks, bonds, mutual funds, and a variety of other investment options! When most people think of financial markets, they often think of the stock market. But financial markets are actually made up of a pretty complex system (rather than a location) that brings together borrowers and savers and facilitates that trade in financial products. In other words, financial markets help to efficiently connect individuals, businesses, and governments that have funds with businesses and governments that have a need for funds. Most people don’t enter financial markets directly but use intermediaries such as commercial banks, mutual funds, pension funds, credit unions, savings and loan associations, and insurance companies to help simplify the process. There are many different financial markets. Financial markets are generally characterized by types of investments, types of transactions, and types of borrowers and lenders. The most common types of markets are described below. Money Markets The money market is the financial market that provides short-term borrowing and lending. Some of the most common types of investment instruments that are used in the money market are certificates of deposits and US Treasury bills. Money markets provide short-term debt financing for borrowers who are seeking funds with maturity dates of one year or less. Money markets only include debt instruments because stocks (equity instruments) have no specific maturity date. Money markets provide individuals, businesses, and even the government with short-term funds that have varying maturity dates to match particular financial needs. Capital Markets The capital market is used primarily by governments or companies who hope to raise long-term funds by issuing stocks or bonds. Capital markets include investment instruments that typically have maturity dates of more than a year. Capital markets include stock markets, which provide financing by issuing shares of stock, and bond markets, which provide financing by issuing bonds. The capital market is regulated by the US Securities and Exchange Commission (SEC), which actually regulates and enforces the conduct of every organization participating in the US securities market.One of the most common forms of capital markets is the stock market. Stock markets operate with a few main functions, such as providing companies with the capital to grow, providing investment opportunities for investors, and providing a system for people who want to buy stocks, bonds, and other investment options. Although there are seven major security exchanges in the United States, the three most common are the New York Stock Exchange (NYSE), the NYSE Amex Equities (formerly the American Stock Exchange, or AMEX), and the NASDAQ stock exchange. Companies must meet specific requirements (which vary by stock exchange) in order to have their stocks listed and traded on these exchanges. The NYSE is one of the largest securities exchanges in the world, and it is probably the best known. It is located in Manhattan, New York. In order for a company to be listed on the NYSE, a company must have issued at least a million shares of stock worth at least $100 million and must have earned more than $10 million over the last three years. NASDAQ refers to the National Association of Securities Dealers Automated Quotations system and came into existence in 1971. NASDAQ refers to the largest electronic stock market. It is a screen-based, floorless system that uses a telecommunications network to connect brokers and dealers. It accounts for a large percentage of the equity market trading and has more trading volume per hour than any other stock exchange in the world. The NASDAQ stock exchange is home to the thousands of smaller companies, including many high tech companies. To be listed on the NASDAQ, a company must have issued at least 1.25 million shares of stock worth at least $70 million and must have earned more than $11 million over the last three years.The NYSE Amex Equities is another well-known stock exchange that is located in New York. It is known for listing smaller companies than the NYSE and the NASDAQ. Its core business has recently changed from stocks to options and ETFs (exchange-traded funds). ETFs are similar to mutual funds and are traded on the open market like stocks. Financial markets allow society to consume amounts that are in excess of their income and are relied on by the nation to help individuals, businesses, and the government raise the capital they need. For instance, financial markets give many young people the chance to go to college and give families the ability to purchase homes. Financial markets also enable businesses to raise funds to expand and grow. Financial markets, in general, facilitate the wealth and the stability of our country. Student Resource 10.6Assignment: Investment PosterStudent Names:_______________________________________________________ Date:___________Directions: Your group must research an investment option and create a poster that highlights its specific characteristics. When designing your poster keep in mind the purpose of the assignment: to educate your fellow classmates on the most important aspects of your particular investment option. Before you begin, make sure to read through the directions, review the assessment criteria, and refer to the example provided by your teacher to help guide you. Cross off the Following Steps as Your Group Completes ThemWe have read through the assignment directions and understand the assessment criteria.We have chosen our investment instrument and written down some things that we already know about it.We have completed all sections of the research guide.We have highlighted the most important information on Student Resource 10.7.We have used the information from our research to complete a written draft of the content that will be included on our poster.We have organized the layout and content of our poster.We have completed the construction and design of our poster.Before You BeginOnce your group has chosen which investment instrument to research, take a few minutes and write down what you already know about your particular investment option. We know… Two questions that we have…Make sure your poster meets or exceeds the following assessment criteria:Accurately describes the investment option and its specific characteristics Effectively informs the audience as to whom the investment option targets (in other words, this investment option is a good choice for someone who…)Correctly highlights the risks and rewards of the specific investment instrumentAccurately explains why being knowledgeable about this particular investment instrument is importantContains content that is informative, accurate, and geared toward the appropriate audience Includes a balanced combination of text and graphics that is organized in a neat and visually appealing mannerContains proper spelling and grammarRough Draft of PosterUse your research from Student Resource 10.7 along with the required criteria above to complete a written draft of the content that will be included on your poster. Assign each group member a different area to concentrate on and then come together to share your drafts. Student Resource 10.7Research Guide: Investment PosterStudent Name:_______________________________________________________ Date:___________Directions: The content of your poster will be developed around the prompts listed below. Be sure to thoroughly and accurately complete each section of the guide before you begin your poster. When you have completed your research, reread your notes and highlight the most important information as it pertains to the poster assignment. The investment instrument that we are researching is: ________________________________________Describe the investment option and its specific characteristics.Source:This investment option is a good choice for someone who…Source:The risks associated with this investment option include…Source:The benefits associated with this particular investment option include…Source:This type of investment option is similar to…Source:This investment option is considered a (circle one) short-term, intermediate-term, or long-term investment because…Source:Things to keep in mind or questions to ask before making this type of investment include…Source:Understanding this particular investment option can better prepare you for the future because…Source:Student Resource 10.8Feedback Form: Investment PostersStudent Name:_______________________________________________________ Date:___________Directions: Review your classmates’ investment posters. Be sure to note the particular investment option that is highlighted and list two distinguishing features about each instrument. For each poster answer the following question: when you have money to invest, what is the most important thing you would want to remember about this investment option? An example has been provided for you.Investment Option: Precious Metals Two distinguishing features:1. Investing in precious metals can take a variety of forms: bullion, coins, certificates, mutual funds, and stock in mining companies. 2. Precious metals are exempt from capital gains taxes.When I have money to invest, the most important thing I would want to remember about this investment option would be… Investing in precious metals provides the investor with a great way to diversify his or her portfolio. About 5%–10% of an individual’s portfolio should be placed in precious metals. Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be…Investment Option:Two distinguishing features:When I have money to invest, the most important thing I would want to remember about this investment option would be… ................
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