CHAPTER 1

Total Return = Income + Capital Gains/Losses (Appreciation)

Investment • Commitment of current funds in anticipation of receiving a larger future flow of funds • To use money for the purpose of obtaining an income or profit

Risk-Reward

Financial Assets • Financial claim on an asset – usually documented legally o Stocks, bonds, options – debt

• Direct Equity Claims o Represent ownership interests and common stock, also warrants and options ▪ Warrants & Options ← Allow holder to buy a stipulated number of shares in the future at a given price ← Warrants – convert to one share and are long term ← Options – based on 100 share units & short term • Indirect Equity o Acquired through placing funds in investment companies ▪ Mutual Funds ▪ Pools resources of many investors and reinvests in common stock or other investments ▪ Diversification and professional management • Creditor Claims o Debt instruments offered by financial institutions, industrial corporations, or the government ▪ Rate of return often initially fixed, though actual return may vary with changing market decisions • Preferred Stock o Hybrid form of security combining some of the elements of equity ownership and creditor claims • Commodity Futures o Contract to buy or sell a commodity in the future at a given price ▪ Wheat, corn, copper, T-Bonds or Foreign Exchange

Real Assets • Tangible asset that may be seen, felt, held, or collected o Real estate, gold

Objectives • Safety of Principal o Cant risk money we have • Liquidity o How fast can we convert to cash? Penalty? o Ability to convert investment quickly into cash at fair market value • Income • Growth o Saving and trying to increase amount ▪ Short term vs. Long term, Tax, Ease of Management

Short Term vs. Long Term • Short term o One year or less • Intermediate term o Between 1-10 years • Long Term o Over 10 years • Diversification of maturity dates • People who manage funds for others may have a lot of pressure • Convinced investment will double in 3 years, currently down 15%, discomfort for those around you
Tax Factors • High tax bracket investors o Municipal bonds – interest not taxable o Real estate – depreciation and interest write-offs o Investments that provide tax credits or tax shelters • Tax Relief Act of 2003 o Prior to, dividends taxed as ordinary income and maximum tax rate was 38.8%, long-term only 20% ▪ High income investors went to companies like Home Depot or eBay that didn’t pay much dividends but grew ▪ AT&T shunned because taxes on dividends o Tax Relief in 2003 put dividends and long-term capital gains on equal footing ▪ Both taxed at a maximum of 15%
Ease of Management • Professional Investment Manager vs. Do it Yourself Approach o Managers fee vs. possible higher return o Opportunity costs o Time needed to analyze, choose and manage o Psychic Income o Leisure time • Day trader or longer-term perspective • Personally owning and managing rental houses or going in with 10 other investors to form limited partnership

Current Income vs. Capital Appreciation (trade-off) • Current Income o Objective: Income, NOT growth o High-yielding utilities, expect slow growing earnings and stock price •