Chapter 11 PMM

Investment

An asset that generates value or a return. For example, stocks pay dividends and bonds pay interest.

Income Return

Received directly from the company or organization in which you’ve invested, usually in the form of dividends or interest payments.

Speculation

Buying an asset whose value depends solely on supply and demand as opposed to being based on the return that it generates. For example, gold coins and baseball cards are worth more in the future only if someone is willing to pay more for them.

Derivative Securities

Securities whose value is derived from the value of other assets.

Option

A security that gives its owner the right to buy or sell an asset—generally common stock—at a specified price over a specified period.

Investment is less risky than speculation, and value is based on how much income the investment is producing now, along with what it is expected to produce in the future.

True

Principle 2

Nothin Happens Without a Plan

Step one of principle 2

write your goals down and prioritize them

Step two of principle 2

attach costs to them

Step three of principle 2

figure out when the money for those goals will be needed

Step four of principle 2

periodically reevaluate your goals

Principle 3

The Time Value of Money

Don’t make your saving and investing automatic

False

Windfall

inheritance, a salary bonus, a gift, a tax refund, or maybe even something from the lottery

Principle 4

Taxes Affect Personal Finance Decisions

Lending Investments

Savings accounts and bonds, which are debt instruments issued by corporations and by the government

Ownership Investments

Preferred stocks and common stocks, which represent an ownership position in a corporation, and income-producing real estate

Maturity Date

The date at which the borrower must repay the loan or borrowed funds.

Per Value or Principal

The stated amount on the face of a bond, which the firm is to repay at the maturity date.

Coupon Interest Rate

The interest to be paid annually on a bond as a percentage of par value, which is specified in the contractual agreement.

Stock

A fractional ownership in a corporation.

Dividend

A payment by a corporation to its shareholders.

Nominal (or Quoted) Rate of Return

The rate of return earned on an investment, unadjusted for lost purchasing power.

Real Rate of Return

The current or nominal rate of return minus the inflation rate.

Interest Rate Risk

The risk of fluctuations in security prices due to changes in the market interest rate.

Inflation Risk

The risk that rising prices will eat away the purchasing power of your money and that changes in the anticipated level of inflation will result in interest rate changes, which will in turn cause security price fluctuations.

Business Risk

The risk of fluctuations in security prices resulting from good or bad management decisions or how well or poorly the firm’s products are doing in the marketplace.

Financial Risk

The risk associated with a company’s use of debt. If a company takes on too much debt and can’t meet its obligations, the company may default, or the value of its stock may drop.

Liquidity Risk

Risk associated with the inability to liquidate a security quickly and at a fair market price.

Market Risk

Risk associated with overall market movements.

Political and Regulatory Risk

Risk resulting from unanticipated changes in the tax or legal environment.

Exchange Rate Risk

The risk of fluctuations in security prices due to the variability in earnings resulting from changes in exchange rates.

Call Risk

The risk to bondholders that a bond may be called away from them before maturity.

Calling a Bond

Redeeming a bond before its scheduled maturity. Many bonds are callable.

Diversification

The elimination of risk by investing in different assets. It works by allowing the extreme good and bad returns to cancel each other out. The result is that total variability or risk is reduced without affecting expected return.

Portfolio

A group of investments held by an individual.

Systematic or Market-Related or Nondiversifiable Risk

That portion of a security’s risk or variability that can’t be eliminated through investor diversification. This type of variability or risk results from factors that affect all securities.

Unsystematic or Firm-Specific or Company-Unique Risk or Diversifiable Risk

Risk or variability that can be eliminated through investor diversification. Results from factors that are unique to a particular firm.

Asset Allocation

An attempt to ensure that the investor’s strategy reflects his or her investment time horizon and that the investor is well diversified, generally with assets in several different classes of investments, such as domestic common stocks, international common stocks, and bonds.

Efficient Market

A market in which all relevant information about the stock is reflected in the stock price.

Stock Bubble

The situation when the price of a stock or group of stocks rises dramatically over a period of time, well in excess of its true or intrinsic value.

Securities Markets

A term used to describe a place where financial securities or instruments—for example, common stocks and bonds—are traded.

Primary Markets

The markets in which newly issued, as opposed to previously issued, securities are traded.

Initial Public Offering (IPO)

The first time a company’s stock is traded publicly.

Seasoned New Issue

A stock offering by a company that already has common stock traded in the marketplace.

Investment Banker

The intermediary between the firm issuing securities and the buying public. This term describes both the firms that specialize in selling securities to the public and the individuals who work for investment banking firms.

Underwriter

An investment banker who purchases and subsequently resells a new security issue. The issuing company sells its securities directly to the underwriter, who then sells the new issue to the public and assumes the risk of selling it at a satisfactory price.

Prospectus

A legal document that describes a securities issue and is made available to potential investors.

Secondary Markets

The markets in which previously issued securities are traded.

Organized Exchange

An exchange that occupies a physical location where trading occurs, such as the New York Stock Exchange.

Over-the-Counter Market

A market in which transactions are conducted over the telephone or via a computer hookup rather than in an organized exchange.

Bid Price

The highest price someone is willing to pay for a security.

Ask or Offer Price

The lowest price at which someone is willing to sell a security.

American Depository Receipt (ADR)

A marketable document that certifies a bank holds shares of a foreign firm’s stock that back the receipt. Trades just like a normal share of stock.

Churning

Excessive trading in a security account that is inappropriate for the customer and serves only to generate commissions.

Round Lot

A group or lot of 100 shares of common stock. Stocks are traded in round lots on the New York Stock Exchange.

Odd Lot

An order involving between 1 and 99 shares of stock.

Fractional Share

A portion of a share of stock, less than a full share.

Discretionary Account

An account that gives your broker the power to make trades for you.

Market Order

An order to buy or sell a set number of securities immediately at the best price available.

Limit Order

An order that specifies a security is to be sold only at or above a certain price or bought only at or below a certain price.

Stop or Stop-Loss Order

An order to sell a security if the price drops below a specified level or to buy it if the price climbs above a specified level.

Short Selling

Borrowing stock from your broker and selling it with an obligation to replace the stock later.

Margin Requirement

The percentage that an investor must have on deposit with a broker when selling short.

Asset Management Account

A comprehensive financial services package offered by a brokerage firm that can include a checking account; credit and debit cards; a money market mutual fund; loans; automatic payment of fixed debt (such as mortgages or other debt); brokerage services (buying and selling stocks or bonds); and a system for the direct payment of interest, dividends, and proceeds from security sales into the money market mutual fund.

Cash Account

A securities trading account in which the investor pays in full for security purchases, with the payment due within 3 business days of the transaction.

Margin Account

A securities trading account in which the investor borrows a portion of the purchase price from the broker.

Margin or Initial Margin

A 50 percent limit set by the Federal Reserve on the minimum percentage of the purchase price of a security that an investor must initially pay.

Maintenance Margin

The minimum percentage margin of collateral that you must maintain.

Margin Call

A requirement that you replenish your margin account by adding cash or securities to bring it back to a minimum level.

Joint Tenancy Account with the Right of Survivorship

A type of joint ownership in which the surviving owner receives full ownership of the assets in the account when the joint owner dies.

Tenancy-in-Common Account

A type of joint ownership in which the deceased’s portion of the account goes to the heirs of the deceased rather than to the surviving account holder.

Discount or Online Broker

A “no-frills” broker who executes trades without giving any advice and thus charges much lower commissions than a full-service broker.

Full-Service Broker or Account Executive

A broker who gives advice and is paid on commission, where that commission is based on the sales volume generated.

Principle 1

The Best Protection is Knowledge

Principle 6

Waste Not, Want Not - Smart Spending Matters

Day Traders

Individuals who trade, generally over the Internet, with a very short time horizon, generally less than 1 day.