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In personal financial planning, everything begins and ends with your goals. You must first decide what your goals are and how much you can set aside to meet those goals. Once you’ve done this, you can develop an investment plan.
It’s important to know the difference between investments and speculation. Investing involves buying an asset that generates a return. Speculation occurs when an asset’s value depends solely on supply and demand. Buying gold coins and baseball cards is considered speculation because they’re worth more in the future only if someone is willing to pay more for them.
An asset that generates value or a return. For example, stocks pay dividends and bonds pay interest, so these are considered investments.
Investment return received directly from the company or organization in which you’ve invested, usually in the form of dividends or interest payments.
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.
Securities whose value is derived from the value of other assets.
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.
The date at which the borrower must repay the loan or borrowed funds.
The stated amount on the face of a bond, which the firm is to repay at the maturity date.
The interest to be paid annually on a bond as a percentage of par value, which is specified in the contractual agreement.
A fractional ownership in a corporation.
A payment by a corporation to its shareholders.
The gain (or loss) on the sale of a capital asset. For example, any return (or loss) from the appreciation (or drop) in value of a share of stock would be considered a capital gain (or loss).
There are a number of different sources of risk associated with investments, including interest rate risk, inflation risk, business risk, financial risk, liquidity risk, market risk, political and regulatory risk, exchange rate risk, and call risk.
The rate of return earned on an investment, unadjusted for lost purchasing power.
The current or nominal rate of return minus the inflation rate.
The risk of fluctuations in security prices due to changes in the market interest rate.
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.
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.
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.
Risk associated with the inability to liquidate a security quickly and at a fair market price
The risk to bondholders that a bond may be called away from them before maturity.
The redeeming of a bond before its scheduled maturity. Many bonds are callable.
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.
A group of investments held by an individual.
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.
Risk or variability that can be eliminated through investor diversification. Unsystematic risk results from factors that are unique to a particular firm.
As your investment horizon lengthens, you can afford to invest more in riskier assets. This is because the returns of risky assets tend to dominate those of less risky assets as the investment horizon lengthens.
Asset allocation attempts to ensure that the investor is well diversified, generally with investments in several different classes of investments, such as domestic common stocks, international common stocks, and bonds. It also incorporates the concept of the time dimension of investing into the allocation process.
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 markets are concerned with the speed at which information is reflected in security prices. The more efficient the market is, the faster prices react to new information. It is very difficult to beat the market, and as a result, you should keep to your plan and invest for the long term.
A market in which all relevant information about the stock is reflected in the stock price.
The primary securities market is where new securities are sold. A new issue of IBM stock would be considered a primary market transaction. Actually, the primary markets can be divided into two other markets: those for initial public offerings (IPOs) and those for seasoned new issues. An initial public offering is the first time a company’s stock is traded publicly. Seasoned new issues are stock offerings by companies that already have common stock traded in the market. Securities that have previously been issued are traded in the secondary markets.
A term used to describe a place where financial securities or instruments—for example, common stocks and bonds—are traded.
A market in which newly issued, as opposed to previously issued, securities are traded.
The first time a company’s stock is traded publicly.
A stock offering by a company that already has common stock traded in the marketplace.
The middleman 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.
A legal document that describes a securities issue and is made available to potential investors.
The markets in which previously issued securities are traded.
A market in which transactions are conducted over the telephone or via a computer hookup rather than in an organized exchange.
The highest price someone is willing to pay for a security.
The lowest price at which someone is willing to sell a security
A marketable document (a receipt) that certifies a bank holds shares of a foreign firm’s stock that backs the receipt. As a result, the ADR trades just like a normal share of stock.
Excessive trading in a security account that is inappropriate for the customer and serves only to generate commissions.
A market order is simply an order to buy or sell a set number of securities immediately at the best price available. A limit order specifies that the trade is to be made only at a certain price or better. A stop-loss order is an order to sell if the price drops below a specified level or to buy if the price climbs above a specified level.
An order involving between 1 and 99 shares of stock.
A trading order that expires at the end of the trading day during which it was made.
A trading order that remains effective until filled or cancelled.
A trading order which if not filled immediately expires.
An account that gives your broker the power to make trades for you.
An order to buy or sell a set number of securities immediately at the best price available.
An order that specifies a securities trade is to be made only at a certain price or better.
An order to sell a security if the price drops below a specified level or to buy if the price climbs above a specified level.
Borrowing stock from your broker and selling it with an obligation to replace the stock later.
The percentage that an investor must have on deposit with a broker when selling short
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.
Securities trading accounts in which the investors pay in full for their security purchases, with the payment due within 3 business days of the transaction
Securities trading accounts in which the investors borrow a portion of the purchase price from their broker.
percentage of the purchase price of a security that must initially be paid for by the investor, which is set by the Federal Reserve.
The minimum percentage margin of collateral that you must maintain.
A requirement that you replenish your margin account by adding cash or securities to bring it back to a minimum level.
A type of joint ownership in which the surviving owner receives full ownership of the assets in the account when the joint owner dies.
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.
A “no-frills” broker who executes trades without giving any advice and thus charges much lower commission than a full-service broker.
A broker who gives advice and is paid on commission, where that commission is based on the sales volume generated.
Making trades on the Internet.
Individuals who trade, generally over the Internet, with a very short time horizon, generally less than 1 day.
If you’re going to make informed investment decisions, you have to seek investment information, read it, and interpret it. Fortunately, you don’t have to do your own research. That’s already done for you, and it’s available from the companies themselves, from brokerage firms, and from the press—magazines, newspapers, and investment advisory services—and on the Web. The Web is the first place you’ll want to look, with new investment sites being added almost daily. This provides all investors with the same opportunities. Still, because there are no controls on who can post on the Web, you’ve got to be careful of where you get your information.
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