Many investors rely on a company’s dividend yield as a guide for selecting companies. Read about a popular approach called "Dogs of the Dow" ( http://www.dogsofthedow.com/www.dogsofthedow.com). Click on "YTD Performance" (or choose “YTD Performance” from the drop-down menu) to compare the approach to the overall Dow Jones Industrial Average. For the current year, are the Dogs of the Dow beating the overall market? Explain your answer. Problem 2: Use the following bond screener to answer the questions below: http://cxa.marketwatch.
INVESTING IN STOCKS AND BONDS INVESTING IN STOCKS AND BONDS Why Consider Bonds? Bonds reduce risk through diversification. Bonds produce steady income. Bonds can be a safe investment if held to maturity. Your Rights as a Bondholder Bondholders are creditors Bond indenture Protective covenants Payment Characteristics of Bonds Face value: The amount the issuer pays to redeem the bond It is usually $1,000 for corporate bonds. Coupon interest payments: Most bonds have a fixed rate of return, which are the interest payments that are made every 6 months. The amount of the payment is determined by multiplying the bond’s coupon rate by the face value of $1,000. Example: An 8% bond pays $80 in interest per year (0.08 × $1,000) divided into two payments of $40 semiannually. Retirement Methods Redeemed at maturity Call provision Sinking fund provision Convertible bonds can be converted into common stock. Corporate Bonds Corporate bonds - allow firms to borrow money, are a major source of funding. Denominations in $1000. Secured bond – backed by collateral. Unsecured bond – a debenture. Hierarchy of bonds – subordinated debentures are low on the list. Government-Issued Bonds U.S. Treasury Securities U.S. Agency Bonds Conventional Mortgage-backed Municipal Bonds General obligation (GO) bonds Revenue bonds Special Types of U.S. Treasury Bonds U.S. Treasury Strips Inflation-Indexed Bonds Intended to lessen price risk of bonds The coupon rate is not changed. The redemption value is adjusted periodically to reflect inflation. Example: If annual inflation is 3%, the redemption value is increased to $1,030. Munis’ Income Tax Advantage Example: Muni Yield = 5.91% and Tax rate = 28% (0.28) FTEY = 5.91/(1.00 – 0.28) = 5.91/0.72 = 8.21% Compare to yields on taxable bonds and choose the bond with the highest yield. Special Situation Bonds Zero Coupon Bonds Junk bonds Bond Ratings – A Measure of Riskiness Moody’s and Standard & Poor’s provide ratings on corporate and municipal bonds. Ratings involve a judgment about a bond’s future risk potential. Default risk – ability to repay principal. Inability to meet interest obligations. The lower the rating, the higher the rate of return demanded by investors. Safest bonds receive AAA, D is extremely risky. Expected Return from Bonds Current yield (CY): annual interest divided by current price Example: Bond price (P) = $900 Annual coupon interest (I) = $120 The current yield calculation: CY = I/P = $120/$900 = 0.1333 or 13.3% The advantage of this calculation is that it is easy. The disadvantage is that ignores maturity. Yield to Maturity (YTM) Yield to maturity is the return you would earn by buying a bond today and holding it until it is redeemed by the issuer. Formula (approximation) YTM = [ I + (1,000 – P)/N]/ [(P + 1,000)/2] Example: I = 120, P = 900, N = 5 YTM= [120+(1,000 – 900)/5]/ [(900 + 1,000)/2] = [120 + 20]/ [950] = 140/950 = 0.1474 or 14.74% YTM Example..contd. N5 PMT120 FV1000 PV-900 CPT I/Y = 14.74% If bond purchased at a discount, YTM > coupon rate. If bond purchased at a premium, YTM < coupon rate. if bond is purchased at face value, ytm = coupon rate. yield to maturity (ytm) bond prices present value of a coupon bond a coupon bond’s present value (pv) has two components: present value of the coupon interest payments present value of the future redemption value (usually $1,000) but these payments are all in the future the future cash flows are discounted using the bond’s yield to maturity (not the coupon rate) to determine the present value of the bond. present value of a coupon bond: an example data: ytm = 15%; coupon rate = 12% ($120 a year); redemption value = $1,000; 5 years to maturity find: pv of $1000 at 15%, in 5 years = $497.18 pv of $120 annuity at 15%, 5 years = $402.26 present value (price): = $899.44 present value of a zero coupon bond there is only one cash inflow with a zero coupon bond – the future redemption value. example: find the pv of a zero coupon bond that matures in 10 years with a ytm of 8%. pv of the bond = $463.19. n=10, i/y=8, fv=1000, pmt=0 reading corporate bond quotes in the wall street journal selling price is quoted as a percent of par. price listed at 101 -- 101% x $1000 = $1010. include accrued interest. treasury and agency securities trade in thirty-seconds (1/32). price listed as 102:31 = 102 31/32 if par value is $10,000 then price is $10,296.88. quotes list both bid and ask prices. bond valuation what causes the required rate of return to change? if the issuer becomes riskier, the required rate of return should rise. a change in general interest rates, increase in expected inflation, the required rate of return should increase. when interest rates rise, the value of outstanding bonds falls. risk in bond investment default risk is the possibility that the issuer will not make the interest payments and/or redeem the bonds at maturity. interest rate risk is the price volatility of a bond in relationship to the changes in market rates of interest. why bonds fluctuate in value inverse relationship between interest rates and bond values. longer-term bonds fluctuate in price more than shorter-term bonds. preferred stock hybrid security: preferred stock has some characteristics of both bonds and stocks form of equity ownership – similar to common stock pays a fixed return – similar to bonds stockholders’ rights are provided in the offering agreement this agreement is similar to a bond indenture but is weaker. preferred stock usually does not vote. preferred stock features $100 par value is common but other par values can also be used. cumulative dividend (frequently used) participating dividends (rarely used) convertibility (sometimes used): preferred stock may be exchanged for common stock. expected return from preferred stock similar to common stock, most preferred stock does not have a maturity the expected return is simply the preferred stock’s current return (cr): cr = dividend/stock price example: if the dividend = $2 and the price = $8, then cr = $2/$8 = 0.1111 or 11.11%. value of preferred = dividend/ current return lawrence j. gitman, ph.d., cfp® – san diego state university michael d. joehnk, ph.d., cfa – arizona state university randall s. billingsley, ph.d., frm, cfa – virginia tech personal financial planning 12th edit ion © 2011, 2008 south-western, cengage learning all rights reserved. no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means— graphic, electronic, or mechanical, including photocopying, recording, taping, web distribution, information storage and retrieval systems, or in any other manner—except as may be permitted by the license terms herein. examview® is a registered trademark of einstruction corp. windows is a registered trademark of the microsoft corporation used herein under license. macintosh and power macintosh are registered trademarks of apple computer, inc. used herein under license. © 2011 cengage learning. all rights reserved. library of congress control number: 2009942102 isbn-13: 978-1-4390-4447-6 isbn-10: 1-4390-4447-3 south-western cengage learning 5191 natorp boulevard mason, oh 45040 usa cengage learning products are represented in canada by nelson education, ltd. for your course and learning solutions, visit www.cengage.com. purchase any of our products at your local college store or at our preferred online store www.cengagebrain.com. personal financial planning, twelfth edition lawrence j. gitman, michael d. joehnk, randall s. billingsley vp editorial director: jack w. calhoun publisher: joe sabatino executive editor: mike reynolds senior developmental editor: laura ansara developmental editor: mike guendelsberger senior editorial assistant: adele scholtz marketing manager: nathan anderson marketing coordinator: suellen ruttkay director, content and media production: barbara fuller-jacobsen content project manager: emily nesheim media editor: scott fidler senior frontlist buyer: kevin kluck production service: integra copyeditor: matt darnell compositor: integra senior art director: michelle kunkler cover and internal designer: jen2design cover image: © guy erwood/istockphoto senior rights acquisitions manager, text: mardell glinksi schultz text permissions researcher: elaine kosta senior rights acquisitions manager, images: deanna ettinger images permissions researcher: pre-presspmg for product information and technology assistance, contact us at cengage learning customer & sales support, 1-800-354-9706 for permission to use material from this text or product, submit all requests online at www.cengage.com/permissions further permissions questions can be emailed to
[email protected] printed in the united states of america 1 2 3 4 5 6 7 13 12 11 10 09 www.cengage.com www.cengagebrain.com www.cengage.com/permissions for our children: zachary, jessica, and caren ljg for colwyn, grace, and rhett, because they’re so special mdj for bonnie, lauren, and evan rsb iv brief contents preface, ix about the authors, xx part 1 foundations of financial planning, 1 chapter 1 understanding the financial planning process, 2 chapter 2 developing your financial statements and plans, 39 chapter 3 preparing your taxes, 75 part 2 managing basic assets, 108 chapter 4 managing your cash and savings, 109 chapter 5 making automobile and housing decisions, 141 part 3 managing credit, 186 chapter 6 using credit, 187 chapter 7 using consumer loans, 224 part 4 managing insurance needs, 254 chapter 8 insuring your life, 255 chapter 9 insuring your health, 289 chapter 10 protecting your property, 320 part 5 managing investments, 349 chapter 11 investment planning, 350 chapter 12 investing in stocks and bonds, 394 chapter 13 investing in mutual funds and real estate, 433 part 6 retirement and estate planning, 472 chapter 14 planning for retirement, 472 chapter 15 preserving your estate, 509 appendix a table of future value factors, 533 appendix b table of future value annuity factors, 533 appendix c table of present value factors, 544 appendix d table of present value annuity factors, 544 appendix e using a financial calculator, 545 index, 547 brief contents contents v preface, ix about the authors, xx part 1 foundations of financial planning, 1 chapter 1 understanding the financial planning process, 2 the rewards of sound financial planning, 2 the personal financial planning process, 7 worksheet 1.1 summary of personal financial goals, 14 from goals to plans: a lifetime of planning, 14 worksheet 1.2 analyzing the benefit of a second income, 20 the planning environment, 27 what determines your personal income?, 31 chapter 2 developing your financial statements and coupon="" rate.="" if="" bond="" is="" purchased="" at="" face="" value,="" ytm="coupon" rate.="" yield="" to="" maturity="" (ytm)="" bond="" prices="" present="" value="" of="" a="" coupon="" bond="" a="" coupon="" bond’s="" present="" value="" (pv)="" has="" two="" components:="" present="" value="" of="" the="" coupon="" interest="" payments="" present="" value="" of="" the="" future="" redemption="" value="" (usually="" $1,000)="" but="" these="" payments="" are="" all="" in="" the="" future="" the="" future="" cash="" flows="" are="" discounted="" using="" the="" bond’s="" yield="" to="" maturity="" (not="" the="" coupon="" rate)="" to="" determine="" the="" present="" value="" of="" the="" bond.="" present="" value="" of="" a="" coupon="" bond:="" an="" example="" data:="" ytm="15%;" coupon="" rate="12%" ($120="" a="" year);="" redemption="" value="$1,000;" 5="" years="" to="" maturity="" find:="" pv="" of="" $1000="" at="" 15%,="" in="" 5="" years="$497.18" pv="" of="" $120="" annuity="" at="" 15%,="" 5="" years="$402.26" present="" value="" (price):="$899.44" present="" value="" of="" a="" zero="" coupon="" bond="" there="" is="" only="" one="" cash="" inflow="" with="" a="" zero="" coupon="" bond="" –="" the="" future="" redemption="" value.="" example:="" find="" the="" pv="" of="" a="" zero="" coupon="" bond="" that="" matures="" in="" 10="" years="" with="" a="" ytm="" of="" 8%.="" pv="" of="" the="" bond="$463.19." n="10," i/y="8," fv="1000," pmt="0" reading="" corporate="" bond="" quotes="" in="" the="" wall="" street="" journal="" selling="" price="" is="" quoted="" as="" a="" percent="" of="" par.="" price="" listed="" at="" 101="" --="" 101%="" x="" $1000="$1010." include="" accrued="" interest.="" treasury="" and="" agency="" securities="" trade="" in="" thirty-seconds="" (1/32).="" price="" listed="" as="" 102:31="102" 31/32="" if="" par="" value="" is="" $10,000="" then="" price="" is="" $10,296.88.="" quotes="" list="" both="" bid="" and="" ask="" prices.="" bond="" valuation="" what="" causes="" the="" required="" rate="" of="" return="" to="" change?="" if="" the="" issuer="" becomes="" riskier,="" the="" required="" rate="" of="" return="" should="" rise.="" a="" change="" in="" general="" interest="" rates,="" increase="" in="" expected="" inflation,="" the="" required="" rate="" of="" return="" should="" increase.="" when="" interest="" rates="" rise,="" the="" value="" of="" outstanding="" bonds="" falls.="" risk="" in="" bond="" investment="" default="" risk="" is="" the="" possibility="" that="" the="" issuer="" will="" not="" make="" the="" interest="" payments="" and/or="" redeem="" the="" bonds="" at="" maturity.="" interest="" rate="" risk="" is="" the="" price="" volatility="" of="" a="" bond="" in="" relationship="" to="" the="" changes="" in="" market="" rates="" of="" interest.="" why="" bonds="" fluctuate="" in="" value="" inverse="" relationship="" between="" interest="" rates="" and="" bond="" values.="" longer-term="" bonds="" fluctuate="" in="" price="" more="" than="" shorter-term="" bonds.="" preferred="" stock="" hybrid="" security:="" preferred="" stock="" has="" some="" characteristics="" of="" both="" bonds="" and="" stocks="" form="" of="" equity="" ownership="" –="" similar="" to="" common="" stock="" pays="" a="" fixed="" return="" –="" similar="" to="" bonds="" stockholders’="" rights="" are="" provided="" in="" the="" offering="" agreement="" this="" agreement="" is="" similar="" to="" a="" bond="" indenture="" but="" is="" weaker.="" preferred="" stock="" usually="" does="" not="" vote.="" preferred="" stock="" features="" $100="" par="" value="" is="" common="" but="" other="" par="" values="" can="" also="" be="" used.="" cumulative="" dividend="" (frequently="" used)="" participating="" dividends="" (rarely="" used)="" convertibility="" (sometimes="" used):="" preferred="" stock="" may="" be="" exchanged="" for="" common="" stock.="" expected="" return="" from="" preferred="" stock="" similar="" to="" common="" stock,="" most="" preferred="" stock="" does="" not="" have="" a="" maturity="" the="" expected="" return="" is="" simply="" the="" preferred="" stock’s="" current="" return="" (cr):="" cr="Dividend/Stock" price="" example:="" if="" the="" dividend="$2" and="" the="" price="$8," then="" cr="$2/$8" =="" 0.1111="" or="" 11.11%.="" value="" of="" preferred="Dividend/" current="" return="" lawrence="" j.="" gitman,="" ph.d.,="" cfp®="" –="" san="" diego="" state="" university="" michael="" d.="" joehnk,="" ph.d.,="" cfa="" –="" arizona="" state="" university="" randall="" s.="" billingsley,="" ph.d.,="" frm,="" cfa="" –="" virginia="" tech="" personal="" financial="" planning="" 12th="" edit="" ion="" ©="" 2011,="" 2008="" south-western,="" cengage="" learning="" all="" rights="" reserved.="" no="" part="" of="" this="" work="" covered="" by="" the="" copyright="" hereon="" may="" be="" reproduced="" or="" used="" in="" any="" form="" or="" by="" any="" means—="" graphic,="" electronic,="" or="" mechanical,="" including="" photocopying,="" recording,="" taping,="" web="" distribution,="" information="" storage="" and="" retrieval="" systems,="" or="" in="" any="" other="" manner—except="" as="" may="" be="" permitted="" by="" the="" license="" terms="" herein.="" examview®="" is="" a="" registered="" trademark="" of="" einstruction="" corp.="" windows="" is="" a="" registered="" trademark="" of="" the="" microsoft="" corporation="" used="" herein="" under="" license.="" macintosh="" and="" power="" macintosh="" are="" registered="" trademarks="" of="" apple="" computer,="" inc.="" used="" herein="" under="" license.="" ©="" 2011="" cengage="" learning.="" all="" rights="" reserved.="" library="" of="" congress="" control="" number:="" 2009942102="" isbn-13:="" 978-1-4390-4447-6="" isbn-10:="" 1-4390-4447-3="" south-western="" cengage="" learning="" 5191="" natorp="" boulevard="" mason,="" oh="" 45040="" usa="" cengage="" learning="" products="" are="" represented="" in="" canada="" by="" nelson="" education,="" ltd.="" for="" your="" course="" and="" learning="" solutions,="" visit="" www.cengage.com.="" purchase="" any="" of="" our="" products="" at="" your="" local="" college="" store="" or="" at="" our="" preferred="" online="" store="" www.cengagebrain.com.="" personal="" financial="" planning,="" twelfth="" edition="" lawrence="" j.="" gitman,="" michael="" d.="" joehnk,="" randall="" s.="" billingsley="" vp="" editorial="" director:="" jack="" w.="" calhoun="" publisher:="" joe="" sabatino="" executive="" editor:="" mike="" reynolds="" senior="" developmental="" editor:="" laura="" ansara="" developmental="" editor:="" mike="" guendelsberger="" senior="" editorial="" assistant:="" adele="" scholtz="" marketing="" manager:="" nathan="" anderson="" marketing="" coordinator:="" suellen="" ruttkay="" director,="" content="" and="" media="" production:="" barbara="" fuller-jacobsen="" content="" project="" manager:="" emily="" nesheim="" media="" editor:="" scott="" fidler="" senior="" frontlist="" buyer:="" kevin="" kluck="" production="" service:="" integra="" copyeditor:="" matt="" darnell="" compositor:="" integra="" senior="" art="" director:="" michelle="" kunkler="" cover="" and="" internal="" designer:="" jen2design="" cover="" image:="" ©="" guy="" erwood/istockphoto="" senior="" rights="" acquisitions="" manager,="" text:="" mardell="" glinksi="" schultz="" text="" permissions="" researcher:="" elaine="" kosta="" senior="" rights="" acquisitions="" manager,="" images:="" deanna="" ettinger="" images="" permissions="" researcher:="" pre-presspmg="" for="" product="" information="" and="" technology="" assistance,="" contact="" us="" at="" cengage="" learning="" customer="" &="" sales="" support,="" 1-800-354-9706="" for="" permission="" to="" use="" material="" from="" this="" text="" or="" product,="" submit="" all="" requests="" online="" at="" www.cengage.com/permissions="" further="" permissions="" questions="" can="" be="" emailed="" to=""
[email protected]="" printed="" in="" the="" united="" states="" of="" america="" 1="" 2="" 3="" 4="" 5="" 6="" 7="" 13="" 12="" 11="" 10="" 09="" www.cengage.com="" www.cengagebrain.com="" www.cengage.com/permissions="" for="" our="" children:="" zachary,="" jessica,="" and="" caren="" ljg="" for="" colwyn,="" grace,="" and="" rhett,="" because="" they’re="" so="" special="" mdj="" for="" bonnie,="" lauren,="" and="" evan="" rsb="" iv="" brief="" contents="" preface,="" ix="" about="" the="" authors,="" xx="" part="" 1="" foundations="" of="" financial="" planning,="" 1="" chapter="" 1="" understanding="" the="" financial="" planning="" process,="" 2="" chapter="" 2="" developing="" your="" financial="" statements="" and="" plans,="" 39="" chapter="" 3="" preparing="" your="" taxes,="" 75="" part="" 2="" managing="" basic="" assets,="" 108="" chapter="" 4="" managing="" your="" cash="" and="" savings,="" 109="" chapter="" 5="" making="" automobile="" and="" housing="" decisions,="" 141="" part="" 3="" managing="" credit,="" 186="" chapter="" 6="" using="" credit,="" 187="" chapter="" 7="" using="" consumer="" loans,="" 224="" part="" 4="" managing="" insurance="" needs,="" 254="" chapter="" 8="" insuring="" your="" life,="" 255="" chapter="" 9="" insuring="" your="" health,="" 289="" chapter="" 10="" protecting="" your="" property,="" 320="" part="" 5="" managing="" investments,="" 349="" chapter="" 11="" investment="" planning,="" 350="" chapter="" 12="" investing="" in="" stocks="" and="" bonds,="" 394="" chapter="" 13="" investing="" in="" mutual="" funds="" and="" real="" estate,="" 433="" part="" 6="" retirement="" and="" estate="" planning,="" 472="" chapter="" 14="" planning="" for="" retirement,="" 472="" chapter="" 15="" preserving="" your="" estate,="" 509="" appendix="" a="" table="" of="" future="" value="" factors,="" 533="" appendix="" b="" table="" of="" future="" value="" annuity="" factors,="" 533="" appendix="" c="" table="" of="" present="" value="" factors,="" 544="" appendix="" d="" table="" of="" present="" value="" annuity="" factors,="" 544="" appendix="" e="" using="" a="" financial="" calculator,="" 545="" index,="" 547="" brief="" contents="" contents="" v="" preface,="" ix="" about="" the="" authors,="" xx="" part="" 1="" foundations="" of="" financial="" planning,="" 1="" chapter="" 1="" understanding="" the="" financial="" planning="" process,="" 2="" the="" rewards="" of="" sound="" financial="" planning,="" 2="" the="" personal="" financial="" planning="" process,="" 7="" worksheet="" 1.1="" summary="" of="" personal="" financial="" goals,="" 14="" from="" goals="" to="" plans:="" a="" lifetime="" of="" planning,="" 14="" worksheet="" 1.2="" analyzing="" the="" benefit="" of="" a="" second="" income,="" 20="" the="" planning="" environment,="" 27="" what="" determines="" your="" personal="" income?,="" 31="" chapter="" 2="" developing="" your="" financial="" statements="">