Critical Thinking Cases
11.1 The Woodsons Struggle with Two Investment Goals
Like many married couples, Damian and Brandi Woodson are trying their best to save for
two important investment objectives: (1) an education fund to put their two children
through college; and (2) a retirement nest egg for themselves. They want to have set aside
$40,000 per child by the time each one starts college. Given that their children are now 10
and 12 years old, Damian and Brandi have 6 years remaining for one child and 8 for the
other. As far as their retirement plans are concerned, the Woodsons both hope to retire in
20 years, when they reach age 65. Both Damian and Brandi work, and together, they
currently earn about $90,000 a year. Six years ago, the Woodsons started a college fund by
investing $6,000 a year in bank CDs. That fund is now worth $45,000—enough to put one
child through an in-state college. They also have $50,000 that they received from an
inheritance invested in several mutual funds and another $20,000 in a tax sheltered
retirement account. Damian and Brandi believe that they’ll easily be able to continue
putting away $6,000 a year for the next 20 years. In fact, Brandi thinks they’ll be able to
put away even more, particularly after the children are out of school. The Woodsons are
fairly conservative investors and feel they can probably earn about 6 percent on their
money. (Ignore taxes for the purpose of this exercise.)
Critical Thinking Questions
1. Use Worksheet 11.1 to determine whether the Woodsons have enough money right now to
meet their children’s educational needs. That is, will the $45,000 they’ve accumulated so far
be enough to put their children through school, given they can invest their money at 6
percent? Remember, they want to have $40,000 set aside for each child by the time each one
starts college.
The Woodsons have a balance of $45,000 saved for the education fund. Assuming that the fund
is split in half for each child, they need an additional $35,000. The present value of the amount
they need for the educational fund is $53,283 of which they now have $45,000. Thus they need
an additional $8,283 in the fund now. Assuming that the funds earn 6%, they could designate
Determining the Amount of
Investment Capital
Financial Goal: To accumulate an additional $35,000 in
8 years
Child 1 Child 2
A. Finding a Lump Sum Investment:
3. Future Value Factor, from Appendix A
based on _____6 or_8_____ years to target date and a projected
average return on investment of ___6%_______
1.419 1.594
4. Required Lump Sum Investment
B. Making a Series of Investments over Time:
5. Amount of Initial Investment, if any (see Note 2) 22,500 22,500
6. Future Value Factor, from Appendix A
based on __6 or_8___ years of target date and a projected average
9. Future Value Annuity Factor, from Appendix B
based on __6 or_8___ years to target date and a projected average
return on investment of __6%____
6.975 9.897
10. Series of Annual Investments Required over Time
line 8 / line 9 $1,352 $418
Total
$1,770
2. Regarding their retirement nest egg, assume that no additions are made to either the
$50,000 they now have in mutual funds or to the $20,000 in the retirement account. How
much would these investments be worth in 20 years, given that they can earn 6 percent?
Using Appendix A, the future value of the two amounts will be:
Using the financial calculator set on 1 P/YR and End Mode, these investments would
be worth a total of $224,499.48 in 20 years, given a 6% investment rate.
Mutual Fund: Retirement Account:
50,000 +/- PV 20,000 +/- PV
3. Now, if the Woodsons can invest $6,000 a year for the next 20 years and apply all of that
to their retirement nest egg, how much would they be able to accumulate given their 6
percent rate of return?
From appendix B, the annuity of $6,000 per year for 20 years at 6% will accumulate to 36.786 *
4. How do you think the Woodsons are doing with regard to meeting their twin investment
objectives? Explain.
They will meet their goal for the educational fund. Their retirement fund is another matter.
Assuming at least one lives for another 20 years after retirement, to fund an annuity of $90,000
11.2 Russ Alonzo Takes Stock of His Securities
Russ Alonzo is 42 years old, single, and works as a designer for a major architectural firm.
He is well paid and over time has built up a sizable portfolio of investments. He considers
himself an aggressive investor and, because he has no dependents to worry about, likes to
invest in high-risk/high-return securities. His records show the following information.
1. In 2006, Russ bought 200 shares of eBay (NASDAQ; symbol EBAY) at $29.77 a share.
2. In 2013 he bought 250 shares of Facebook (NYSE; symbol FB) at $26.89 a share.
3. In 2008, Russ bought 200 shares of United Technologies Corp. (NYSE; symbol UTX)) at
$74.92 a share.
4. In early 2009, he bought 450 shares of JPMorgan Chase (NYSE; symbol JPM) at $16 a
share.
5. Also in 2009, Russ bought 400 shares of Pepsico (NYSE; symbol PEP) at $52.50 a share.
6. He has $12,000 in a 1 percent money market mutual fund.
Every three months or so Russ prepares a complete, up-to-date inventory of his investment
holdings.
Critical Thinking Questions
1. Use a form like Worksheet 11.2 to prepare a complete inventory of Russ’s investment
holdings.
(Note: Look in the latest issue of The Wall Street Journal, or pull up an online source such
as http://finance.yahoo.com, to find the most recent closing price of the five stocks in Russ’s
portfolio.)
An Inventory of Investment Holdings
Names Russ Alonzo Date August 28,
2015
Type of
Investment
Description
of
Investment
Date
Purchase
d
Amount of
Investment
Overall
Return
Latest
Market
Value
Common
Stock
200 sh,
EBAY
2006 $5,954 -8.5% $5,450
Common
Stock
250 sh, FB 2013 $6,722 238% $22,752
2. What is your overall assessment of Russ’s investment portfolio? Does it appear that his
personal net worth is improving because of his investments?
Russ has done some better than the market as a whole. From 2010 to August 28, 2015, the DJIA
3. Based on the worksheet you prepared in Question 1, do you see any securities that you
think Russ should consider selling? What other investment advice might you give Russ?
He should review EBAY and UTX [United Technology]. These two stock are not performing as
Terms Found in the Chapter
annual
stockholders’
report
A report made available to stockholders and other interested parties
that includes a variety of financial and descriptive information about a
firm’s operations in the recent past.
arbitration A procedure used to settle disputes between a brokerage firm and its
clients; both sides present their positions to a board of arbitration,
which makes a final and often binding decision on the matter.
ask price The price at which one can purchase a security.
asset allocation A plan for dividing a portfolio among different classes of securities in
order to preserve capital by protecting the portfolio against negative
market developments.
bid price The price at which one can sell a security.
bear market A condition of the market typically associated with investor pessimism
and economic slowdown; characterized by generally falling securities
prices.
bull market A market condition normally associated with investor optimism,
economic recovery, and expansion; characterized by generally rising
securities prices.
day trader An investor who buys and sells stocks (and other securities) rapidly
throughout the day in hopes of making quick profits.
discount broker A broker with low overhead who charges low commissions and offers
little or no services to investors.
diversification The process of choosing securities with dissimilar risk–return
characteristics in order to create a portfolio that provides an acceptable
level of return and an acceptable exposure to risk.
Dow Jones
Industrial Average
(DJIA)
The most widely followed measure of stock market performance;
consists of 30 blue-chip stocks listed mostly on NYSE.
Dow Jones
Wilshire
5000 index
An index of the total market value of the approximately 6,000–7,000
most actively traded stocks in the United States.
full-service broker A broker who, in addition to executing clients’ transactions, offers a
full array of brokerage services.
investing The process of placing money in some medium such as stocks or bonds
in the expectation of receiving some future benefit
investment plan A statement—preferably written—that specifies how investment
capital will be invested to achieve a specified goal.
limit order An order to either buy a security at a specified or lower price or to sell
a security at or above a specified price.
market order An order to buy or sell a security at the best price available at the time
it is placed.
National
Association
of Securities
Dealers
(NASD)
An agency made up of brokers and dealers in over-the-counter
securities that regulates OTC market operations.
NYSE index An index of the performance of all stocks listed on the New York Stock
Exchange.
odd lot A quantity of fewer than 100 shares of a stock.
online broker Typically a discount broker through which investors can execute trades
electronically/ online through a commercial service or on the Internet;
also called Internet broker or electronic broker.
portfolio A collection of securities assembled for the purpose of meeting
common investment goals.
prospectus A document made available to prospective security buyers that
describes the firm and a new security issue.
risk averse The average investor’s attitude toward risk is such that, when presented
with two investments having the same expected return, the one with the
lowest risk will be chosen.
rate of return The increase or decrease in the price of an investment as well as any
income received over the investment period, both stated as a
percentage of the initial investment.
round lot A quantity of 100 shares of stock, or multiples thereof.
Securities and
Exchange
Commission (SEC)
An agency of the federal government that regulates the disclosure of
information about securities and generally oversees the operation of
securities exchanges and markets.
Securities Investor
Protection
Corporation
(SIPC)
A nonprofit corporation, created by Congress and subject to SEC and
congressional oversight that insures customer accounts against the
financial failure of a brokerage firm.
securities markets The marketplace in which stocks, bonds, and other financial
instruments are traded.
short sale A transaction that involves selling borrowed securities with the
expectation that they can be replaced at a lower price at some future
date; made in anticipation of a decline in the security’s price.
speculating A form of investing in which future value and expected returns are
highly uncertain.
Standard & Poor’s
(S&P) indexes
Indexes compiled by Standard & Poor’s that are similar to the DJIA but
employ different computational methods and consist of far more
stocks.
stockbroker
(account executive,
financial
consultant)
A person who buys and sells securities on behalf of clients and gives
them investment advice and information.
stop-loss
(stop order)
An order to sell a stock when the market price reaches or drops below a
specified level.
Investment Planning
Chapter Outline
Learning Goals
I. The Objectives and Rewards of Investing
A. How Do I Get Started?
B. The Role of Investing in Personal Financial Planning
1. Coming Up With the Capital
2. An Investment Plan Provides Direction
C. What Are Your Investment Objectives?
1. Retirement
2. Major Expenditures
3. Current Income
4. Shelter from Taxes
D. Different Ways to Invest
1. Common Stock
2. Bonds
3. Preferreds and Convertibles
4. Mutual Funds, Exchange Traded Funds, and Exchange Traded Notes
5. Real Estate
*Test Yourself*
II. Securities Markets
A. Primary and Secondary Markets
1. Primary Markets
2. Secondary Markets
B. Broker Markets and Dealer Markets
1. Broker Markets
2. Dealer Markets
C. Foreign Securities Markets
D. Regulating the Securities Markets
E. Bull Market or Bear?
*Test Yourself*
III. Making Transactions in the Securities Markets
A. Stockbrokers
1. Selecting a Broker
2. Full-Service, Discount, and Online Brokers
3. Brokerage Fees
4. Investor Protection
B. Executing Trades
C. Types of Orders
1. Market Order
2. Limit Order
3. Stop-Loss Order
D. Margin Trades and Short Sales
*Test Yourself*
IV. Becoming an Informed Investor
A. Annual Stockholders’ Reports
B. The Financial Press
1. Market Data
a. Dow Jones Industrial Averages
b. Standard & Poor’s Indexes
c. The NYSE, NASDAQ, and Other Market Indexes
2. Industry Data
3. Company Data
4. Stock Quotes
C. Brokerage Reports
D. Advisory Services
*Test Yourself*
V. Online Investing
A. Online Investor Services
1. Investor Education
2. Investment Tools
a. Investment Planning
b. Investment Research and Screening
c. Portfolio Tracking
3. Online Trading
*Test Yourself*
VI. Managing Your Investment Holdings
A. Building a Portfolio of Securities
1. Investor Characteristics
2. Investor Objectives
B. Asset Allocation and Portfolio Management
C. Keeping Track of Your Investments
*Test Yourself*
Summary
Financial Planning Exercises
Applying Personal Finance
Research Your Investments!
Critical Thinking Cases
11.1 The Woodsons Struggle with Two Investment Goals
11.2 Russ Alonzo Takes Stock of His Securities
Money Online!