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Introduction to Investing Answer Key Introduction to Investing Note Taking Guide 1.12.1.L1:
What is Investing?
Characteristics of investing: Focuses on wealth accumulation Appropriate for long‐term goals
What is investing? The purchase of assets with the goal of increasing future income
Example of long‐term goals accomplished by investing: Buying a home Retiring in thirty years Paying for a child’s college education in eighteen years
Rate of Return Rate of Return: The total return on an investment expressed as a percentage of the amount of money invested What is Mandy’s Rate of Return? 5%
Amount of Money Invested
Total Return
Rate of Return
What is Derek’s Rate of Return? 16.7%
$110
$2,200
.05 = 5%
$150
$900
Investment Risk
A rise in potential return results in increased risk.
Risk: The uncertainty regarding the outcome of a situation or event
Investment Risk: The possibility that an investment will fail to pay the expected return or fail to pay a return at all
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
.167 = 16.7%
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Inflation Inflation:
Inflation Risk:
The rise in the general level of prices
The danger that money won’t be worth as much in the future as it is today
When should inflation risk be a concern? With long‐term investments
Types of Investment Tools
Record the definition and one characteristic of each investment tool below.
Stocks: Definition‐ A share of ownership in a company Characteristics‐ The owner of the stock is called the stockholder or shareholder Can receive a profit through dividends or an increase in market price
Index Funds: Definition‐ A mutual fund that was designed to reduce fees by investing in the stocks and bonds that make up an index Characteristics‐ An index is a group of similar stocks and bonds Offer high diversification with low fees
Bonds: Definition‐ A form of lending to a company or the government Characteristics‐ The company or government pays annual interest to the investor until the maturity date is reached
Real Estate: Definition‐ Includes any residential or commercial property or land as well as the rights accompanying that land Characteristics‐ A family home is usually not an investment asset Can be risky and more time consuming but has the potential for large returns
Mutual Funds: Definition‐ Created when a company combines the funds of many different investors and then invests that money in a diversified portfolio of stocks and bonds Characteristics‐ Reduces risk Saves investors time Fees can be high Speculative Investments: Definition‐ Have the potential for significant fluctuations in return over a short period of time Characteristics‐ Examples‐ futures, commercial paper, options, collectibles High risk
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
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FINANCIAL RISK PYRAMID What is one type of saving or investing tool that may be located on each level of the pyramid?
Draw an arrow in the direction that risk increases on the pyramid.
Futures, commercial paper, options, or collectibles
Stocks, real estate, mutual funds, index funds, or bonds
Draw an arrow in the direction that potential return increases on the pyramid.
Checking account, savings account, money market deposit account, certificate of deposit, or savings bonds
Investment Philosophy Each individual has a tolerance level for the amount of Risk they are willing to take on
Investment Philosophy:
Divided into three categories:
An individual’s general approach to investment risk
Conservative, moderate, aggressive
Portfolio Diversification Portfolio Diversification: Reduces risk by spreading investment money among a wide array of investment tools
What is the purpose of portfolio diversification? Reduce investment risk
Referred to as: Building a portfolio
BUYING AND SELLING INVESTMENTS
What is a brokerage firm? The buying and selling agent for an investor
What is the difference between a full service brokerage firm and a discount broker? A full service brokerage firm offers investment advice and one‐on‐one attention from a broker. A discount broker does not offer advice.
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
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Taxation
What is a tax‐sheltered investment?
What is an employee‐sponsored investment account?
An investment that eliminates, reduces, defers, or adjusts the current year tax liability
A tax‐sheltered investment offered by employers. Money is automatically taken out of an employee’s paycheck every month to invest. Employers often contribute a portion of money to the investment with no additional cost from the employee.
Rule of 72 Rule of 72: Allows a person to easily calculate when the future value of an investment will double the principal amount
72
What can the “Rule of 72” determine?
Number of years needed to double the principal investment
Interest Rate
How long will it take Doug’s investment to double? 11 years
1. How many years it will take an investment to double at a given interest rate using compounding interest?
2. How long it will take debt to double if no payments are
72
6.5%
made
11 years to double
3. The interest rate an investment must earn to double within a specific time period
4. How many times money (or debt) will double in a
How long will it take for Jessica’s balance to double? 4 years
specific time period 72
18%
4 years to double
Rule of 72 FYI
The rule is only an approximation The interest rate must remain constant The interest rate is not converted to a decimal The equation does not allow for additional payments to be made to the original amount Interest earned is reinvested Tax deductions are not included
What interest rate is required for Jacob to double his investment? 18%
72
4 years
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
18% interest rate
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Investing Math 1.12.1.A3: 1. 2. 3. 4. 5. 6.
7. 8. 9. 10. 11.
50/500=10% 400/1100= 36% 500/1500= 33% 79/800= 9.875% 130,000/30,000= 433.33% Round Answers to two decimal places Investment Interest Rate Money Market Mutual Fund 3.1% Small Company Stock 12.6% 3 year Certificate of Deposit 2.8% 5 year Certificate of Deposit 5.1% Large Company Stock 11.3% Government Bond 5.3% Treasury Bills 3.8% Money Market Account 2.6% Savings Account 2.3% 72/18 = 4 years to double 72/22 = 3.27 years to double 72/4 = 18% interest rate 72/7 = 10.29% interest rate 72/6 = 12 years to double 52‐16 = 36 years for investment to grow 36/12 = 3 times the investment will double Years Investment 16 $300.00 28 $600.00 40 $1,200.00 52 $2,400.00 72/6 = 12 years to double 52‐28 = 24 years for investment to grow 24/12 = 2 times the investment will double Years Investment 28 $300.00 40 $600.00 52 $1,200.00
Years to Double 23.23 5.71 25.71 14.12 6.37 13.58 18.95 27.69 31.30
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
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12. 10 = 7.2 years to double 36‐0 = 36 years for investment to grow 36/7.2 = 5 times the investment will double Years Investment 0 $3000.00 7.2 $6000.00 14.4 $12,000.00 21.6 $24,000.00 28.8 $48,000.00 36 $96,000.00 72/10 = 7.2 years to double 36‐7 = 29 years for investment to grow 29/7.2 = 4.03 times the investment will double Years Investment 7 $3000.00 14.2 $6000.00 21.4 $12,000.00 28.6 $24,000.00 35.8 $48,000.00 13. Money has more time to compound interest and increase in value. Introduction to Investing 1.12.1.A4: 1. A share of ownership in a company. 2. A form of lending to a company or the government (city, state, or federal). 3. A mutual fund is created when a company combines the funds of many different investors and then invests that money in a diversified portfolio of stocks and bonds. 4. An index fund is a mutual fund that was designed to reduce fees by investing in the stocks and bonds that make up an index. 5. Any residential or commercial property or land as well as the rights accompanying that land. 6. Speculative investments have the potential for significant fluctuations in return over a short period of time and can include futures, options, collectibles and commercial paper. 7. D 8. B 9. A 10. E 11. C 12. To increase wealth and reach a desired standard of living. 13. As potential return increases, so does the risk involved with the investment. 14. Investment philosophy is an individual’s general approach to investment risk. Investment philosophies are generally divided into three main categories: conservative, moderate, and aggressive. An individual with an aggressive investment philosophy will be willing to take on more risk for the potential of higher returns. © Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona
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15. Portfolio diversification reduces risk by spreading investment money among a wide array of investment tools. It is a method to assist with investment risk reduction. The goal of portfolio diversification is to create a collection of investments that will provide an acceptable return with an acceptable exposure to risk. 16. Both a full‐service and discount broker act as a buying and selling agent for the investor. A full‐service general brokerage firm offers the completion of an investment transaction as well as investment advice and one‐on‐one attention from an employee of the firm, known as a broker. A discount broker provides limited services to investors. A discount broker only completes orders to buy and sell investments; they do not provide any advice as to which investments to buy and sell. Because of this, discount brokers can charge commissions that are 40 to 60 percent less than general brokerage firms. 17. The “Rule of 72” allows a person to easily calculate when the future value of an investment will double the principal amount. When 72 is divided by the interest rate, the answer is the number of years it will take the investment to double. 18. F 19. T 20. T 21. F 22. F 23. T 24. F 25. T
© Family Economics & Financial Education – Updated April 2011 – Investing Unit – Introduction to Investing –Answer Key Funded by a grant from Take Charge America, Inc. to the Norton School of Family and Consumer Sciences Take Charge America Institute at The University of Arizona