When you purchase a bond you know that after a certain period of time you are going to get your money back and during that time you will also know at what point or what intervals you will collect your interest for loaning that money (buying the bond). If you need to sell your bond before the “maturity date” the price you will get for it will depend upon the current interest rates. If the company (or city, etc.) that issued the bond goes bankrupt, well, you probably won’t get back all your money, but you do have priority over stock holders as if you remember they are “owners” of the company and “lenders” have priority in getting paid back after selling off the company’s assets.

So what establishes the price of a bond and the interest rate? Well, it comes down to risk. The length of time till maturity, this is the amount of time you are loaning the money for, which is just the maturity date. The longer the time to maturity the greater the risk that something could go wrong such as financial difficulties, a natural disaster will force bonds to drop in value. They drop in value because less people will want to buy them at the original price when the can purchase bonds in more secure companies for relatively the same cost.

Interest rates also play a huge role in the price of bonds as anyone who has been watching the business news on television lately. The interest rates on bonds is fixed when they are sold, so as economic conditions change the interest rates change, if interest rates go higher the value of bonds will go down and if interest rates go down the value of bonds will increase.  Remember that the interest rate of the bond you already purchased doesn’t change. So, if interest rates have gone up from the point that they were sometime in the past year or so, an individual just looking to buy bonds could get a higher interest rate than the person who bought a bond last year. If you are holding the bonds you bought last year at the lower interest rate, the only way some other investor would buy them is if you sold them cheaper than what you paid for them last year.

In a nutshell, risk is the determining factor in interest rates and bond value. Risk can be looked at as the length of time to maturity or the credit worthiness of a company or city, etc., the more risk you take the more you deserve as a return on your investment. United States Treasury Bonds have always been considered the safest bond investment due to the fact that the chance of the US government actually defaulting on them is very slim. A riskier bond would need to provide a higher return to make up for the higher risk incurred by the bond purchaser.

The bottom line for the new investor to understand is that risk comes in various forms, the amount of time until maturity, the credit worthiness of the issuer, General Electric should be less of a risk than Joe’s 5 day old fish market and finally what are the interest rates being offered.

The purpose of this upcoming series of articles is to enlighten the novice who is interested in the stock and financial markets but has little knowledge of them. It is for this reason that I am going to offer the basics, beginning with a bit of common terminology and then in latter posts how all these terms relate to you and your quest for financial security. So the best place to begin is in understanding the most common items you may come across either on television, the papers or your financial advisor.

Lets say you have a reasonably successful company and you need money to expand. Perhaps you need to hire additional staff, build new facilities or purchase new assets, these things do not come cheap and you realize you will need to raise money to accomplish this. You can go about this in two ways, you can borrow the funds needed and pay an interest rate on a common debt instrument (called a bond) or you can raise the capital (money) from investors by selling them a piece (shares of stock) of the company.

If you purchase shares of stock in this company, no matter how few shares (even one share) you become a part owner of that company and are entitled to a share of the assets and earnings of that company relative to the number of shares you own. Remember if you own 1 share or 1000 shares, the amount you own per share is the same; you just multiply dividends or stock price by the number of shares you own. Small investors who do not purchase large blocks of shares rarely consider the fact that they are owners and are merely concerned with how much the stock is worth at a particular period in time compared to the price they paid for it and although they may have voting rights relative to the number of shares they own, they usually don’t have a large say in the day to day operations of the company. Large institutions such as unions or pension funds that have huge amounts of a particular stock can sway votes in the company however, and are called institutional investors.

If you bought a top of the line PowerBook G3 in 1997 for $5700 get ready to pinch yourself… if you had purchased the equivalent in Apple shares instead it would have grown to a whopping $330,563 over the past 13 years.

It is this claim that investors have on their shares of stock that create the value of that issue. Lets assume a company needs money to expand and sold stock at $2.00 a share, but the company had yet to produce and market a product to the public and could not give Its investors (you included) a piece of the earnings, but after a short time one of the products they manufactured started selling like hotcakes! The company began making great money. Remember, how Apple grew when it produced the iPods and iPhones. Well, because the company is now making a lot of money those shares you bought at $2.00 a share are worth a lot more because the earnings from that company are considerably greater. So, if a person wanted to purchase a claim on those earnings (shares of stock) you might consider selling the shares that you purchased at $2.00 a share for $10.00 a share. That is a profit of $8.00 a share (multiplied by the number of shares you own).

This process of buying stocks and holding on to them in hopes of them rising in price is known as investing. If you own shares of stock in several different companies, this would be called your portfolio of stocks. Some may rise in price while others may drop and you would then decide which you deem are worthy of keeping or increasing the number of shares owned, and those you have less confidence in and may consider limiting your loss potential by selling off shares. Investing in stocks is usually done over a longer time horizon than trading, in which stocks may be bought and sold in a relative short period of time in order to take advantage of short-term price fluctuations.

Different types of stocks have different characteristics but the most familiar to individual investors would be the type known as common stock, which is what we discussed here. Preferred stock, which usually has no voting rights, but gives the holder a priority position on claim over common stock share holders in regards to dividends and any possibly bankruptcy claims on assets. Unlisted stocks will be discussed much later but are usually purchased in direct placements from the issuer or purchased in what is called a secondary market, and these unlisted stocks may carry and even greater degree of security and yield on their investment.

Our next lesson will be on Bonds and who might want to use them as an investment.

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Remember, Trading is not investing!

Hot stocks May 18th

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Remember, Trading is not investing!

may 17 results of Market Scan

If you would like different criteria for this scan let me know via comments.

Remember, Trading is not investing!

Again, our thanks to the folks at nextrend.com.