Stocks and Mutual Funds
LESSON DESCRIPTION AND BACKGROUND
In this lesson, the students examine the nature of stocks including how stocks are issued, differences in their levels of risk, and the differences in possible returns. The students also compare and contrast stocks with various savings plans provided by financial institutions. The nature of mutual funds, which allows diversification and reduction of risk, will also be covered. This lesson is correlated with national standards for mathematics and economics as well as the national guidelines for personal financial management.
ECONOMIC AND PERSONAL FINANCE CONCEPTS
Equity, stocks, mutual funds, risk, diversification
TOMORROW’S MONEY: GETTING TO THE END OF THE RAINBOW (SAVING)
Student Objectives:
At the end of this lesson, the student will be able to:
TIME REQUIRED: 2 to 3 class periods
EQUIPMENT AND GETTING READY!
Materials needed for this lesson:
WORKOUT WARM-UP
1. Introduce the lesson by asking the students if they’ve heard of stocks. Ask the students to describe stocks. Ask them whether they
can explain the differences between U.S. Savings Bonds and a stock. (Bonds are debt instruments; stocks are equity.)
2. Choose two students to role-play the interview with Mr. Stock, Exercise 9.l in Student Workouts. After the role-play, discuss the
answers to questions found in the exercise.
Answers to questions are:
a. Stocks show ownership or equity in a corporation.
b. Firms receive money from a stock when it is initially issued.
c. Stocks are primarily traded at stock exchanges (e. g. New York and American) and through brokerage houses that make a
market in specific stocks (NASDAQ).
d. Advantages of owning stocks: owns part of business, has a voice in the business, has the possibility of getting above average
return on investment. Disadvantages: may lose investment, may not receive any annual return.
e. Stock owners receive their return in two ways—dividends that they receive and selling their stocks for more than they paid for them.
f. U.S. Savings Bonds, corporate bonds, and other savings instruments are debt. This means that the party purchasing the bonds
or putting money in a savings account is loaning money to another party for a period of time. Stockholders are owners of a corporation; they have a voice in the selection of people who run the corporation.
g. With bonds, there is a promise that interest will be paid and that the loan will be repaid. Stockholders are not promised a return on their investment, or that the amount invested will be repaid if they sell the stock.
h. People buy stocks because they want the possibility of earning a greater return on their investment than is possible with other investments.
3. Have the students read the Warm-Up for Lesson 9 in Student Workouts. Discuss the ideas presented in the reading with the class.
EXERCISE
1. How Stocks are Exchanged
a. Display Visual 9.1, Steps in the Life of a Stock, and explain that a stock is a share of ownership in a business, so stockholders
are owners. Stocks are also called equities, meaning they are property. Each share owned by the stockholder entitles him or her to vote for the business’ top managers or directors. In addition, each share entitles the stockholder to a share of the business’s profits.
b. Using Visual 9.1 as a guide, describe how stocks are created and issued. When a business needs money to grow, it can
issue stock. The first issue of the stock is called an Initial Public Offering or IPO. This big block of stock shares is sold to an investment firm that specializes in initial offerings of stocks. This sale takes place in the primary market. The primary market is where stocks are offered for sale the first time. The investment firm then sells smaller blocks to its best customers.
c. Display Visual 9.2, Secondary Markets, and explain that the secondary market is where stocks are bought and sold after the initial offering. The secondary market primarily consists of stock exchanges and over-the-counter markets. The major stock exchanges in the United States are the New York Stock Exchange and the American Stock Exchange. Stocks bought and sold on these exchanges are only those listed on the exchanges. NASDAQ is the major over-the counter market. In the NASDAQ market, individual brokerage
houses make markets in specific stocks. Making a market means that the brokerage house is a centralized place where a certain stock can be traded. As a member of NASDAQ, the brokerage house reports the sales to a centralized location so that others will know what the stock is selling for at a particular time.
d. Redisplay Visual 9.1, Life of a Stock. Explain that when Success, Inc.’s shares of stock were purchased in the primary market, Success, Inc. got the money. But, Success, Inc. will never get money from the sale of its stock after its primary market sale. It no longer owns the stock. Ownership has been transferred to the purchaser of the stock. The next time those shares of stocks are sold, the money will go to the stockholder selling the stock.
2. The Risks of Owning Stocks Compared to Loaning Money
a. Indicate that savings instruments and U.S. Savings Bonds are forms of debt. In the case of savings instruments, the person
putting money into a savings account, a CD, or a money market deposit account are loaning money to the financial institution to loan out to other people. In the case of U.S. Savings Bonds, the person buying the bond is loaning money to the U. S. government.
Corporations also issue bonds. They sell bonds, just like the government, which investors buy. Investors receive interest at least two times a year on the debt and there is a certain time when the corporation must pay back the amount of the loan. After that background, have the students read the case problem in Exercise 9.2 and answer the three questions.
The answers are:
1. Creditors are favored over owners when firms are liquidated.
2. The stocks were riskier to Juanita since she did not receive any dividends or a return of her investment.
3. All stocks are not riskier than bonds. A stock in a company that is well run and has a good track record as to profitability carries less risk than a bond in a firm that is just getting started or is having difficulty making a profit. When looking at stocks and bonds
issued by the same firm, though, stocks are riskier than bonds because of the differences in legal rights of stockholders and bondholders.
b. Point out an important maxim in the investment world—the more risk of losing your money, the higher the possible return. Or the less risk, the lower the possible return. This has been very true of investments over the long run.
3. Mutual Funds
a. Explain that investors can reduce their risk by purchasing stocks in the form of mutual funds. Demonstrate mutual funds by placing a small box on your desk. Introduce yourself as the fund manager. Open a newspaper to the stock report page. Name a stock and say something like, “Hmm, IBM. I think I’ll buy 10,000 shares of this.” Cut a small chunk out of the paper and place it in the box. Continue doing this four or five times. Each time, mention a Blue Chip stock such as International Paper Company, Boeing Company, McDonalds, General Motors, Ford Motor Company, or Wal-Mart Stores, Inc.
b. Remind the students that you are the fund manager. This means you pick the stocks and the amount of shares of the
stocks that will be included in the fund. As a fund manager, you want your fund to increase in value. By purchasing many different stocks, you reduce the risk that your fund will lose money because even if some stocks in your fund go down in value, it is likely other stocks in your fund will go up in value.
c. Explain that having many different stocks allows investors to reduce their risk.
Having many different stocks, as well as other investment and some cash is called diversification. If an investor wants diversification, she or he can carefully choose many different stocks to include in his or her holdings. Or, she or he can buy shares in a mutual fund. If a person holds shares in a mutual fund, he or she is holding shares of stock in all of the companies included in the fund.
d. Place another small box on your desk. Go through the same procedure as above, but this time name smaller company stocks, such as Grey Wolf, Inc., Covad Communications Group, Inc., S3, Inc., and CenturyTel, Inc. Ask the students if they have detected any difference in these two mutual funds. (The students have likely not heard of these companies.)
e. Explain that the first fund contained all “blue chip” stocks. These are stocks in big companies that have been doing a profitable business for a long time. It is not likely that the price of these stocks will decrease greatly. It is also unlikely that they will have large percentage increases in a short amount of time. This type of “blue-chip” mutual fund is considered to provide sustained but relatively
slow growth. It is for people who want to receive a regular income from their investments, don’t want to risk losing large amounts of money, and are satisfied with small, sustained gains in value.
f. Explain that the second fund contained smaller companies that look like they will prosper, but how well they will do in the future is uncertain. This is a growth fund, and it is riskier. It is for investors who are willing to lose some money but are hoping that these mid-size companies will grow and that the stock will increase greatly in value.
g. Point out that there are many different kinds of funds and that each carries different levels of risk. There are overseas growth funds containing stocks in foreign companies. There are money market funds that contain government-insured bonds. Each mutual fund is designed to meet the investment goals of a particular type of investor.
COOL DOWN
1. Have the students read the Fitness Vocabulary, Muscle Developers, and Showing Your Strength in Student Workouts as a
review. Go over any of the concepts that they do not understand.
2. Remind the students that stocks offer an investor ownership in a company. As an owner, an investor faces the risk of losing
part or all of his or her investment if the business fails. For that reason, an investor should purchase stock carefully. If he or she is comfortable with a relatively high level of risk, the investor may want to purchase stock in a small or new firm that shows great potential for growth. However, if an investor would rather have slow and steady growth, with less risk of losing his or her initial investment, stocks in stable, large companies would be preferred.
3. Ask the students what the following statement means, “Don’t put all of your eggs in one basket.” The students should recognize that if all of the eggs are in one basket and the basket falls, all of the eggs would be worthless. The same is true for investments. It is important that investors reduce their risk by having a number of diverse investment instruments. In part, this can be accomplished by choosing individual stocks carefully. However, this can also be accomplished by investing in mutual funds.
4. Ask the students the following questions:
a. What are stocks? (Stocks are shares in the ownership of a business.)
b. Why are stocks called equities? (Equity means ownership, and stocks are ownership in a corporation.)
c. What is the difference between stocks and bonds? (Bonds are a debt of the issuer to the bondholder; stocks show ownership.)
d. What is a primary market? (It is the market where stocks are offered for the first time.)
e. What are secondary markets? (Secondary markets are those markets in which stocks can be bought or sold after being initially
issued.)
f. What are the risks associated with stock ownership? (There is no guarantee of return on your investment. The price of the stock could go down or gain more slowly than other financial investments. The company could go bankrupt and the stockholder would likely lose his or her entire investment.)
g. What are the returns for stocks? (Dividends and capital gains.)
ASSESSMENT1. Explain that education offers many different areas of study. Students study math, history, language arts, science, and other subject areas. Ask the students to consider what their adult lives would be like if all they learned in school were math. Explain that
there is diversity in the education they receive. Education provides an analogy for the importance of diversity in investments.
2. Place the students in six groups. Tell the students that they are to present an analogy of a diversified or undiversified stock portfolio in collage form or in a drawing. Be sure that students understand what an analogy is. (A similarity between two things
that can be compared.) Provide the students with poster board, magazines, and art supplies. Assign two groups each of the following topics: education, diet, and exercise. An “education poster” or drawing could depict a person’s limited opportunities or abilities if he or she has studied only one subject area. A “diet” poster or collage could contain pictures of many types of foods representing a diversified diet that helps people remain healthy. An “exercise” poster or collage could include a depiction of what a person would look like if he or she only performed leg exercises at the gym.
3. Have each group make an oral presentation of their analogy as to why a diversified stock portfolio is important for financial health and well-being.
Financial Fitness for Life: Shaping Up Your Financial Future Teacher Guide, ©National Council on Economic Education
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