2022 AFBA Financial Planning Guide

The option writer believes that the stock will not fall below a specified level. On the other hand, the investor who buys the put believes the market price of the stock will decline. If the holder is correct, he or she will have the opportunity to buy the stock at a low price in the market and immediately sell or put the stock to the option writer at the higher option price. Calls reverse this process. They provide the holder with the ability to “call” on the option writer and buy a specified stock at a specified price. In this case the writer believes that a particular stock will stay below a certain price. However, if the price of the stock rises, the holder of the option has the opportunity to exercise the call and buy the stock from the option writer then sell the investment at the higher market price. Futures are security contracts in which two investors agree to buy/sell a particular item at a specified price at a future point in time. The futures market started with agricultural commodities (i.e., corn, wheat, etc.) but over time has expanded to include financial items such as currency, stock indices, and interest rates. Futures contracts are in effect guesses on the future value of an item. Using corn as an example, two investors may agree in May to buy/sell September corn for $5.00 per bushel. By the time September arrives, the actual market price for September corn will be clearly established. The investor who is buying believes that the final price for September corn will be above $5.00. Therefore he or she envisions a profit because they will be able to sell the September corn above the future’s price of $5.00. The investor who opens a sell position in May believes that the final price for September corn will be below $5.00. He or she envisions a profit because their futures position is above the final market value of the item. One of these investors will make a profit and one will incur a loss. Investors in the futures market rarely take delivery on the item. Instead they close out their initial position by entering into a new, off–setting contract before the original contract becomes due. 10–10. REAL ESTATE. Real estate is a widely used investment vehicle for both income and capital gain returns. Real estate investments have the potential for a higher than average total yield; have the potential to serve as a hedge against inflation; have the potential for favorable cash flow; and offer tax advantages associated with depreciation, operating costs, and deferral of capital gains. Also, investment real estate can be traded or exchanged for similar property on a tax–free basis.

with the performance of similar funds; (d) Determine from both the prospectus and other information sources the qualifications and experience of the people who manage the fund’s portfolio; (e) Evaluate the securities contained in the fund’s portfolio. Are they generally acceptable to you?; (f) Examine the fund’s sales charges (load or no–load, administrative expenses and other charges). Low expense, no–load funds often perform as well as or better than high cost funds; (g) Finally, examine shareholder services, i.e. online account access, the right of accumulation, investment withdrawal and investment exchange privileges, which can be important considerations in selecting a mutual fund. 10–9. DERIVATIVES. Derivative securities are investment contracts to buy or sell a specific item at a specific price within a specific time frame. The value of these contracts is derived or determined by the market price of the particular item. Derivative investors are generally seeking a capital gain based upon fluctuations in the market value of the item. Investors may also use derivative investments as a hedge to either minimize potential losses or maximize the potential gains that are associated with another investment position. The two most common types of derivative investments are option securities and futures. Option securities are contracts which provide the investor with the opportunity (but not the requirement) to take a specific action. Although the investor is not required to act, the creator of the option (sometimes referred to as the option writer) is required to honor the contract should the investor choose to exercise the option. There are four types of stock option securities — rights, warrants, puts, and calls. Stock rights and warrants are options to buy a company’s common stock at a specified price within a specified time frame. They are created by the company who is issuing the stock and are generally given to the investor in order to satisfy a statutory requirement or to promote the sale of another security. For example, a company may use stock warrants as a sweetener in a bond offering. In effect the company is promoting the sale of its bonds by providing a second security called a stock warrant. Puts and calls are stock contracts which are created and sold within the investing community. For example, a company may not normally create and sell a call on its own stock. However, an investment banking firm can readily create a call with the objective of making money by selling the call to another investor. Puts and calls are effectively guesses on the future selling price of a particular stock. Puts allow the holder to sell or “put” the stock to the option writer.


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