CH 11 Financial MarketsCH 11 Financial Markets

11.1 Saving and Investing11.1 Saving and Investing

Investment and Free EnterpriseInvestment and Free Enterprise

Investment - something bought for future financial benefitOR - the use of assets to earn income or profit

Promotes economic growth Personal - Banks Banks - Businesses Businesses - Jobs

Investment - something bought for future financial benefitOR - the use of assets to earn income or profit

Promotes economic growth Personal - Banks Banks - Businesses Businesses - Jobs

Savers and BorrowersSavers and Borrowers

Financial system allows transfer of money between savers and borrowers

Financial intermediaries connect savers to borrowers Financial assets (securities)- claim on income

or property or income of a borrower

Financial system allows transfer of money between savers and borrowers

Financial intermediaries connect savers to borrowers Financial assets (securities)- claim on income

or property or income of a borrower

Financial IntermediariesFinancial Intermediaries

Banks, Credit Unions, Savings and Loans Finance Companies - give loans to people and

small businesses Usually charge higher interest

Mutual Funds - pool of savings invested in various markets, bonds

Banks, Credit Unions, Savings and Loans Finance Companies - give loans to people and

small businesses Usually charge higher interest

Mutual Funds - pool of savings invested in various markets, bonds

Financial Intermediaries Financial Intermediaries

Life Insurance - collect premiums Pay out to compensate for lost income

Pensions - $ collected or taken from employees Invested into stocks, bonds

Life Insurance - collect premiums Pay out to compensate for lost income

Pensions - $ collected or taken from employees Invested into stocks, bonds

Advantages to IntermediariesAdvantages to Intermediaries

Shared Risk - Savings Accounts - almost no risk Stock - high potential for gain/ loss

Diversification Prevents possibility of losing all $$$

Information - Prospectus- investment report to potential investors Helps people build portfolio

Liquidity

Shared Risk - Savings Accounts - almost no risk Stock - high potential for gain/ loss

Diversification Prevents possibility of losing all $$$

Information - Prospectus- investment report to potential investors Helps people build portfolio

Liquidity

Trade offsTrade offs

Savings Account vs CDs Return on Investment Liquidity

Return vs Risk CDs and stocks Higher potential for return = higher risk

Savings Account vs CDs Return on Investment Liquidity

Return vs Risk CDs and stocks Higher potential for return = higher risk

Chapter 11.2 Bonds and Other Financial Assets

Chapter 11.2 Bonds and Other Financial Assets

Bonds as financial assets

Different types of bonds

4 types of financial asset markets

Bonds as financial assets

Different types of bonds

4 types of financial asset markets

BondsBonds

Certificates sold by businesses or governments to raise money

Basically loans or IOU’s

Low risk, guarantee return

Certificates sold by businesses or governments to raise money

Basically loans or IOU’s

Low risk, guarantee return

Three components of bondsThree components of bonds

1. Coupon Rate - interest rate which the bond will pay

2. Maturity - time at which payment is due Usually will mature in 10, 20 or 30 yrs

3. Par value - amount paid for the bond Face value

1. Coupon Rate - interest rate which the bond will pay

2. Maturity - time at which payment is due Usually will mature in 10, 20 or 30 yrs

3. Par value - amount paid for the bond Face value

Bonds can be bought and sold while maturing Based on yield

Annual rate of return on a bond

Buying a bond on discount Discount on par Why sell bonds?

Bonds can be bought and sold while maturing Based on yield

Annual rate of return on a bond

Buying a bond on discount Discount on par Why sell bonds?

Interest rates constantly change Rates go up - more potential for $

Bond Ratings Standard and Poor’s Moody’s Rate bonds based on the ability of a issuer to

repay AAA (Aaa) to D Higher rating, lower interest Higher rating will sell for more

Interest rates constantly change Rates go up - more potential for $

Bond Ratings Standard and Poor’s Moody’s Rate bonds based on the ability of a issuer to

repay AAA (Aaa) to D Higher rating, lower interest Higher rating will sell for more

Advantages to IssuerAdvantages to Issuer

1. Coupon rate won’t fluctuate Fixed payments for 10 years

2. Bonds do not entitle buyer to part of the profit, like stocks do Business will keep more profit

1. Coupon rate won’t fluctuate Fixed payments for 10 years

2. Bonds do not entitle buyer to part of the profit, like stocks do Business will keep more profit

Disadvantages to IssuerDisadvantages to Issuer

1. Fixed interest rates, even in bad years Interest rates on bonds go down

2. Bond ratings may go down Harder to sell

1. Fixed interest rates, even in bad years Interest rates on bonds go down

2. Bond ratings may go down Harder to sell

Types of bondsTypes of bonds

1. Savings bonds $50 - $10,000 Issued by Govt Bought at a discount

2. Treasury Bonds, Bills, Notes $1000 minimum Exempt from state and local taxes Different maturity times

1. Savings bonds $50 - $10,000 Issued by Govt Bought at a discount

2. Treasury Bonds, Bills, Notes $1000 minimum Exempt from state and local taxes Different maturity times

www.treasurydirect.gov

3. Municipal Bonds Issued by local govts to finance public works Tax free at Federal level

4. Corporate Bonds Larger denominations Risky Securities and Exchange Commission regulates

3. Municipal Bonds Issued by local govts to finance public works Tax free at Federal level

4. Corporate Bonds Larger denominations Risky Securities and Exchange Commission regulates

5. Junk Bonds High yield, low rating Up to 12% interest

5. Junk Bonds High yield, low rating Up to 12% interest

Other types of Financial AssetsOther types of Financial Assets

Certificates of Deposit

Money Market Mutual Funds Not covered by FDIC Pay higher interest rates

Certificates of Deposit

Money Market Mutual Funds Not covered by FDIC Pay higher interest rates

Financial Asset MarketsFinancial Asset Markets

Bonds, CD’s and Money Market Mutual Funds are all traded for Capital Markets - money lent for long periods

of time Take more than a year to mature

Money Markets Short term, less than a year

Bonds, CD’s and Money Market Mutual Funds are all traded for Capital Markets - money lent for long periods

of time Take more than a year to mature

Money Markets Short term, less than a year

Primary Market Assets redeemed only by original holder Nontransferable

Secondary Market Can be resold More liquidity

Primary Market Assets redeemed only by original holder Nontransferable

Secondary Market Can be resold More liquidity

CH 11.3 The Stock MarketCH 11.3 The Stock Market

Benefits and Risks of buying stock

How are stocks traded

How is performance measured

The Crash

Benefits and Risks of buying stock

How are stocks traded

How is performance measured

The Crash

Buying StockBuying Stock Stock represents ownership in a company

SHARES - Portions of stock EQUITIES - claims of ownership in a company

Benefits DIVIDENDS - Usually paid quarterly

Size depends on profit made

CAPITAL GAINS - selling stock for more than you paid CAPITAL LOSS - selling for less than you paid

Stock represents ownership in a company SHARES - Portions of stock EQUITIES - claims of ownership in a company

Benefits DIVIDENDS - Usually paid quarterly

Size depends on profit made

CAPITAL GAINS - selling stock for more than you paid CAPITAL LOSS - selling for less than you paid

TYPES OF STOCKTYPES OF STOCK

2 types based on whether they pay dividends or not

Income Stock - pays dividends at regular times throughout the year

Growth Stock - does NOT pay dividends Reinvests the stock into the business which

makes the business more valuable

2 types based on whether they pay dividends or not

Income Stock - pays dividends at regular times throughout the year

Growth Stock - does NOT pay dividends Reinvests the stock into the business which

makes the business more valuable

TYPES OF STOCKTYPES OF STOCK

2 types that allow stockholders to have a vote or not

1. Common Stock - voting owners of the company Use vote to elect Board of Directors One person may own enough to control the entire company

Stock Split - dividing one share into more Brings price of stock down, more available

2 types that allow stockholders to have a vote or not

1. Common Stock - voting owners of the company Use vote to elect Board of Directors One person may own enough to control the entire company

Stock Split - dividing one share into more Brings price of stock down, more available

2. Preferred Stock - NONVOTING members

Will receive money before common stock holders

2. Preferred Stock - NONVOTING members

Will receive money before common stock holders

Risks of Buying StocksRisks of Buying Stocks

Firm may lose money Stocks go down - Capital loss

Company goes under, sells all of its assets, pays bondholders first

Firm may lose money Stocks go down - Capital loss

Company goes under, sells all of its assets, pays bondholders first

Trading StocksTrading Stocks

Stockbrokers - person who links buyers and sellers of stocks Work for brokerage firms Charge commission on sales Buy stock at a discount and sell it for a higher

price

Stockbrokers - person who links buyers and sellers of stocks Work for brokerage firms Charge commission on sales Buy stock at a discount and sell it for a higher

price

Stock Exchange - secondary markets for stocks and bonds 1. New York Stock Exchange - (NYSE) largest

most powerful exchange Started in 1792 Seats sold to investors so they can trade on the

market Serves largest and best known companies

Stock Exchange - secondary markets for stocks and bonds 1. New York Stock Exchange - (NYSE) largest

most powerful exchange Started in 1792 Seats sold to investors so they can trade on the

market Serves largest and best known companies

2. NASDAQ-AMEX National Association of Securities Dealers’

Automated Quotation system + American Stock Exchange (AMEX) Combined list of companies with internet

technology Specialized in high tech and energy Risky

2. NASDAQ-AMEX National Association of Securities Dealers’

Automated Quotation system + American Stock Exchange (AMEX) Combined list of companies with internet

technology Specialized in high tech and energy Risky

3. OTC Market Over The Counter (electronically) Smaller companies

Most do NOT pay dividends

4. Futures and Options Futures - contract to buy/sell at a future date Options - Buy/sell for a certain amount of time

Call option (Buy)/ Put Options (Sell)

3. OTC Market Over The Counter (electronically) Smaller companies

Most do NOT pay dividends

4. Futures and Options Futures - contract to buy/sell at a future date Options - Buy/sell for a certain amount of time

Call option (Buy)/ Put Options (Sell)

5. Daytrading Buying and selling many stocks the same day,

within hours sometimes in an attempt to make a profit

5. Daytrading Buying and selling many stocks the same day,

within hours sometimes in an attempt to make a profit

Trading Places

PerformancePerformance

Bull Markets Stocks go up over a long period of time

Bear Markets Stocks prices fall for a long period of time

Dow Jones Industrial Average 1896 Shows 30 specific large companies

Bull Markets Stocks go up over a long period of time

Bear Markets Stocks prices fall for a long period of time

Dow Jones Industrial Average 1896 Shows 30 specific large companies

S&P 500 Standard and Poor’s 500 Mostly NYSE, some NASDAQ and OTC

S&P 500 Standard and Poor’s 500 Mostly NYSE, some NASDAQ and OTC

CRASH of 1929CRASH of 1929

1929 - Started off great From 1925 to 1929 grew from $27 to $87 Billion

Buying on credit New technology, led to overproduction

Speculation - high risk investments with borrowed money

Buying on Margin - paying part of the price for stock, borrowing the rest

1929 - Started off great From 1925 to 1929 grew from $27 to $87 Billion

Buying on credit New technology, led to overproduction

Speculation - high risk investments with borrowed money

Buying on Margin - paying part of the price for stock, borrowing the rest

The Crash - Prices of stock rose above actual value of the

companies – Speculation + buying on margin Brokers demanded payment as prices began to

fall More and more sales drove prices down even

further October 29, 1929

The Crash - Prices of stock rose above actual value of the

companies – Speculation + buying on margin Brokers demanded payment as prices began to

fall More and more sales drove prices down even

further October 29, 1929

AftermathAftermath

Contributed to the Great Depression First the Fed cuts interest rates to encourage

growth Then decreased money supply Discouraged lending

Today - people are still cautious about investing New regulations help ensure confidence

Contributed to the Great Depression First the Fed cuts interest rates to encourage

growth Then decreased money supply Discouraged lending

Today - people are still cautious about investing New regulations help ensure confidence