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Financial Markets
Chapter 11
BELLRINGER
What would you do if you suddenly received a cash payment of $100,000 that you were not expecting and didn’t need to fulfill your daily expenses?
Section 1 – Saving and Investing
Investing in Free Enterprise The Financial System
Financial Assets The Flow of Savings and Investment
Financial Intermediaries Sharing Risk Providing Information Providing Liquidity
Risk, Liquidity, and Return Return and Liquidity Return and Risk
Investing and Free Enterprise
Investment: redirecting resources from being consumed today so that they may create benefits in the future. The use of assets to earn income or profit
Investing and Free Enterprise
Spend money today to earn money in the future Going to college to get a “better job” Expanding manufacturing for a new product Building a dam for a hydroelectric plant
Investing and Free Enterprise
Consumer spending vs Consumer savings People depositing money into savings accounts
so banks can lend to businesses to grow and expand
New jobs and better products are created
The Financial System
Financial System: a system in which there is a transfer of money between savers and borrowers
Financial Assets: claim on the property or income of a borrower A way to indicate ownership of owning a
money device
The Financial System
Savers Households, individuals, and businesses Make deposits to Financial Institutions Receive financial assets
The Financial System
Financial Institutions Banks, Credit Unions, Finance Companies, etc Make loans to investors
The Financial System
Investors The borrowers Government and Business Build roads, factories, homes etc Develop new products, markets, or services
Financial Intermediaries
You can obtain a direct link between savers in borrowers
Financial Intermediaries: institution that helps channel funds from savers to borrowers
Financial Intermediaries
Banks, Savings and Loan Associations and Credit Unions Take deposits from savers Lend out money to businesses and individuals
Finance Companies Higher risk lending companies People who typically cannot meet the standards
to borrow from a Bank, S&L or CU
Financial Intermediaries Mutual Funds
Pool savings of many and invest in stocks, bonds or other financial assets
Allow for a broad range of investments Diversification
Life Insurance Companies Financial protection for a family for the death of
a family member Customers pay “premiums” Lend premiums to investors for return
Financial Intermediaries
Pension Fund Income a retiree receives after working a
certain number of years Withholding of a portion of your pay
Financial Intermediaries
Why have Financial Intermediaries? Share Risk Provide information Provide liquidity
Financial Intermediaries
Sharing Risk 50% of new business fail Reduce the risk of losing your entire investment Diversification: spreading out investment to
reduce risk
Financial Intermediaries
Providing information Monitoring borrowers spending and income Classify borrowers based on risk of default Saves individuals the time to research
individual borrowers
Financial Intermediaries
Providing Liquidity Matching investors (bringing borrowers and
sellers together) Investing in mutual funds vs buying a Picasso Allow you to sell and receive cash upfront
instead of waiting for a buyer
Risk, Liquidity and Return
Tradeoffs in investing Placing money in a savings account for the
convenience and access, despite lower rate of return
Using a CD to earn a higher rate but having limited access in an emergency
Weighing the return against the loss of liquidity
Risk, Liquidity and Return Placing your money in a bank account that is
insured with a lower rate of return? Using your money to invest in a new business? Higher potential return, the greater the risk
Bonds as Financial Assets
A business can obtain money by borrowing When a business or government borrows
money, they issue bonds Bonds
Low risk Low interest rate (relatively)
Bonds as Financial Assets
Three Components of Bonds Coupon Rate Maturity Par Value
Bonds as Financial Assets Coupon Rate
Interest rate that a bond issuer will pay to a bondholder
Maturity The time at which payment to a bondholder is
due Par Value
The amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity
Bonds as Financial Assets
A business needs $1,000 The issue a bond for $1,000 Set an interest rate of 5% The Bond will mature in 10 years
Bonds as Financial Assets Mary takes $1,000 out of her savings account
paying 1% interest to buy a bond at 5% She will receive interest payments of $50 each
year (5% of $1,000) for 10 years At the end of 10 years, she will receive her final
payment of $50 + her initial investment of $1,000
In total, she will earn $500 in 10 years and get back what she put in of $1,000
Bonds as Financial Assets What was the coupon rate? What is the maturity? What is the Par Value?
Bonds as Financial Assets
Buying bonds at a discount Selling/Buying a bond less than par value Interest rate increase, sell/buy at a discount
If $1,000 bonds go from 5% to 6%, you would buy the 6% bond Selling/Buying at a discount is an incentive to
buy the lower rate bond
Bonds as Financial Assets Bond Ratings
A way to measure the risk of a bond AAA --- highest rating D --- Bond in Default
Triple A Bonds (AAA) pay lowest interest rate
May sell “above par” BBB bonds are riskier and pay higher
interest rate May sell “below par”
Bonds as Financial Assets
For an investor, bonds are relatively safe Advantages to the issuer
Locked in interest rate Does not give up ownership
Disadvantages to the issuer Must make fixed interest payments/cannot
change Poor financial health, bonds are downgraded
Types of Bonds
Savings Bonds Treasury Bonds, Bills and Notes Municipal Bonds Corporate Bonds Junk Bonds
Types of Bonds
Savings Bonds Low denomination bond issued by the US
Government Government issues to fund projects Does not have a “coupon” rate Purchase below par value then redeem for
face value at maturity
Types of Bonds
Treasury Bonds, Bills and Notes Government Issued debt for varying lengths of
maturity Treasury Bond (T-Bond)
10 – 30 Years
Treasury Note (T-Note) 2 – 10 Years
Treasury Bill (T-Bills) 3, 6 or 12 months
Types of Bonds
Municipal Bonds State and local governments “Safe” because of taxing authority Poor financial health? Tax Free (at federal level)
Types of Bonds
Corporate Bonds Business issued debt Can be riskier Depends on business strength to repay debt
Types of Bonds
Junk Bonds (High Yield) Lower rated, potentially higher paying bond Lower medium grade
Other Types of Financial Assets
Certificates of Deposit Money Market Mutual Funds
Financial Asset Markets
Capital Markets Market in which money is lent for periods
longer than a year
Money Markets Market in which money is lent for periods less
than a year
Financial Asset Markets
Primary Market Market for selling financial assets that can
only be redeemed by the original holder
Secondary Market Market for reselling financial assets
Section 3 – The Stock Market
Buying Stock Benefits of Buying Stock Types of Stock Stock Splits Risk of Buying Stock
How Stocks are Traded Stock Exchanges The New York Stock
Exchange The OTC Market NASDAQ Futures and Options Day Trading
Measuring Stock Performance Bull and Bear Markets
The Down Jones Industrial Average S & P 500
The Great Crash of 1929 Investing During the
1920’s Signs of Trouble The Crash The Aftermath of the Crash The Market Today
Buying Stock
Corporations can raise money by selling stock Represents ownership in the corporation Shares: portion of stock Equities: claims of ownership in a corporation
Buying Stock
How do you make money buying stock? Dividends Capital Gains
Buying Stock
Dividends Paid 4 times per year (quarterly) Payout based on profits Paid per share
Buying Stock
Capital Gains Selling the stock for more than the purchase
price Capital Gain: the difference between a higher
selling price and a lower purchase price resulting in a financial gain for the seller.
Capital Loss: the difference between a lower selling price and a higher purchase price resulting in a financial loss to the seller
Buying Stock
Types of Stock Income Stock: Pays dividends at regular times
during the year Growth Stock: Pays few or no dividends,
company reinvests to grow the company and make stock worth more
Buying Stock
Types of Stock Common Stock: owners of the company with
one vote. A vote is used to elect the directors of the company
Preferred Stock: Non voting owners of the company. First to receive a dividend, paid back first if business shuts down
Buying Stock
Stock Split: the division of a single share of stock into more than one share.
Does not increase % of ownership but doubles the number of shares. Owning 100 shares that are $100 each After a 2 for 1 split, 200 Shares at $50
Buying Stock
Risks of buying stock Smaller profits, smaller stock value May sell stock for less than the purchase Going out of business
Sell assets
Pay off debt Pay off preferred stock
Pay off common stock
How Stocks Are Traded
Contact a Stockbroker A person who links buyers and sellers of stocks Works for a brokerage firm: a business that
specializes in trading stocks
Buy stocks to sell at a premium to earn money on the “spread”
How Stocks Are Traded
Stock Exchanges A market for buying and selling stocks NYSE (______ _______ _______ _____________) OTC Market National Association of Securities Dealers
Automated Quotations (___________)
How Stocks Are Traded
New York Stock Exchange Began in 1792 as an informal outdoor
exchange Must have a “seat” on the exchange Handles stock and bond transactions for the
largest most established companies in the US Blue Chips – Large profitable companies that
are considered stable
How Stocks Are Traded
Over the Counter (Electronic) Stocks and bonds that are not traded on the
NYSE Investors buy directly from a dealer or a
broker
How Stocks Are Traded
Nasdaq Created in 1971 Bring the OTC market together No trading floor; sends out information
automatically through 360,000 computer terminals worldwide
How Stocks Are Traded
Futures and Options Futures: contracts to buy or sell at a specific
date in the future at a price specified today For commodities New York Mercantile
How Stocks Are Traded Options
Contracts that give investors the choice to buy or sell stock and other financial assets
Call Options Buy shares of stock at a specified time in the
future Put Options
Sell shares of stock at a specified time in the future
How Stocks Are Traded
Call Option Pay a fee for a call (example: $10) Gives you the right to buy stock at $100 per
share in a specific time period If stock is greater than $100 + the Call Fee,
you would exercise your Call Stock goes to $115 per share, you would buy
at $100 per share, plus your $10 per share fee, make a $5 per share profit
How Stocks Are Traded Put Option
Pay a fee for a call (example: $5) Gives you the right to sell stock at $50 per
share in a specific time period If stock is now $40 + the Put Fee, you would
exercise your Put Selling stock at $50 per share when the market
rate is $40 you make a $5 profit If stock is above $50 you can just sell above
that price
How Stocks Are Traded
Day Trading Very Risky Trading stocks minute by minute instead of
holding for the long term
Measuring Stock Performance
Bull and Bear Markets Bull Market: Steady rise in the stock market
over a period of time Bear Market: Steady drop in the stock market
over a period of time
Measuring Stock Performance
The Dow Jones Industrial Average 30 Large Companies
The S & P 500 Tracks the price of 500 different stocks as a
measure of overall stock market performance
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