Financial MarketsInvesting: Chapter 11

Investment – use of assets to earn an income or profit

The Financial System◦ Financial Assets (or securities)

Flow of Savings and Investments◦ Savers make deposits to Financial Institutions◦ Financial Institutions make loans to Investors

Saving and Investing

Financial Intermediaries Banks, Saving and Loan Associations, Credit Unions,

Finance Companies Mutual Funds Hedge Funds Life Insurance Companies Pension Funds

Saving and Investing

◦ Sharing Risk Credit risk, liquidity risk, inflation rate risk, and time

risk DIVERSIFY!!!! – spread out your investments

◦ Providing information Portfolio – collection of one’s financial assets Prospectus – investment report that provides info to

potential investors◦ Providing Liquidity

Saving and Investing

Liquidity, Return, and Risk◦ Liquidity and Return

Return – the money an investor receives above and beyond the sum of money initially invested

More liquid, usually lower return◦ Return and risk

Typically, higher return, higher risk Must weigh potential return with risk

Saving and Investing

Bonds as Financial Assets◦ Three components of Bonds

1. Coupon Rate – interest rate that bond issuer will pay to a bondholder

2. Maturity – time at which payment to a bondholder is due

3. Par value – the amount to be paid at maturity (face value or principal)

- Yield – the annual rate of return on a bond if held to maturity

Bonds and Other Financial Assets

◦ Buying Bonds at a Discount Interest change, so price of a bond must change as

well◦ Bond Ratings

Standard & Poor’s; Moody’s AAA (highest)

◦ Advantage of Bonds to Issuer Fixed coupon rate once sold Not part of a company

◦ Disadvantage of Bonds to Issuer Must make fixed payments Bonds can be downgraded

Bonds and Other Financial Assets

Types of Bonds◦ Savings bonds◦ Treasury Bonds, Bills, and Notes◦ Municipal Bonds◦ Corporate Bonds◦ Junk Bonds

Treasury Bond

Treasury Note

Treasury Bill

Term Long-term

Middle-term

Short-term

Maturity 30 years 2, 5, or 10 yrs

4, 13, 26, 52 weeks

Liquidity and Safety Safe Safe Liquid and

safe

Minimum Purchase $100 $100 $100

Denomination $100 $100 $100

Bonds and Other Financial Assets

Other Types of Financial Assets◦ Certificates of Deposits (CDs)

Very common; through banks; very flexible◦ Money Market Mutual Funds

Higher interest than savings account but no FDIC

Bonds and Other Financial Assets

Financial Assets Markets◦ Capital Markets and Money Markets

Capital Market – market in which money is lent for periods longer than a year Ex: Long-term CDs and bonds (over 1 yr)

Money markets – market in which money is lent for less than a year Ex: short-term CDs, T-Bills, and money market mutual funds

◦ Primary and Secondary Markets Primary Market- a market for selling financial assets that

can be redeemed only by the original holder Secondary Market – a market for reselling financial

assets

Bonds and Other Financial Assets

Shares – a portion of a stock Benefits of Buying Stock

◦ Dividends – portion of company profit (quarterly)◦ Capital Gains – sell for more than purchased

Capital loss

Buying Stock

Types of Stock◦ Income Stock◦ Growth Stock

or- Common Stock- Preferred Stock

Stock Splits- Split single shares to lower price of single stock

Buying Stock

Risks of Buying Stock◦ Company may lose money

Dividend is smaller, stock price drops◦ If Company goes bankrupt, shareholders are paid

last

Buying Stock

Stockbroker – person who links buyers and sellers of stock

Brokerage Firm – a business that specializes in trading stocks

Stock Exchange◦ The market for buying and selling stock◦ NYSE, Nasdaq

How Stocks Are Traded

Futures and Options◦ Futures – contracts to buy or sell commodities at a

particular date in the future at a price specified today

◦ Options – contracts that give investors the right to buy or sell stock and other financial assets at a particular price until a specified future date

◦ Call/Put Option – contract to buy/sell stock at a particular price until a future date

Day Trade??????

How Stocks Are Traded

Bull and Bear Markets◦ Bull Market – a steady rise in the stock market

over a period of time◦ Bear Market – a steady drop or stagnation in the

stock market over a period of time Dow Jones Industrial Average

◦ 30 large companies in various industries◦ Meant to represent the whole market

S&P 500◦ 500 stocks to measure performance

Measuring Stock Performance