NEXT Financial Markets. NEXT Chapter 11: Financial Markets KEY CONCEPT The financial system consists of institutions, such as banks, insurance markets,

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Text of NEXT Financial Markets. NEXT Chapter 11: Financial Markets KEY CONCEPT The financial system consists...

Financial Markets KEY CONCEPT
The financial system consists of institutions, such as banks, insurance markets, bond markets, and stock markets, that help transfer funds between savers and investors.
WHY THE CONCEPT MATTERS
When you open a savings account, you play an important role in our economy. Your savings will be borrowed and invested by businesses and the government. The new products created by these investments help to fuel the nation’s economy.
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Savings—income not used for consumption
Investment—use of income now in a way that provides a future benefit
economic investment: money lent to businesses
personal investment: individuals putting savings into financial assets
Financial system—transfers funds between savers and investors
Savings and Investment
People, businesses save funds; receiver issues written confirmation
confirmation called financial asset, or claim on borrower’s property
Financial market—where buyers and sellers exchange assets directly
Financial intermediary—collects funds from savers, invests in financial assets
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also finance companies, pension funds, life insurance companies
Mutual fund—pools individuals’ money to buy range of financial assets
investors own shares of entire fund
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depositors earn interest
federal government insures deposits up to $100,000
Make loans; to make profit charge higher interest than pay depositors
Offer uninsured money market mutual funds, stocks, bonds, insurance
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Mutual funds let individuals own many assets; managers make decisions
Pension funds invest employees’ money, so will have more at retirement
Life insurance companies invest income in financial assets
let people save by building cash values, protect them against loss
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Capital market—for buying and selling long-term financial assets
Money market—for buying and selling short-term financial assets
Primary market—for financial assets that original buyer must redeem
Secondary market—where financial assets are resold
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include stocks, bonds, mortgages, long-term CDs
Money markets—loans made for less than a year
include short-term CDs, Treasury bills
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Financial Asset Markets
Factor 2: Resalability
Primary markets—financial assets can be redeemed only by original buyer
include savings bonds, small denomination CDs
also market where first issue of stock sold through investment bankers
Secondary markets—resale markets; offer liquidity to investors
include stocks, bonds
Reviewing Key Concepts
Explain the differences between the terms in each of these pairs:
savings and investment
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Individual must first determine own investment objective:
financial goal investor uses to decide if an investment is appropriate
Investing in a Market Economy
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Savings for emergencies should be liquid
Long-term investments good for retirement and college
Can choose CDs to coincide with timing of savings goals
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Creating Educated Investors
Developed study on African-American investing; works to promote it
Believes more people should participate in stock market
as financial contributor on ABC, reaches millions with information
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Risk—possibility for loss on an investment
Return—profit or loss on an investment
refers to interest paid on savings or increase in value of stock
Diversification—investing in different financial assets
purpose: maximize returns, minimize risk
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What Kind of Risk Are You Willing to Take?
Risk usually means loss of part of initial investment, or principal
no-risk investments: insured savings and CDs, U.S. government bonds
Safe investments risk interest rate may not keep up with inflation
Return on riskier investments depends on how profitable company is
bonds less risky than stocks; bondholders paid off first
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Safe investments have lowest return through fixed interest rates
Stocks, bonds—no guaranteed rates; stocks—higher return over time
If investing over long period, can risk losses in stock some years
if less time and money, may want safer investment
Diversification gives better chance of offsetting a loss with a gain
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Reviewing Key Concepts
Use each of the three terms below in a sentence that illustrates the meaning of the term:
investment objective
Companies issue stock, sell to investment bankers in primary market
initial public offering (IPO) is sale that raises money for corporation
Stock exchange—secondary market where securities resold and bought
buyers expect stock price to rise, so they can resell for a profit
Capital gains—profit made from sale of stock
Buying and Selling Stocks
investors who want income, want dividends
Buy to earn capital gains through resale of stock
investors who want growth look for potential for capital gains
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one vote per share owned to elect board of directors
Preferred stock—gives shareholders share of profits, no voting rights
investors get guaranteed dividends, paid off first if company closed
dividends do not increase if stock increases in value
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Stock prices determined by demand and supply; influencing factors:
company profits or losses, technological advances, overall economy
Stockbroker—buys and sells securities for customers, earns commission
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Organized Stock Exchanges
New York Stock Exchange (NYSE) on Wall Street; oldest, largest in U.S.
traditionally, each stock auctioned from trading post on exchange floor
today, hand-held computers used to execute many trades
2006 merger with Archipelago Exchange allowed electronic trades
American Stock Exchange (AMEX) companies smaller than on the NYSE
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Trading Stock
Electronic Markets
Over-the-counter (OTC) market for stocks not traded on NYSE or AMEX
NASDAQ is centralized computer system for OTC trading
second largest exchange in world in number of companies, shares traded
companies from many sectors of U.S. economy, most in technology
OTC Bulletin Board is electronic market for smaller companies
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Most investors do not trade futures and options
Future—contract to buy, sell on specific future date at preset price
Option—contract giving right to buy, sell in future at preset price
investor pays small fraction of stock’s current price for option
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Trading Stock
Recent Developments
1990s regulations allow any firm to trade stocks in any exchange
Through electronic communications networks (ECNs), 24-hour trading
Investors access Internet; huge growth in online brokerage companies
lower commissions than traditional brokers
computer technology matches buyers, sellers automatically; rapid trades
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About half of U.S. households own stocks
Stock index measures, reports the change in prices of a set of stocks
measures individual stocks and stock market as a whole
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U.S. indexes: DJIA, Standard & Poor’s 500, NASDAQ Composite
Global indexes: Hang Seng, DAX, Nikkei 225, TSE 300, FTSE 100
Since 1896, Dow Jones Industrial Average changed with U.S. economy
includes most successful companies in most important economic sectors
uses points to measure changes in prices at which stocks traded
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Bull market—prices rise steadily over a relatively long period
Bear market—prices decline steadily over a relatively long period
1972 to 2000 longest bull market in history; most last two to three years
Dow affected by previous close, Fed, foreign indexes, trade balance
About 21 stock markets overseas with over 1,000 large companies each
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Reviewing Key Concepts
Explain the relationship between the terms in each of these pairs:
stock exchange and stockbroker
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Par value—amount issuer must pay buyer at maturity
Maturity—date when bond is due to be repaid
Coupon rate—interest rate bondholder gets every year until maturity
Bonds and Other
KEY CONCEPTS
Investors buy bonds for interest paid and gains made by selling
Yield—annual rate of return on a bond
If bond sold at par value, yield is same as coupon rate
if sold for less, yield is higher; if sold for more, yield is lower
Bonds with longer maturity dates have higher yields than with shorter
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Corporate bonds higher risk than government, pay higher coupon rate
Junk bonds are high-risk, high-yield corporate bonds
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Most buyers want guaranteed interest income; yield is most important
Investors who sell before maturity want to make profit
as market interest rates rise, price of bonds with lower rate falls
Main risk to investor is default
governments, companies get evaluated by credit-rating companies
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are very low risk; provide interest income
not generally sold for profit
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longer maturity dates pay higher interest rates
Federal government insures funds up to $100,000
Risks: can lose interest, some principal if funds withdrawn early
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MMMFs’ financial assets have maturities of one year or less
Give higher yield than savings accounts with similar liquidity
can redeem shares by check, phone, electronic transfer
Funds not insured but tightly regulated, so principal considered safe
Yield varies based on yield of assets in fund
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Reviewing Key Concepts
Use each of the terms below in a sentence that illustrates the meaning of the term:
coupon rate
Background
The Internet provided a new tool for accessing potential buyers. Many new companies, known as dot-coms, quickly appeared.
The value of dot-com stock rose quickly as investors were encouraged by the initial success of dot-coms and low interest rates in the 1990s. In 2000 and 2001, dot-com stocks fell and many companies went out of business.
What’s the Issue
Thinking Economically
During the dot-com bubble, do you think it was relatively easy or difficult for Internet start-up companies to raise capital? Why?
Why do you think so many dot-coms failed? Explain with evidence.