Ch 11 Financial Markets

Section 1 Saving & Investing

• STGs: Describe/Explain:1. How investing contributes to the Free

Enterprise System2. How the financial system brings savers and

borrowers together3. How financial intermediaries link savers and

borrowers4. Trade offs between risk, liquidity and return on

investment (ROI)

Borrowers & Savers

• Financial Institutions provide a place to deposit your money and GROW IT (And sometimes lose some of it – thru investing)

• Deposits are then Invested or loaned out to Borrowers

Investing & the Free Enterprise System

• These Investments (from Savers’ Deposits)Are used to:• Start new businesses• Buy inventory to be sold in retail stores• Expand existing businesses

Without these funds, the Free Enterprise System would be limited to the Personal Savings of each Business Owner to start or grow a business.

Financial Intermediaries

• Financial Institutions that take your money and invest it:

1. 2. 3. 4. 5.

Diversify your Portfolio

• In other words, invest in more than one place and type of investment.

• Ex: a Diversified Portfolio:– Savings Account(s)– Mutual Fund(s)– Bonds: Government and Corporate– Real Estate– Certificates of Deposit– Stocks

Risk, Liquidity & Return on Investment

• The higher the Risk, the Higher the Return (Interest rate paid to you or Amount of Profit)

• The longer the Term (less liquid), the Higher the Rate

• The shorter the Term (more liquid), the Lower the Rate

Types of RiskPg 274, Figure 11.2

Summarize in your own words

Risk Description Example

Credit Risk

Liquidity Risk

Inflation Rate Risk Inflation Calculator

Time Risk

Section 2: Bonds & Other Financial Assets

• STGs: Describe/Explain1. Characteristics of Bonds2. Types of Bonds3. Characteristics of other types of financial

assets4. Four different types of financial asset markets

Three Components of Bonds:1. Coupon Rate – Interest rate the issuer pays2. Maturity – The date (length of time) after

which the issuer will pay you the face value of the bond

3. Par Value – The face value the issuer will pay the bondholder when the bond matures

Ex: Coupon Rate: 5%Maturity: 10 yearsPar Value: $1,000

Corporate Bonds: How it Works

Buy $1,000 Bond (Face or Par Value) issued by a Corporation5% Coupon Rate, 10 year Maturity

• The bondholder receives $50 yearly (interest earned)• For 10 years• At the end of the 10 years (Maturity), the bondholder

gets $1,000 from the Issuer.• Bottom Line: The Bondholder has earned $500 over 10

years on a $1,000 investment in the bond.

Sub Par – Buying Bonds at a Discount

• Pg 278, Figure 11.3• Buy a Bond from a Bondholder not the Issuer• The Bondholder may need the cash of the Par

Value BEFORE the Maturity Date• So, the Bondholder sells the Bond at Sub Par

(a discount)

Bond RatingsPg 279, Figure 11.4

• Indicate the credit worthiness of a bond• The Rating is made by Standard & Poors, and

Moody’s, who track how well companies are doing, the amount of debt they carry and management of the companies.

• The less risk = the lower the Coupon Rate• AAA/Aaa = Highest quality, lowest risk bond

Buying BondsAdvantages Disadvantages

1. 1.

2. 2.

Types of Bonds1.

2.

3.

4.

5.

Treasury SecuritiesPg 280-Figure 11.6Fill in the squares

Treasury Bond Treasury Note Treasury Bill

Term

Maturity

Liquidity & SafetyMinimum PurchaseDenomination

Other Types of Financial Assets

• Certificates of Deposit• Money Market Mutual Funds (Money

Markets)

Certificates of Deposit

• Offered by Banks,…• Similar to a regular savings accounts except:– The rate is locked in (set %)– You commit to leave the $ in the account for a pre-

set length of time (term)• FDIC insured• The shorter the term, the lower the rate paid to

you• The longer the term, the higher the rate

Mutual Funds• Financial Institutions pool your money and that of other investors• Invest it in a variety of Financial Assets:

– Stocks– Bonds, …

• You can choose the type of Mutual Fund:– Blue Chip– Utilities– Alternative Energy– Real Estate

• NOT insured by FDIC so, they are riskier than a Savings account and CDs

• Higher Rate of Return than on a Savings account

Financial Asset Markets

• Capital Markets – Term longer than one year– Corporate & Gov’t Bonds– Long term CDs

• Money Markets – Term less than one year– Short term CDs– Treasury Bills– Money Market Mutual Funds

Financial Asset Markets

• Primary Markets – can be redeemed ONLY BY THE ORIGINAL HOLDER. They are NOT transferrable, cannot be resold.– Savings Bonds– Certificates of Deposit (CDs) in low $ amounts

• Secondary Markets – CAN be resold– Stocks!!! This is how Common Stockholders make

money - by selling it in the Secondary Market (The Stock Market) to another investor.

Section 3: The Stock Market

• STGs: Describe/Explain:1. Benefits & Risks of buying stock2. How stocks are traded3. How stock performance is measured4. Causes & Effects of the Great Crash of 1929

Stocks

• Ownership in a Company, but you don’t run the company. A stock is called a Share as in shared ownership. Aka Equities.

• A Prospectus is provided by the Company– Provides financial information such as income,

expenses and liabilities– Discusses future outlook – Is used by Financial Planners, Stock Brokers and

Investors to decide if a company is one in which they want to invest

Benefits Risks1. Dividends 1. Dividends are not guaranteed.

2. Capital Gains 2. Capital Losses

Buying Stock

Types of Stock

1. Common StockHow do Stockholders make money?

2. Preferred StockHow do Stockholders make money?

Stock Splits

• What is it?

• Why do companies split stocks?

How Stocks are Traded

• Through Stock____________• On the Stock ____________ or Stock Market– New York Stock Exchange (NYSE)

• OTC (Over the Counter) Market– Electronic online purchase– Nasdaq (National Association of Securities Dealers Automated

Quotations)• Daytrading – Buying & Selling stocks in the short term

rather than hold for growth. – Very risky– Buyer may buy and sell daily – several stocks

Futures & Options

How do you know how well a stock is doing?

• Look at Stock Indexes:– The Dow Jones Industrial Average– S & P 500– Pg 289, Figure 11.8

• Bull Market–

• Bear Market (Grin and Bear It)–

The Stock Market Crash of 1929

• Stock Market Crash of 1929Causes:1. Speculation – High Risk investments purchased

on credit2. Overspending & buying on credit3. Loans to German businesses & Gov’t defaulted

on4. Nation’s wealth concentrated in relatively few

hands (a few companies & a few families)

Aftermath of Stock Market Crash 1929

• Bull Market crash led to Bear Market– People hesitant to buy stocks

• Widespread unemployment (25%)• Tight Money Supply Policy led to less spending• Less Spending dampened Economic Recovery

(fewer jobs needed to produce goods & services)

• Regulations to prevent Crashes & Runs

Stock Market in Recent Times

• Steady growth with peaks and valleys• Mutual Funds make it possible for more people

to afford to buy stocks• Black Monday – October 19, 1987– The Dow lost 22.5% of value in one day– Rebounded over the next two days

• 9/11/2001 -– Trading temporarily halted– Economy did not crash