Financial Markets OverviewIEMS 326

Why this Lecture? Goals:

financial literacy financial numeracy

Will this be on the exam? Yes. Know orders of magnitude, relative sizes. Stocks vs. Flows vs. Trades Market functions

Debt versus Budget What’s bigger, the debt or deficit of the US?

U.S. federal debt: over $11T U.S. federal deficit 2009: about $1½T

In general, distinguish among 3 things: stocks—e.g. how much has been invested? flows—an increase or decrease in stocks trades—exchanges of ownership

(may not affect the real economy)

Debt, Deficit, Bonds The U.S. federal debt is a…

stock—total amount borrowed The U.S. federal deficit is a…

flow—this year’s increase in the debt When I buy a U.S. Treasury bond, it’s a…

trade—if I buy it from you flow—if I buy it from the U.S. Treasury

Budgets The U.S. federal budget is…

about $3T about twice the U.S. federal deficit about $10K per person (population ~300M)

Illinois has population ~13M and its state budget is… about $50B about $4K per person

Budgets The City of Evanston’s budget is…

$191M about $2.5K per person (population ~75K)

Northwestern’s budget is… $1.6B about $100K per student (~16K students)

Values of Investments What’s worth more, American Airlines or

Northwestern’s endowment? Our endowment: about $6B (~$400K/student) American Airlines (AMR):

market capitalization $2.2B = (# shares of stock)*(price of a share) = 333M shares * $6.70/share

Shareholding and Market Cap If I buy 333 shares of American Airlines…

a trade on the NYSE stock exchange …I’ll own 1 millionth of the corporation

If NU tries to buy all 333M shares… the price would probably go up

Market capitalization: valuation of the whole company based on small trades now.

Typical share prices From $1 to $100s Not too low…

(penny stocks) …or too high!

Berkshire Hathaway

How to make money in stocks buy low sell high

…or collect dividends When the share price goes up, (trade)

the company is more expensive shareholders are happy

real economy vs. financial trades

Primary&Secondary Equity Market primary equity market: (flow)

e.g. initial public offering (IPO) Google issued new shares sold them to investors for $30B invested $30B in cool stuff

secondary equity market (exchanges): (trade) shares and $$ change hands brokers get ¢ (~0.1% of value)

Bond Market primary bond market:

U.S. Treasury or G.E. borrows money by issuing bonds to investors

secondary bond market: bonds and $$$ change hands brokers get $ (1-2% value) trades: $1T/day

Global Bond Market $80T oustanding

(stock) about $13K/person

Foreign Exchange Market currency: trade $ for euros

open 24/7 trades: about $3T/day

about $500/person/day about $200K/person/year

purposes: international trade hedging speculation

Foreign Exchange Market

Commodities Markets spot vs. futures exchanges:

CME/CBoT NYMEX, etc.

pork bellies 20 tons, frozen physical delivery

hedging, speculation

Derivatives

Backup slides

How companies make money successful business projects…

create positive earnings increase book value make it possible to pay higher dividends

real economy vs. financial trades

Bonds issued

Nationality of bond issuer

Nationality of bond holder

Government Bonds

Bond market

Foreign Exchange Market: What?

Foreign Exchange Market: Where?