ECONOMICS CHAPTER 11: FINANCIAL MARKETS SECTION 2: BONDS AND OTHER FINANCIAL ASSETS

BONDS AS FINANCIAL ASSETS THE THREE COMPONENTS OF BONDS Bonds are loans that represent debt that the seller must repay to the investor at a fixed amount of interest at regular intervals for a specific amount of time. Bonds have three basic components: 1.Coupon Rate: the interest rate that a bond issuer will pay to a bondholder 2.Maturity: the time at which payment to a bondholder is due 3.Par Value: the amount to be paid to the bondholder at maturity; can also be called face value or principal

BONDS AS FINANCIAL ASSETS THE THREE COMPONENTS OF BONDS Example: Suppose you buy a $1,000 bond from Jeans, Etc. Coupon Rate: 5%, paid to the bondholder annually Maturity: 10 years Par Value: $1,000 $1,000 investment x 0.05 coupon rate = $50 interest in one year $50 interest x 10 years = $500 in interest At the end of the 10 years, Jeans, Etc. will pay you back your $1,000 investment + $ years of interest = $1,500

BONDS AS FINANCIAL ASSETS BUYING BONDS AT A DISCOUNT Discount from Par: Investors can not only earn money from the interest on their bonds, but they can also earn money by buying bonds at a discount.

BONDS AS FINANCIAL ASSETS BOND RATINGS In order to decide which bonds to buy, investors can check bond quality through independent firms (such as Standard and Poor’s and Moody’s) which publish bond issuers’ credit ratings. These firms rate bonds on the issuer’s financial strength, its ability to make future interest payments, and its ability to repay the principal when the bond matures. A high grade (AAA) means that the bond is safe to invest in.

BONDS AS FINANCIAL ASSETS ADVANTAGES AND DISADVANTAGES TO THE ISSUER ADVANTAGES Once a bond is sold, the coupon rate remains the same. DISADVANTAGES The company must make fixed interest payments. A firm’s bonds may be given a low bond rating and be harder to sell when the firm is not doing well.

TYPES OF BONDS SAVINGS BONDS, TREASURY BONDS, BILLS, AND NOTES Savings Bonds: Low-denomination ($50-$10,000) bonds issued by the U.S. government, who pays the interest on the bonds. Pays for public works projects (buildings, roads, dams) Treasury Bonds, Bills, and Notes (T-bills and T-notes) The U.S. Treasury Department issues Treasury bonds, bills, and notes, which are among the safest investments in terms of the default risk.

TYPES OF BONDS SAVINGS BONDS, TREASURY BONDS, BILLS, AND NOTES Which of these three types of government securities is the most liquid?

TYPES OF BONDS MUNICIPAL BONDS State and local governments issue municipal bonds to finance projects such as highways, libraries, parks, and schools. These are attractive to long-term investments and are relatively safe.

TYPES OF BONDS CORPORATE AND JUNK BONDS Corporate bonds are issued by corporations to help raise money to expand business. These bonds have a moderate risk level because investors must depend on the corporation’s success. Junk bonds are bonds with a high risk and a potentially high return. Investors in junk bonds face a strong possibility that some of the issuing firms will default on their debt.

ECONOMICS CHAPTER 11: FINANCIAL MARKETS SECTION 3: THE STOCK MARKET

INTRODUCTION How does the stock market work? Stock, or shares in a company, are bought and sold on the stock market. Stock brokers help individuals and businesses invest their money in the stock market. When the market is doing well, people see a large return on the initial investment. When it is not doing well, people may lose a great deal of money.

BUYING STOCK BENEFITS OF BUYING STOCK In addition to selling bonds, corporations can raise money by selling stock shares in that corporation. The benefits of buying stock include: Dividends: part of the firm’s profits Capital Gains: selling the stock for more than you paid for it

BUYING STOCK TYPES OF STOCK

Stock is also classified by whether or not the holder has a voice in the company: Common Stock: These holders are voting members of the company (one vote per share of stock owned) Preferred Stock: These holders are nonvoting members of the company Receive dividends before common stock owners and if the company goes out of business Get their investments back before common stock owners if the company goes out of business

HOW STOCKS ARE TRADED STOCK EXCHANGES, THE NEW YORK STOCK EXCHANGE, AND NASDAQ If you want to buy stock, you would first contact a stockbroker to advise you on which stocks to buy. You buy stocks on a secondary market known as a stock exchange. The New York Stock Exchange is the country’s largest and most powerful exchange, handling stock and bond transactions for the top companies in the world. The Nasdaq is the second largest securities market and the largest electronic market.

MEASURING STOCK PERFORMANCE BULL AND BEAR MARKETS AND THE DOW JONES INDUSTRIAL AVERAGE Bell Market: when the stock market rises steadily over a period of time Bear Market: when the stock market falls or stagnates for a significant period of time Dow Jones Industrial Average: measures stock performance