Financial Markets Chapter Eleven

Savings and the Financial System Objective – To learn how the components of a financial system work together to transfer savings to investors

Quote of the Day “Very often a change of self is needed more than a change of scenery” A.C. Benson

Savings and the Financial System In your groups….. Identify and describe methods of investing and savings that you are familiar with Create a table listing each method and also how they work Why do you think the governments and institutions would want participants in a market to save and invest their money?

Savings and the Financial System What is saving? Savings is the action of not spending While savings is what is accumulated by not spending

Savings and Economic Growth Savers and Financial Assets How can you save? Savings account, bonds, CD(Certificate of Deposit) – Investor has made a loan, interest paying, to the bank All of these are called Financial assets – claims on the property and the income of the borrower Stocks can also be purchased…..ownership claims on a company

The Circular Flow of Finance We need a financial system to use the savings of others – A network of savers, investors, and financial institutions that work together to transfer savings to investors

The Circular Flow of Finance Financial system has three parts 1. Funds that a saver transfers to a borrower 2. Financial assets that certifies conditions of the loan 3. The organizations that bring the surplus funds and financial assets together

The Circular Flow of Finance Financial Intermediaries -Are the institutions that lend the funds that the savers provide -Inter = Between or among -Mediate = To work between two parties -Banks, credit unions, life insurance companies, pension funds, or any other funds that channel savings to borrowers. -Help the small savers – limited funds to deposit

The Circular Flow of Finance Financing Capital Formation Any sector of the economy can borrow Sector = Government, businesses, households, individuals Corporations borrows from savers or through financial intermediaries Corporation issues bonds or other financial assets to lender Government borrows issues government bonds or other financial assets to lender

The Circular Flow of Finance Financing Capital Formation In terms of savings, households and businesses are the biggest source Capital formation depends on saving and borrowing When households borrow invest some of money in homes When businesses borrow funds invested in tools, machinery, equipment When governments borrow funds invested in hospitals, highways, universities, etc.

The Circular Flow of Finance Financing Capital Formation Answer this question in your groups….. How does the financial system benefit both the borrowers and the savers?

Nonbank Financial Intermediaries These are non-depository institutions that also channel savings to borrowers Three prime examples Finance companies Life Insurance Companies Pension Funds

Nonbank Financial Intermediaries Finance Companies A firm that specializes in making loans to consumers. Buys installment contracts from merchants that sell goods on credit. Easy for company to sell products FC assumes risk with loan Makes direct loans – some risky, higher interest rates to consumer.

Nonbank Financial Intermediaries Life Insurance Companies Provide financial protection for insured people Collects a lot of cash Premium – money paid on a regular basis for policy Can also act as lenders as well

Nonbank Financial Intermediaries Pension Funds Basic security for when you retire from the workforce. Pension is the payment, a pension fund is used for monetary disbursement. Can be company pensions or private pension funds.

Basic Investment Considerations Four basic considerations Consistency Invest over long length of time Simplicity Keep it simple Ignore anything too complicated Go with what you know Risk-Return Relationship Risk is degree to which outcome is uncertain All investments have risk although degrees vary Investment Objectives What is reason for investing? Retirement vs. more immediate funds….

Question????? In what type of situation might an investor seek an investment with a high level of risk?

Financial Assets and their Markets Bonds as Financial Assets Most are long term investments Government Bonds $100.00 US Saving Bond Purchase Price - $50.00 Maturity – 20 years Money accrued – Predetermined interest from time of purchase to maturity + the Par Value of bond (total value at Purchase) Corporate Bonds Example – 20 year, $1000.00 Par Value Bond @ 6% interest Interest paid semi-Annually .06 x 1000/2 = $30.00 paid twice a year for length of maturity After 20 years – Par Value is paid back to investor 60 x 20 = $1200.00 + $1000.00 (par value) = $2200.00

Financial Assets and their Markets Bonds yields Comparing bonds = computing current yield Annual interest divided by purchase price $60.00/$950.00 = 6.32% $60.00/$1100.00 = 5.45% Interest received and price paid determine the actual current yield All bonds have ratings – Great companies = great ratings & vice versa Standard and Poor's and Moody’s publish bond ratings Using your phones…as a group, look up the top and bottom 5 bond rated companies from each of the above mentioned bond rating companies

Financial Assets and their Characteristics Certificates of Deposit (CD’S) Most common form of investment As low as $500 - $1000 Investor can select length of maturity, tailored for just about anything…college, car, house, etc. FDIC insured as well! Corporate Bonds Long term investments $1,000 - $10,000 – Prices are lower than par value Use bond ratings to decide which to invest in Junk Bonds, very risky, can produce a high yield, but high possibility of default

Financial Assets and their Characteristics Municipal Bonds (Munis) Bonds issued by state and local governments Finance items at state or local level Very safe, tax-exempt – no federal taxation Government Saving Bonds Low-denomination nontransferable bonds Paper/Paperless Paper $50 - $10,000 – 30 year maturity – Interest + Par Value Paperless Purchased directly from treasury via internet Pay face value Interest added monthly and compounded semi-annually Bond will double every 20 years

Financial Assets and their Characteristics Treasury Notes and Bonds T-Notes Matures in 2-10 years T-Bonds Denominations of $1,000.00 Issued electronically Periodic interest is added automatically to your account Safest of all financial assets

Financial Assets and their Characteristics Treasury Bills T-Bills Very short-term investment 4,13, or 26 weeks Do not pay interest directly Price discounted at purchase – par value at maturity $960.00 Paid - $1000.00 after maturation Individual Retirement Accounts IRA’S Long-term tax sheltered time deposits All taxes deferred Will be paid upon withdrawal Penalties for early withdrawal Great retirement option

Financial Asset Markets All financial assets are grouped into different markets based on two factors: Maturity Liquidity

Financial Asset Markets Money Market < one year Capital Market > one year Primary Market – Only original issuer can sell or repurchase a financial asset. *Money market mutual funds *Small CDs *Government saving bonds *IRAs Secondary Market-Existing financial assets can be resold to new owners *Jumbo CDs *Treasury bills *Corporate bonds *International bonds *Municipal bonds *Treasury bonds *Treasury notes

Investing in Equities and Options We know that Government bonds are the safest investment, however, they have the lowest return Equities and Futures are the riskiest, but could have a large reward.

Investing in Equities and Options Stocks and Efficient markets Shares of common stock are called Equities Represent ownership of corporations Share Values Can purchase shares via a stockbroker – Buys or sells equities for clients Internet account can allow investor, you, to buy, sell, and monitor Value is determined by profitability of the company Goes up and down daily

Investing in Equities and Options Stocks and Efficient markets Reading a listing – Page 306 DIV – Annual dividend paid in four equal installments Yld% - Dividend divided by the closing price PE – Price-Earnings ratio – Stocks closing price divided by annual earnings of each share of common stock outstanding. NET CHG – Where the stock closes today versus the day prior

Investing in Equities and Options Stocks and Efficient markets Using your phone….look up the share price of the following common stocks: Apple – Google - Microsoft – Alibaba – GE – Heinz – Ebay – Facebook – - Then, using your technology, determine which stock would you determine to be the most profitable in your opinion

Investing in Equities and Options Stocks Market Efficiency Nothing is guaranteed in the market – Rise and fall Efficient Market Hypothesis (EMH) Stocks are usually priced correctly and bargains are hard to find due to the competitive nature of investors. They, investors, constantly analyze the market for any fluctuations Portfolio Diversification Being diverse, allows you to make up for losses by gaining in other stocks at the same time Don’t put all of your money into one stock!!!!!

Investing in Equities and Options Mutual Funds A company that sells stock in itself to individual investors Then invests money it receives into other company’s stock and sometimes bonds Mutual fund stockholders receive dividends from their investments Net Asset Value NAV – Market value of a mutual fund share Allows for diversification – invested in many companies 401K A tax deferred investment and savings plan that acts as a personal pension fund for employees Contribute via payroll deductions Lowers your taxable income – do not pay taxes on it until you withdraw

Investing in Equities and Options 401K Simple, safe way for employees to save Employer usually matches your contribution based on a certain %

Investing in Equities and Options Stock Markets and Performance Most stocks are traded in a stock exchange (securities) Members pay a fee to join, then can trade openly NYSE – New York Stock Exchange – Oldest, largest, exchange in U.S Wall Street – lists stock from around 2,700 companies AMEX – American Stock Exchange New York City Deals with smaller companies Regional exchanges as well – Chicago, Philadelphia, etc.

Investing in Equities and Options OTC – Over the Counter Markets Electronic marketplace for securities not traded in an exchange Most stocks in world traded this way NASDAQ – National Association of Security Dealers Automated Quotation World’s largest automated electronic stock market Connected to 80 countries

Investing in Equities and Options How stock performance is measured Dow Jones Industrial Average (DJIA) Most popular 1884 – Dow Jones Corporation published average closing of 11 active stocks Basically tells us the % change of stocks that averaged $1.00 of change – Only with the NYSE Standard and Poor’s 500 (S&P 500) Uses a representative change of 500 stocks as an indicator of overall market performance. NYSE, AMEX, OTC markets

Investing in Equities and Options Bull Vs. Bear Market Bull Market – Term used to describe a strong market with prices moving up for a long period of time Bear Market – A mean or a nasty market….prices moving downwardly