Financial Markets Chapter 11

TYPES OF INVESTMENTS Financial Intermediaries Is a “middle man” handling money for the investor – you pay this person or company to make investments for you. Includes banks, S&Ls, credit unions Also finance companies, pension funds, life insurance companies

Financial Intermediaries Mutual fund—pools individuals’ money to buy range of financial assets investors own shares of entire fund 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

Financial Asset Markets Financial markets categorized according to time, resalability: Time Capital markets—assets held for over a year includes stocks, bonds, mortgages, long-term CDs Money markets—loans made for less than a year includes short-term CDs, Treasury bills

Financial Asset Markets Financial markets categorized according to time, resalability: 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

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

Risk and Return 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

The Stock Market Two ways to earn money in stock Buy to earn dividends, share of company profits Buy to earn make money when you sell the stock

The Stock Market Types of Stock Common stock—gives shareholders voting rights, share of profits 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

Trading Stock 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 American Stock Exchange (AMEX) companies smaller than on the NYSE

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

Trading Stock Recent Developments Investors access Internet; huge growth in online brokerage companies Through electronic communications networks (ECNs), 24-hour trading computer technology matches buyers, sellers automatically; rapid trades

Measuring How Stocks Perform Stock Indexes measure how stocks are performing. U.S. indexes: DJIA, Standard & Poor’s 500, NASDAQ Composite Since 1896, Dow Jones Industrial Average changed with U.S. economy Includes 30 most successful companies in most important economic sectors uses points to measure changes in prices at which stocks traded

Measuring How Stocks Perform Tracking the Dow Bull market—prices rise steadily over a relatively long period Bear market—prices decline steadily over a relatively long period Many things impact stock performance Government action, overseas markets, Fed announcements

Other Financial Instruments Certificates of Deposit CDs offered primarily by banking institutions; have maturity date Pay fixed or variable interest, reinvested for compound interest 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

Other Financial Instruments Money Market Mutual Funds 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