Making more money than you know what to do with!!! Ch. 11 Financial Markets Making more money than you know what to do with!!!

INVESTMENT The act of redirecting resources from being consumed today so that they ma create benefits in the future IN HUMAN LANGUAGE: using your assets to earn income or profit Using your money to make more of it

Investing and Free Enterprise Financial System: includes savers and borrowers and where money is transferred Financial Assets: claim on the property or income of a borrower (document that provides proof someone owes you money)

Financial Intermediaries Help channel funds from savers to borrowers (you to companies for example) Banks, Savings and Loans, Credit Unions Finance Companies Mutual Funds Life Insurance Companies Pension Funds

Sharing Risk Don’t put all of your eggs in one basket Invest in several things, so if one goes bad you don’t lose everything!

Return and Risk The higher the potential return, the riskier the investment CD’s: low risk low return Stocks: high risk & potential for big returns

Intermediaries and Information Portfolios: collection of financial assets What investments you have Prospectus: information provided by investors to let you know how investments are doing. REQUIRED BY LAW

Return & Liquidity Return: the money an investor receives above and beyond the sum of money initially invested Liquidity: an investment is more liquid the easier it is for you to get to it Savings Accounts: very liquid CD’s: not liquid

Bonds & Other Financial Assets Bonds: are similar to loans or IOUs Debt that the government or corporations must repay the investor Typically pay a fixed amount of interest at regular intervals for a fixed amount of time Generally lower risk, lower rate of return

3 Components of Bonds Coupon Rate: interest rate the bond issuer pays the bond holder Maturity: time at which payment to the bondholder is due Par Value: amount that an investor pays to purchase the bond and that will be repaid to the investor at maturity (face value or Principle)

More Bond Info Yield: annual rate of return on the bond if the bond were held to maturity Important because not all bonds are held to maturity. Why? Buying bonds at a Discount People sometimes sell bonds at less than par value because of changing interest rates You want the money to spend, so you sell at a discount if interest rates have went up

Bond Ratings The higher the bond rating the lower the interest rate (less risk, less return) The lower the bond rating the higher the interest rate Bond ratings come from 2 main places Standard & Poor’s Moody’s

Advantages of Bonds to the Issuer Once the bond is sold, the coupon rate will not go up and down (interest rate is fixed) You know ahead of time about your payments Bondholders do not own part of the company Company does not have to share profits with bondholders if it does well

Disadvantages of Bonds to Issuers Must make fixed interest payments even in bad years Cannot change interest rates If firm does not do well, bond rating could be downgraded and could become harder to sell

Types of Bonds Savings Bonds: issued by the government Used to help pay for buildings, roads, & dams Virtually no risk Bondholders do not get interest payments You buy them below par value A $50.00 bond may cost $25.00

More Types of Bonds Treasury Bonds, Bills, & Notes Also Called T-Bills & T-Notes One of the safest investments Backed by the “full faith & credit” of the US government Many Americans invested in these after 9/11

Bond Types Pt. 3 Municipal Bonds State and local governments Used to finance highways, state buildings, libraries, parks, and schools Most are considered safe as long as the financial health of the state or town is good Interest paid on these is not subject to income tax!!!!!!!!!!!!!!!!!! Rock on!

And more bonds Corporate Bonds: usually large and interest is taxed as income Corporations have no tax base to guarantee repayment, so risk level is higher Corporation’s must rely on sales of goods and services to pay back bonds.

Another Bond Junk Bonds High-yield Lower rated Potentially higher paying Popular during the 80’s & 90’s Have been known to pay over 12% interest Speculative ratings Strong possibility some firms will default

Other Financial Assets CD’s Certificates of Deposit Available through banks Popular & inexpensive (low risk) Money Market Mutual Funds Businesses collect money from investors & then buy stock, bonds, & financial assets Higher interest rate than savings account, but not covered by the FDIC

Financial Asset Markets Capital Markets Money is lent for longer than one year Long-term CD’s, Bonds that require more than 1 year to mature Money Markets Money is lent for periods less than one year Short-term CD’s, treasury bills, and money market mutual funds

More Markets Primary Market Secondary Market Financial assets that can be redeemed only by the original holder Savings bonds, small CD’s Secondary Market Financial assets that can be resold Stocks

The Stock Market Buying Stock Shares: stock is issued in portions called shares Equities: stocks are equities, claims of ownership in a corporation Dividends: corporations pay out part of their profits to stockholders (usually 4 times/year) Capital Gain: Sell a stock for more than you paid for it (Capital Loss)

Types of Stock Income Stock: pays dividends during regular times during the year Growth Stock: pays few or no dividends, reinvests earnings into business Common Stock: investors are voting owners, one vote per share owned Preferred Stock: nonvoting owners of company, receive dividends before the owners of common stock

Risks of Stocks Stock values can decrease after you purchase them because you are a dark cloud and bad luck This means you will lose money when you go to sell the stock

Trading Stock Stockbroker: a person who links buyers and sellers Brokerage Firms: stockbrokers work for brokerage firms, these firms earn a profit by charging a commission on each stock transaction They buy shares at a lower price than what they sell them to you for

Stock Exchanges New York Stock Exchange (NYSE) The OTC Market Nasdaq Largest & most powerful (began in 1792) Largest and most established companies The OTC Market Over the counter markets Get stocks not traded at stock exchanges Nasdaq National Association of Securities Dealers Automated Quotations Links OTC markets around the world by computer

Futures & Options Futures: contracts to buy or sell commodities at a specific date in the future at a price specified today Grain & Livestock Options: contracts that give investors the choice to buy or sell stock and other financial assets Gives you the right to buy the stock at that price until sometime in the future Not an obligation

Bull and Bear Markets Bull Market: stock market rises steadily over a period of time Investors buy stock because they expect prices to increase Bear Market: stock market falls for a period of time Investors sell stock because the expect prices to decrease

Measuring the Market The Dow Jones Industrial Average S & P 500 Shows how certain stocks have traded on every business day Today has approximately 30 large companies S & P 500 Broader perspective of stock performance Measures over 500 stocks