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Chapter Menu Chapter Introduction Section 1:Section 1:Savings and the Financial System Section 2:Section 2:Financial Assets and Their Markets Section 3:Section 3:Investing in Equities and Options Visual Summary

Chapter Intro 1 You have just been hired as a financial planner to provide advice on how to invest wisely and effectively. Miguel, your client, is a widower raising two young children. He wants to be sure that (1) he will have enough money to send his children to college, and (2) he will be financially secure in his retirement. What advice would you give Miguel? Read Chapter 11 to learn more about how people can accomplish their financial goals.

Chapter Intro 2 Governments and institutions help participants in a market economy accomplish their financial goals.

Chapter Intro-End

Section 1-Preview Section Preview In this section, you will learn how the components of a financial system work together to transfer savings to investors.

Section 1-Key Terms Content Vocabulary saving savings certificate of deposit financial asset financial system financial intermediary nonbank financial institution finance company premium pension pension fund risk Academic Vocabulary sector compensation

A.A B.B C.C Section 1 Have you ever thought about what your financial goals are and what steps you need to take to reach them? A.Yes, often B.Occasionally C.Never

Section 1 Savings and the Financial System Saving—absence of spendingSaving Savings—dollars that are available once you abstain from consumptionSavings

Section 1 Saving and Economic Growth The financial system brings savers and borrowers together and helps the economy grow.

Section 1 Saving and Economic Growth (cont.) Saving makes economic growth possible. Individuals save by –Opening a savings account –Purchasing a bond –Purchasing a certificate of depositcertificate of deposit Overview of the Financial System

Section 1 Saving and Economic Growth (cont.) Documents are given in each case showing money saved—financial assets.financial assets The economy has a financial system to transfer savings to investors.financial system Overview of the Financial System

Section 1 Three parts to the financial system Saving and Economic Growth (cont.) –Funds a saver transfers to a borrower –Financial assets that certify conditions of the loan –Organizations that bring the surplus funds and financial assets together Overview of the Financial System

Section 1 Financial intermediaries—institutions that lend funds savers provideFinancial intermediaries Governments and businesses are the largest sector of borrowers. Households and businesses are the biggest sources of funds. Saving and Economic Growth (cont.) Overview of the Financial System

A.A B.B C.C D.D Section 1 In the financial system, who really benefits? A.Savers B.Borrowers C.Everyone D.No one

Section 1 Nonbank Financial Intermediaries Organizations other than banks can transfer money from savers to borrowers.

Section 1 Another group of financial intermediaries are the nonbank financial institutions.nonbank financial institutions –Finance companyFinance company –Life insurance companies—charge a premium premium –Pension fund—pays a pension to specified individuals for specific reasonsPension fundpension Nonbank Financial Intermediaries (cont.) Profiles in Economics: Sallie Krawcheck

A.A B.B C.C D.D Section 1 Which entity would charge you a higher interest rate for your car loan? A.Bank B.Credit union C.Finance company D.Relative

Section 1 Basic Investment Considerations Investors should consider several factors before investing their money.

Section 1 Before investing, consider the following –Consistency –Simplicity Basic Investment Considerations (cont.) The Power of Compound Interest

Section 1 –The risk-return relationship Basic Investment Considerations (cont.) Risk and Return –Investment objectives Risk—degree to which outcome is uncertain but a probable outcome can be estimatedRisk

A.A B.B Section 1 An investment that appears too good to be true probably is worth the risk. A.True B.False

Section 1-End

Section 2-Preview Section Preview In this section, you will learn about the characteristics of various investments to help with your investments.

Section 2-Key Terms Content Vocabulary bond coupon rate maturity par value current yield junk bond municipal bond tax-exempt savings bond beneficiary Treasury note Treasury bond Treasury bill Individual Retirement Account (IRA)Individual Retirement Account (IRA) capital market money market primary market secondary market

Section 2-Key Terms offset presumed Academic Vocabulary

A.A B.B C.C Section 2 What determines the price and yield of a bond? A.Risk of investment B.Supply and demand C.Current interest rates

Section 2 Bonds as Financial Assets A bond is a long-term investment, with the price determined by supply, demand, and the buyer’s assessment of repayment risk.

Section 2 Bonds as Financial Assets (cont.) Governments and businesses issue a bond when they need to borrow funds for long periods. bond Bonds have three main components: –Coupon rateCoupon rate –MaturityMaturity –Par valuePar value Bond Ratings

Section 2 To compare bonds, investors compute the bond’s current yield.current yield Interest received and price paid determines the actual current yield of each bond. Bond ratings are published by Standard & Poor’s and Moody’s. Bonds as Financial Assets (cont.) Bond Ratings

Section 2 Bonds rated on –Basic financial health of the issuer –Expected ability to make future coupon and principal payments –Issuer’s past credit history Bonds as Financial Assets (cont.) Bonds with higher ratings sell at higher prices than bonds with lower ratings. Bond Ratings

A.A B.B C.C Section 2 Which of the following rated bonds has the greatest risk? A.BBB or Baa B.CCC or Caa C.CC or Ca

Section 2 Financial Assets and Their Characteristics Investments include CDs, bonds, bills, and IRAs, all of which vary in cost, maturity, and risk.

Section 2 Investors today have many choices. –Certificates of deposit—loans investors make to financial institutions –Corporate bonds—IRS considers interest and payments as taxable income. Junk bonds—offer high rate of return due to exceptionally high riskJunk bonds Financial Assets and Their Characteristics (cont.)

Section 2 –Municipal bonds—issued by state and local governments, generally tax exemptMunicipal bonds Bonds can be purchased for investor’s heirs by designating a beneficiary.beneficiary –Government Savings Bonds—savings bonds are paper-based or paperlesssavings bonds Financial Assets and Their Characteristics (cont.)

Section 2 –Treasury notes—U.S. government borrows funds for 2 to 10 yearsTreasury notes –Treasury bonds—U.S. government borrows funds for 10 to 30 yearsTreasury bonds –Treasury bills—(T-bills) short term obligations, maturity of 4, 13, or 26 weeksTreasury bills –Individual Retirement Account (IRAs)Individual Retirement Account (IRAs) Financial Assets and Their Characteristics (cont.)

A.A B.B C.C D.D Section 2 Which of the following could you invest in today? A.Savings bonds B.IRA C.T-bill D.401(k) plan

Section 2 Markets for Financial Assets Financial assets are grouped into different markets depending on their maturity and liquidity.

Section 2 Markets for financial assets –Capital market—money is loaned for more than one year.Capital market –Money market—money is loaned for periods less than one year.Money market Markets for Financial Assets (cont.) Financial Assets and Their Markets

Section 2 –Primary market—original issuer can sell or repurchase a financial asset.Primary market –Secondary market—existing financial assets can be resold to new owners.Secondary market Markets for Financial Assets (cont.) Financial Assets and Their Markets

A.A B.B C.C D.D Section 2 Under which financial market(s) would Disney bonds with maturity in 5 years be classified? A.Money market B.Capital market C.Primary market D.Secondary market

Section 2-End

Section 3-Preview Section Preview In this section, you will learn more about the equities, or stocks, that are traded in markets.

Section 3-Key Terms Content Vocabulary equities stockbroker Efficient Market Hypothesis (EMH)Efficient Market Hypothesis (EMH) portfolio diversification mutual fund net asset value (NAV)net asset value (NAV) 401(k) plan stock exchange securities exchange over-the-counter market (OTC)over-the-counter market (OTC) Dow Jones Industrial Average (DJIA)Dow Jones Industrial Average (DJIA) Standard & Poor’s 500 (S&P 500)Standard & Poor’s 500 (S&P 500)

Section 3-Key Terms Content Vocabulary (cont.) bull market bear market spot market futures contract option call option put option

Section 3-Key Terms prospects implication Academic Vocabulary

A.A B.B Section 3 Do you think investing is a wise decision? A.Yes B.No

Section 3 Stocks and Efficient Markets Investors can purchase stock through stockbrokers on exchanges, through mutual funds, or through 401(k) plans.

Section 3 Stocks and Efficient Markets (cont.) Equities or shares of common stock represent another financial asset for investors.Equities –StockbrokerStockbroker –Internet account with discount brokerage firm A New York Stock Exchange Listing Ways to purchase equities

Section 3 Stocks and Efficient Markets (cont.) –Mutual fundsMutual funds Net asset value (NAV) –401(k) plan401(k) plan A New York Stock Exchange Listing

Section 3 Value of stock depends on –Number of outstanding shares to be traded –Company’s profitability –Expectations of growth Stocks and Efficient Markets (cont.)

Section 3 Efficient Market Hypothesis (EMH) states that each stock is analyzed constantly by many professional analysts. Any observations result in buying or selling of the stock immediately.Efficient Market Hypothesis (EMH) Portfolio diversification—investors offset losses of one stock with increases in other stocks.Portfolio diversification Stocks and Efficient Markets (cont.) How Much Money Will You Have at Retirement?

A.A B.B C.C D.D Section 3 Which is not an advantage of investing in a 401(k)? A.Analysts on staff to monitor market conditions B.Highly diversified C.Employers typically match a portion of employee’s contribution D.Penalties for early withdrawal

Section 3 Stock Markets and Their Performance Several different stock markets exist, and each is organized in a different way

Section 3 Historically, stocks were traded at a stock or securities exchange.stocksecurities exchange –New York Stock Exchange (NYSE) is the oldest exchange in the United States. –American Stock Exchange (AMEX) is also in New York City. Stock Markets and Their Performance (cont.)

Section 3 –Regional exchanges located in several big cities across the United States –The NASDAQ is the world’s largest electronic stock market. –Exchanges in major Cities throughout the world Stock Markets and Their Performance (cont.) Majority of stocks, however, are traded in an over-the-counter market (OTC).over-the-counter market (OTC)

Section 3 Stock performance can be monitored by several popular indicators. –Dow Jones Industrial Average (DJIA)Dow Jones Industrial Average (DJIA) –Standard & Poor’s 500 (S&P 500)Standard & Poor’s 500 (S&P 500) –NASDAQ Composite Stock Markets and Their Performance (cont.)

Section 3 Bull market—“strong,” prices moving upBull market Bear market—“mean” or “nasty” market with prices falling sharplyBear market Stock Markets and Their Performance (cont.)

A.A B.B C.C Section 3 Is it more advantageous to purchase stocks in a bear or bull market? A.Bear B.Bull C.Does not matter

Section 3 Trading in the Future Financial assets can be bought and sold in the future as well as the present.

Section 3 Most buying and selling takes place immediately, a spot market.spot market Exchanges that take place later in time are a futures contract.futures contract Trading in the Future (cont.) –Option—buyer has the right to cancel futures contract.Option Call option—purchaseCall option Put option—sellPut option

A.A B.B C.C Section 3 The total number of stocks listed on the NASDAQ A.is less than the total on the NYSE but greater than the total on the AMEX. B.is greater than the total on the NYSE and the AMEX. C.is less than the total on the AMEX but greater than the total on the NYSE.

Section 3-End

Financial System Households and businesses invest their surplus funds to earn interest. Governments and businesses invest this money for economic growth. VS 1

VS 2 Investment Risk and Return Investors must weigh the risks of their investments against the returns they expect. Generally, the higher the risk of an investment, the higher the return investors require.

VS 3 Equities and Futures The riskiest investments consist of equities and futures. Equities can be purchased as individual stocks, or as a part of a mutual fund or 401(k) plan. Futures allow investors to speculate on future prices of commodities.

VS-End

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Profile Sallie Krawcheck (1965– ) chief financial officer for Citigroup Inc., the world’s largest financial institution ranked number 6 on Forbes’s top 100 of “The World’s Most Powerful Women” for 2006

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Vocab1 saving absence of spending that frees resources for use in other activities or investments

Vocab2 savings the dollars that become available for investors to use when others save

Vocab3 certificate of deposit document showing that an investor has made an interest-bearing loan to a financial institution

Vocab4 financial asset a stock or other document that represents a claim on the income and property of the borrower, such as a CD, bond, Treasury bill, or mortgage

Vocab5 financial system network of savers, investors, and financial institutions working together to transfer savings for investment uses

Vocab6 financial intermediary institution that channels savings to investors

Vocab7 nonbank financial institution nondepository institution that channels savings to investors

Vocab8 finance company firm that makes loans directly to consumers and specializes in buying installment contracts from merchants who sell on credit

Vocab9 premium price paid at regular intervals for an insurance policy

Vocab10 pension regular payments to someone who has worked a certain number of years, reached a certain age, or has suffered an injury

Vocab11 pension fund fund that collects and invests income until payments are made to eligible recipients

Vocab12 risk situation in which the outcome is not certain, but the probabilities can be estimated

Vocab13 sector an area of the economy in which businesses offer the same or similar products or services

Vocab14 compensation something, such as money, given or received as an equivalent for goods or services, injury, debt, or high risk

Vocab15 bond contract to repay borrowed money and interest on the borrowed money at regular future intervals

Vocab16 coupon rate stated interest on a corporate, municipal, or government bond

Vocab17 maturity life of a bond or length of time funds are borrowed

Vocab18 par value principal of a bond or total amount borrowed

Vocab19 current yield bond’s annual coupon interest divided by purchase price; measure of a bond’s return

Vocab20 junk bond bond that carries an exceptionally high risk of nonpayment and a low rating

Vocab21 municipal bond bond, often tax exempt, issued by state and local governments

Vocab22 tax-exempt not subject to tax by federal or state governments

Vocab23 savings bond low-denomination, non-transferable bond issued by the federal government

Vocab24 beneficiary person designated to take ownership of an asset if the owner of the asset dies

Vocab25 Treasury note U.S. government bond with a maturity of 2 to 10 years

Vocab26 Treasury bond U.S. government bond with maturity of 10 to 30 years

Vocab27 Treasury bill short-term United States government obligation with a maturity of one year or less in denominations of $1,000

Vocab28 Individual Retirement Account (IRA) retirement account in the form of a long-term time deposit, with annual contributions not taxed until withdrawn during retirement

Vocab29 capital market market in which financial capital is loaned and/or borrowed for more than one year

Vocab30 money market market in which financial capital is loaned and/or borrowed for one year or less

Vocab31 primary market market in which only the original issuer can sell or repurchase a financial asset

Vocab32 secondary market market in which financial assets can be sold to someone other than the original issuer

Vocab33 offset to balance higher levels of risk with a larger payoff

Vocab34 presumed taken for granted; supposed

Vocab35 equities stocks that represent ownership shares in corporations

Vocab36 stockbroker person who buys or sells securities for investors

Vocab37 Efficient Market Hypothesis (EMH) argument that stocks are always priced about right because they are closely watched

Vocab38 portfolio diversification strategy of holding different investments to protect against risk

Vocab39 mutual fund company that sells stock in itself and uses the proceeds to buy stocks and bonds issued by other companies

Vocab40 net asset value (NAV) the market value of a mutual fund share found by dividing the net value of the fund by the number of shares issued

Vocab41 401(k) plan tax-deferred investment and savings plan that acts as a personal pension fund for employees

Vocab42 stock exchange physical place where buyers and sellers meet to exchange securities

Vocab43 securities exchange physical place where buyers and sellers meet to exchange securities

Vocab44 over-the-counter market (OTC) electronic marketplace for securities not listed on organized exchanges such as the New York Stock Exchange

Vocab45 Dow Jones Industrial Average (DJIA) measure of stock market performance based on 30 representative stocks

Vocab46 Standard & Poor’s 500 (S&P 500) measure of stock market performance based on 500 stocks traded on the NYSE, AMEX, and OTC market

Vocab47 bull market period during which stock market prices move up for several months or years in a row

Vocab48 bear market period during which stock market prices move down for several months or years in a row

Vocab49 spot market market in which a transaction is made immediately at the prevailing price

Vocab50 futures contract an agreement to buy or sell at a specific date in the future at a predetermined price

Vocab51 option futures contract giving a buyer the right to cancel the contract

Vocab52 call option futures contract giving a buyer the right to cancel a contract to buy something

Vocab53 put option futures contract giving a buyer the right to cancel a contract to sell something

Vocab54 prospects potential or expectations

Vocab55 implication something suggested to be naturally understood

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