Financial Markets Chapter 11 Sections 1 & 2

Savings and Investment Savings-income not used for consumption Investment-use of income now in a way that provides a future benefit Economic investment: money lent to businesses Personal investment: individuals putting savings into financial assets Financial System-Transfer funds between savers and investors

Bringing Savings and Investment Together People & businesses save funds; receiver issues written confirmation Confirmation called financial asset-claim on borrower’s property Financial Market-where buyers and sellers exchange assets directly Financial Intermediary-collects funds from savers, invest in financial assets

Financial Intermediaries Includes banks, S&Ls, & Credit Unions Also finance companies, pension funds, & life insurance companies Mutual Fund-pools individuals’ money to buy a range of financial assets Investors own shares of entire fund

Financial Intermediaries Example:Banking Example:Nonbanking Provide checking, savings, money market accounts, & CDs Depositors earn interest FDIC insures money Make loans; to make profit they charge a higher interest rate than they pay to depositors Offer uninsured money market mutual funds, stock bonds, & insurance Finance companies make small loans to households & small businesses Mutual funds let individuals own many assets; managers make decisions Pension funds invest employees’ money Life insurance companies invest income in financial assets

Financial Asset Markets Financial markets are categorized according to time & resalability Capital market-for buying and selling long-term financial assets Money market-for buying and selling short-term financial assets Primary market-for financial assets that original buyer must redeem Secondary market-where financial assets are resold

Financial Asset Markets Factor 1: Time Capital markets-assets held for over a year Include stocks, bonds, mortgages, & long-term CDs Money Markets- loans made for less than a year Includes short-term CDs & treasury bills Factor 2:Resalability Primary markets-financial assets can be redeemed only by original buyer Includes saving bonds & small denomination CDs Also market where first issue of stock sold through investment 6bankers Secondary markets- resale markets offer liquidity to investors Includes stocks & bonds

Investing in a Market Economy Personal investing is saving Individual must first determine own investment objective: financial goals investor uses to decide if an investment is appropriate

Why are you Investing? Main considerations: when money will be needed Other issues: need to pay off debts, tax concerns Savings for emergencies should be liquid Long-term investments goods for retirement and college Can choose CDs to coincide with timing of savings goals

Risk and Return Risk-possibility for loss on an investment Return-profit or loss on an investment Refers to interest paid on savings or increase in value of stock Diversification-investing in different financial assets Purpose: maximize returns & minimize risk

Risk and Return What kind of risk are you willing to take? What kind of return do you want? Risk usually means loss of part of initial investment or principal No-risk investments: insured savings and CDs, U.S. Bonds Safe investments risk interest rate & may not keep up with inflation Return on riskier investments depends on how profitable company is Bonds are less risky than stocks, bondholders are paid off first Safe investments have lowest returns through fixed interest rates Stocks, bonds-no guaranteed rates Bonds-higher returns over time If investing over a long period, you can risk losses in some years If less time and money, may want safer investment Diversification gives better chance of offsetting a loss with a gain

Vocabulary Savings income not used for consumption Investment use of income now in a way that provides a future benefit Financial System Transfer funds between savers and investors Financial Asset claim on borrower’s property Financial Market where buyers and sellers exchange assets directly Financial Intermediary collects funds from savers, invest in financial assets Mutual Fund pools individuals’ money to buy a range of financial assets

Vocabulary Capital Market for buying and selling long-term financial assets Money Market for buying and selling short-term financial assets Primary Market for financial assets that original buyer must redeem Secondary Market where financial assets are resold Investment Objective financial goals investor uses to decide if an investment is appropriate Risk possibility for loss on an investment Investment The use of income now that allows for a future benefit Diversification investing in different financial assets Return Gain or loss on original investment