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Savings and Investment Chapter 11: Financial Markets Sections 1 and 2

Savings and Investment:  Savings is income not used for consumption.  Investment is the use of income today that allows for a future benefit.

Savings and Investment: The Financial System  The financial system, which consists of institutions such as banks, insurance markets, bond markets, and stock markets, allows for the transfer of funds between savers an investors.

Financial Intermediaries  Sometimes savers and borrowers come together directly in a financial market.  However, many transactions involve a financial intermediary, an institution that collects funds from savers and invests them in financial assets. Financial intermediaries can include commercial banks, S&Ls, and credit unions. Other common intermediaries: a mutual fund – an investment company that gathers money from individual investors and purchases a range of financial assets.mutual fund

The Financial System

Savings and Investment: Pension Funds  A pension fund – allows employees to save for retirement sometimes with the help of their employer;  the fund pools together contributions and invests them in order to provide workers more money when they retire.

Financial Asset Markets  Economists classify markets based on 2 factors:  Time, and  Whether financial assets can be resold.  Based on time, there are:  The capital market – the market for buying and selling long-term financial assets  (ex. stocks, bonds, mortgages)  The money market - the market for buying and selling short-term financial assets  (ex. short term CDs, Treasury bills)

Financial Asset Markets  Based on resalability, there are:  The primary market – the market for buying newly created financial assets directly from the issuing entity.  (ex. savings bonds, small denomination CDS)  The secondary market - the market where financial assets are resold  (ex. stocks, bonds)

Investing in a Market Economy: Why are you investing?  When investing, it is important to define your own investment objective – a financial goal used to determine if an investment is appropriate.  It should consider:  Time: short-term vs. long term goal  Income: how much can be invested?

Investing in a Market Economy: Risk and Return  Once an investor defines their financial objective, they need to consider the risk and return involved in an investment.  Risk is the possibility for loss on an investment.  Return is the profit or loss made on an investment.

Investing in a Market Economy: Risk and Return  Risk and return have a direct relationship – the higher the risk of the investment, the greater the possible return.  Ex. US Govt. Bonds – low risk, low return  Stocks – high risk, high return  Most investors try to balance risk and return through diversification, the practice of distributing investments among different financial assets to maximize return and limit risk.

Calculating Interest