Financial Markets Chapter 11

Financial Intermediaries Example: Nonbank Financial Intermediaries ◦Finance companies make small loans to households, small businesses ◦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 ◦Financial markets 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 Intermediaries Life Insurance & Finance Companies Life Insurance Premiums paid on life insurance is collected by the company. When these funds exceed the benefits paid out the company lend these funds to others. Finance Companies Loan money for small to medium size purchases. Merchants use finance companies to finance sales to customers.

Mutual Fund is a company that sells stock in itself to individual investors and then invests the money it receives in stocks and bonds issued by corporations or the government.

Pension Funds are set up for retirees and collect payments and then disburse them to retirees. Excess revenues are invested in stocks, bonds and other investments

Bonds as Financial Assets Bonds are long-term obligations that pay a stated rate of interest for a specific number of years. ▫ Issued by governments and companies to borrow funds for long periods of time.  Coupon–stated interest rate  Maturity–life of the bond  Par-Value–The initial amount borrowed Discounted- bonds sold for less than par

Financial Asset Markets 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

Risk and Return 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 What Kind of Return Do You Want? ◦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

STOCKS AND EXCHANGES

The Stock Market Why Buy Stock? ◦Buy to earn dividends, share of company profits  investors who want income, want dividends ◦Buy to earn capital gains through resale of stock  investors who want growth look for potential for capital gains

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  2006 merger with Archipelago Exchange allowed electronic 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  second largest exchange in world in number of companies, shares traded  companies from many sectors of U.S. economy, most in technology ◦OTC Bulletin Board is electronic market for smaller companies

Trading Stock Recent Developments ◦1990s regulations allow any firm to trade stocks in any exchange ◦Through electronic communications networks (ECNs), 24-hour trading ◦Investors access Internet; huge growth in online brokerage companies  lower commissions than traditional brokers  computer technology matches buyers, sellers automatically; rapid trades

Measuring How Stocks Perform Stock Indexes ◦U.S. indexes: DJIA, Standard & Poor’s 500, NASDAQ Composite Global indexes: Hang Seng, DAX, Nikkei 225, TSE 300, FTSE 100 ◦Since 1896, Dow Jones Industrial Average changed with U.S. economy  includes 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 ◦1972 to 2000 longest bull market in history; most last two to three years ◦Dow affected by previous close, Fed, foreign indexes, trade balance ◦About 21 stock markets overseas with over 1,000 large companies each

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