Financial Markets Chapter 12

Savings...and saving?  Saving is the absence of spending  Savings  Dollars that become available when people abstain from consumption  This is where banks get their capital

The financial system  A network of savers, investors, and financial institutions that work together to transfer savings  Assets  Things with worth  Certificate of Deposit  Receipt showing that an investor has made an interest-bearing loan to a bank or a government or a corporate bond  Economists call these receipts financial assets because they are worth something (i.e. they have value)

Financial intermediaries  Lend funds to borrowers  Insurance funds, pension funds  There is a circular flow of funds that exists to keep the money cycle going

Nonbank Financial Institutions  Finance company  Firm that specializes in making loans directly to consumers  J.G. Wentworth  Loan consolidation places  Life insurance  Involves premiums  Price paid to keep a policy  Mutual fund  Company that sells stock in itself to individual investors, and then invests the money it receives in stocks and bonds issued by other corporations  Receive a dividend earned from the mutual fund’s investments  A dividend is a check given to stockholders representing a portion of profits

Net Asset Value (NAV)  Value of the mutual fund divided by the number of shares issued by the mutual fund  Pension fund  Collection of funds to pay out as income to retired or disabled individuals

Investing

Strategies  Risk versus reward  Directly proportional to profit  Higher risk = higher profit usually  Optimum investment is usually in the middle  Toleration of scenario is key  It’s all about your psyche  Safest are US Treasury investments  Riskiest are junk bonds  High-yield bonds with a great chance of defaulting

Retirement  Retirement accounts are about generating appreciating value rather than generating income  401(k)  Special retirement fund  Tax deferred investment plan that acts as a personal pension fund for employees  You don’t pay taxes on money given to a 401(k)  80% of employers match contributions  You can roll-over a 401(k) from different jobs

Bonds...Barry Bonds (oops)  Bonds  Long term obligations that pay a stated rate of interest for a specified number of years  Bonds have three components  A Coupon  Interest on the debt  Maturity  Life of the bond  Par value  Principal or total amount initially borrowed that must be repaid to the lender at maturity  Current yield of the bond  Annual interest divided by the purchase price  Financial health or credit worthiness is the key  This means that not all bonds are the same

Bond ratings  Two companies control bond ratings  Standard and Poor’s  Moody’s  Many factors determine bond ratings  Health of company  Stability  Profitability  Trends in market

Financial assets and their characteristics  Certificate of Deposit (CD)  Long term investment  There is a penalty for early withdrawal  Tailor a withdrawal date  College tuition savings is an example  Corporate bonds  Larger investment  Higher risk at times (equals higher profit)  Usually have a B rating  Municipal bonds  State and local governments  Finance public works  Schools

More assets  Savings bonds  Issued through the government  Slow rate of return on investment  Maturity is usually about 18 years  Virtually no risk of default  Treasury items  Notes have 2-10 year maturity  Bonds have year maturity  Safest investment  Bill (T-Bill)  Short-term investment  Auctioned off at a discounted rate

Individual Retirement Accounts  Long-term tax-sheltered time deposits that an employee can setup as a part of a retirement plan  Taxed when you withdraw money  Roth IRA  Taxed initially, so money withdrawn is all after taxes

Markets for Financial Assets  Capital market  Money loaned for over a year  Long-term CDs and Corporate or Government Bonds  Money market  Money is loaned for less than a year  Primary markets  Market where only the original issuer can repurchase or redeem financial assets  Government savings bonds and IRAs  Secondary markets  Market in which existing financial assets can be sold to new investors

Investing in Equities, Futures and Options  Equities  Stocks that represent ownership shares in a company  Market efficiency  There is a theory that exists that suggests that efficient markets work themselves out  Efficient Market Hypothesis  Argument that stocks are always priced about right and that bargains are hard to find because they are followed so closely by investors  Portfolio diversification  Practice of holding a large number of different stocks so that increases in some can offset decreases in others

Organized Stock Exchanges  New York Stock Exchange (NYSE)  Wall Street  NYSE has 1400 seats or memberships  Yield is the dividend divided by closing price  Price to earning ratio or PE ratio is the stock’s price divided by annual earnings of each share of common stock outstanding  American Stock Exchange  Smaller than NYSE

Over-the-Counter Drugs I mean Markets  Over-the-counter markets  Securities that are not traded on an organized exchange  National Association of Security Dealers Automated Quotation (NASDAQ)  4,000 companies are traded  More than AMEX and NYSE combined

How are we doing?  Dow-Jones Industrial Average  Average of thirty active stocks that are the most widely held for the day  Standard and Poor’s 500  Overall market performance  Bull markets are strong  Bear markets are mean (bad)

Back to the Future  Spot markets  Market in which transactions are made immediately at the prevailing price  On-the-spot  Futures contract  An agreement to buy or sell at a predetermined price  These are bought at a futures market

What are my options?  Options are contracts that provide the right to purchase or sell commodities or financial assets at some point in the future at a price agreed upon today  Call options allow you the ability to buy a share of a stock at a specified price in the future  EX: If I have the right to buy a stock at $70.00 and it goes down $30.00, I can tear up the call option and purchase the stock for $ If the reverse happens, I don’t have to pay more than what the call option notes.  Put options allow you the right to sell a stock at a specified price in the future  If I have the right to sell a stock at $50.00 and it goes down $40.00, I can force the buyer to pay the original $ If the reverse happens, I would tear up the option and sell it at the higher price