1. Financial Markets
Chapter 11

2. The Financial System Bear Market
Investors generally sell because they are expecting lower profits
Bull Market
Investors usually buy because they are expecting higher profits
Financial Assets
When savers invest, they receive documents known as financial assets.

3. Financial Intermediaries
Financial intermediaries are institutions that help channel funds from savers to borrowers.
Banks, Savings and Loan Associations
Take in deposits from savers and then lend some of these funds to various businesses
Credit Unions
Member-owned organization to make money for its members, usually considered community-based and more interested in “doing the right thing”
Finance Companies
Make loans to consumers and small businesses, but charge borrowers higher fees and interest rates to cover possible losses
Mutual Funds
Pool the savings of many individuals and invest this money in a variety of stocks and bonds – usually diversified with less risk
Life Insurance Companies
Provide financial protection to the family, or other beneficiaries, of the insured. The premium is usually paid monthly
Pension Funds
Are set up by employers who withhold a certain percentage of a workers’ salary to deposit in a fund distribute for payment when the worker retires – usually covers many years

4. Investing
Financial Planning- financial plans include: spending and saving plan, investment plan, retirement plan, estate plan.
Important factors in financial planning
Budget- list of fixed and flexible expenses.
Fixed Expenses- remain constant from month to month.
Flexible Expenses- can vary from month to month.

5. Your investment Plan
Stocks are pay the highest reward, but have the greatest risk
You don’t want to be risking your money as you get older
The general rule is to subtract your age from 110 to find the percentage of stocks you should have in your portfolio (110 – 30 = 80% or 110 – 55 = 55%)
Stocks
Fixed Income
Cash
Ave return since 1970
Conservative (50 +)
20%
50%
30%
7.9%
Moderate (35-50)
60%
35% 5%
9.8%
High risk (under 35)
95% 0%
10.4%

6. Risk and Return Return and Liquidity
Savings accounts have greater liquidity, but in general have a lower rate of return.
Certificates of deposit usually have a greater return but liquidity is reduced.
Liquidity is important if you might need quick access to the funds
Return and Risk
Investing in a friend’s Internet company could double your money, but there is the risk of the company failing.
In general, the higher potential return of the investment, the greater the risk involved.

7. Bonds as Financial Assets
Bonds are basically loans, or IOUs, that represent debt that the government or a corporation must repay to an investor. Bonds have three basic components:
1. The coupon rate — the interest rate that the issuer will pay the bondholder.
2. The maturity — the time when payment to the bondholder is due.
3. The par value — the amount that an investor pays to purchase the bond and that will be repaid to the investor at maturity.
Not all bonds are held to maturity. Sometimes bonds are traded or sold and their price may change. Economists therefore refer to a bond’s yield, which is the annual rate of return on the bond if the bond were held to maturity.

8. How Bonds Work
Eagle Corporation sells a 4%, 20-year, $1,000 par value bond that pays interest semiannually
The coupon payment to the holder is $20 every 6 months (.04 x 1,000, divided by 2)
When the bond reaches maturity after 20 years the debt is retired and the holder gets the par value of $1,000
Bonds can be compared by using the current yield
(annual interest divided by the purchase price)

9. Bond Ratings
Standard & Poor’s and Moody’s rate bonds on a number of factors, including the issuer’s ability to make future payments and to repay the principal when the bond matures.
A high bond rating usually means that the bond will sell at a higher price, and that the firm will be able to issue the bond at a lower interest rate.
Bond Ratings
Standard & Poor’s
Highest investment grade
High grade
Upper medium grade
Medium grade
Lower medium grade
Speculative
Vulnerable to default
Subordinated to other debt rated CCC
Subordinated to CC debt
Bond in default
AAA AA A
BBB BB B
CCC CC C D
Moody’s
Best quality
High quality
Upper medium grade
Medium grade
Possesses speculative elements
Generally not desirable
Poor, possibly in default
Highly speculative, often in default
Income bonds not paying income
Interest and principal payments in default
Aaa Aa A
Baa Ba B
Caa Ca C D

10. Advantages and Disadvantages to Bond Issuers
Bonds are desirable from the issuer’s point of view for two main reasons:
1. Once the bond is sold, the coupon rate for that bond will not go up or down.
2. Unlike stock, bonds are not shares of ownership in a company so they have a very small risk – defaulting is the big risk!
Bonds also pose two main disadvantages to the issuer:
1. The company must make fixed interest payments, even in bad years when it does not make money.
2. If the issuer does not maintain financial health, its bonds may be downgraded to a lower bond rating. This makes it harder to sell future bonds unless a discount or higher interest rate is offered.

11. Types of Bonds Savings Bonds Treasury Bonds, Bills, and Notes
Savings bonds are low-denomination ($50 to $10,000) bonds issued by the United States government. Savings bonds are purchased below par value (a $100 savings bond costs $50 to buy), interest is paid when bond matures.
Treasury Bonds, Bills, and Notes
These investments are issued by the United States Treasury Department. The absolute least amount of risk!
Municipal Bonds
Municipal bonds are issued by state or local governments to finance such improvements as highways, state buildings, libraries, and schools.
Corporate Bonds
Issued by a corporation to raise money to expand its business.
Junk Bonds
Junk bonds are lower-rated, potentially higher-paying bonds. (High Risk!!!).

12. Other Types of Financial Assets
Money Market Mutual Funds
Investors receive higher interest on a money market mutual fund than they would receive from a savings account or a CD. However, assets in money market mutual funds are not FDIC insured.
Certificates of Deposit
Certificates of deposit (CDs) are available through banks, which use the funds deposited in CDs for a fixed amount of time.
CDs have various terms of maturity, allowing investors to plan for future financial needs.

13. Mutual Funds A mutual fund pools investors’ money.
The fund puts its investors’ money into the markets on their behalf.
In effect, investors own small amounts of many different assets - diversified.
Mutual funds enable investors to avoid risk that comes from owning any one asset. In other words, mutual funds make it easy to diversify.

14. Roth IRA/401(K)
A Roth IRA is an Individual Retirement Account that is usually not taxed
Must be 59.6 years to withdraw tax-free money
In tax year: 0-49 years can contribute - $5, years can contribute - $6,500
401(K) a pension plan in which money is deducted from a paycheck before tax (and sometimes by employer). Tax is not paid until it is withdrawn Annual pre-tax limit (2013) IS $17,500

15. Stock Exchanges The New York Stock Exchange (NYSE)
The NYSE is the country’s largest stock exchange. Only stocks for the largest and most established companies are traded on the NYSE.
NASDAQ-AMEX
NASDAQ-AMEX is an exchange that specializes in high-tech and energy stock.
The OTC Market
The OTC market (over-the-counter) is an electronic marketplace for stock that is not listed or traded on an organized exchange.
Daytrading
Daytraders use computer programs to try and predict minute-by-minute price changes in hopes of earning a profit.

16. Stock Exchanges Every country has a stock exchange
On the NYSE movement is measured by the Dow Jones Industrial Average (Dow).

17. How Stocks Are Traded
Stockbroker is a person who links buyers and sellers of stock.
Stockbrokers work for brokerage firms, or businesses that specialize in trading stock.
Speculation involves picking high-risk investments in the hope of a high reward
Odd lot 1-99 shares
Portfolio is a collection of financial assets
Diversification is the key!!!!!

19. Futures Trading of various types of products.
Ex. wheat, soybeans, oats, corn, steel, coal, gold, silver, diamonds, etc.
High risk investments.
Contracts where investors give money today for the promise of a commodity delivered at a later date. Investor hopes that price of the commodity will rise and the contract can be resold for a profit.

20. Regulating the Market Congress is the top regulator
SEC- securities and exchange commission- set up after big stock market crash requires that companies who sell stock must meet rigorous standards - supply detailed information including a prospectus.