Chapter 11.1Saving

and Investing

• By going to school today, you give up your time now so that you will be prepared for a career in the future.

• If a firm builds a new plant, it spends money today for the sake of earning more money in the future.

• A government may spend money today to build a dam to ensure that people will have a source of water and electricity in the future.

• These actions represent investments.

Definition of Investment

• In its most general sense, investment is the act of redirecting resources from being consumed today so that they may create benefits for the future.

• In more narrow, economic terms, investment is the use of assets to earn income or profit.

Common Types of Investments

• Savings Account: short-term interest bearing account.

• Certificate of Deposit (CD): fixed-term interest bearing deposit.

• Government or Corporate Bond: fixed-term interest bearing loan.

• Stock: proportional ownership in a corporation.• Mutual Fund: fund that pools the savings of many

individuals and invests the money in a variety of stocks, bonds, or other financial assets.

Investing and Free Enterprise

• Investing is an essential part of the free enterprise system by promoting economic growth.

• For example:

Savings Deposit Loan to businessBusiness builds

new plantBusiness expands and creates jobs

The Financial System

• In order for investment to take place, an economy must have some sort of financial system that allows the transfer of money between savers and borrowers.

• Savers and borrowers are usually linked together through a financial intermediary.

• These intermediaries may be Banks, Savings and Loan Associations, Credit Unions, Finance Companies, Life Insurance Companies or Pension Funds.

Services provided byFinancial Intermediaries

Sharing Risk• Diversification is the spreading out of investments to

reduce risk. Financial intermediaries help individual savers diversify their investments.

Providing Information • Financial intermediaries reduce the costs in time and

money that lenders and borrowers would pay if they had to search out investment information on their own.

Providing Liquidity• Financial intermediaries allow savers to easily convert

their assets into cash.

Investment Information

• How does an investor research how well a potential investment has performed?

• This and other legal information is published in a report called a prospectus.

• The company offering the investment provides this.

Investment Information

• When savers make an investment, they receive some sort of document.

• These documents are known as financial assets or securities, and they represent a claim on the property or income of a borrower.

Return, liquidity and Risk

Return is the money an investor receives above and beyond the sum of money initially invested.

Return and Liquidity• Savings accounts have greater

liquidity, but in general have a lower rate of return.

• Certificates of deposit usually have a little greater return but liquidity is reduced.

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.