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Financial MarketsInvesting: Chapter 11
Investment – use of assets to earn an income or profit
The Financial System◦ Financial Assets (or securities)
Flow of Savings and Investments◦ Savers make deposits to Financial Institutions◦ Financial Institutions make loans to Investors
Saving and Investing
Financial Intermediaries Banks, Saving and Loan Associations, Credit Unions,
Finance Companies Mutual Funds Hedge Funds Life Insurance Companies Pension Funds
Saving and Investing
◦ Sharing Risk Credit risk, liquidity risk, inflation rate risk, and time
risk DIVERSIFY!!!! – spread out your investments
◦ Providing information Portfolio – collection of one’s financial assets Prospectus – investment report that provides info to
potential investors◦ Providing Liquidity
Saving and Investing
Liquidity, Return, and Risk◦ Liquidity and Return
Return – the money an investor receives above and beyond the sum of money initially invested
More liquid, usually lower return◦ Return and risk
Typically, higher return, higher risk Must weigh potential return with risk
Saving and Investing
Bonds as Financial Assets◦ Three components of Bonds
1. Coupon Rate – interest rate that bond issuer will pay to a bondholder
2. Maturity – time at which payment to a bondholder is due
3. Par value – the amount to be paid at maturity (face value or principal)
- Yield – the annual rate of return on a bond if held to maturity
Bonds and Other Financial Assets
◦ Buying Bonds at a Discount Interest change, so price of a bond must change as
well◦ Bond Ratings
Standard & Poor’s; Moody’s AAA (highest)
◦ Advantage of Bonds to Issuer Fixed coupon rate once sold Not part of a company
◦ Disadvantage of Bonds to Issuer Must make fixed payments Bonds can be downgraded
Bonds and Other Financial Assets
Types of Bonds◦ Savings bonds◦ Treasury Bonds, Bills, and Notes◦ Municipal Bonds◦ Corporate Bonds◦ Junk Bonds
Treasury Bond
Treasury Note
Treasury Bill
Term Long-term
Middle-term
Short-term
Maturity 30 years 2, 5, or 10 yrs
4, 13, 26, 52 weeks
Liquidity and Safety Safe Safe Liquid and
safe
Minimum Purchase $100 $100 $100
Denomination $100 $100 $100
Bonds and Other Financial Assets
Other Types of Financial Assets◦ Certificates of Deposits (CDs)
Very common; through banks; very flexible◦ Money Market Mutual Funds
Higher interest than savings account but no FDIC
Bonds and Other Financial Assets
Financial Assets Markets◦ Capital Markets and Money Markets
Capital Market – market in which money is lent for periods longer than a year Ex: Long-term CDs and bonds (over 1 yr)
Money markets – market in which money is lent for less than a year Ex: short-term CDs, T-Bills, and money market mutual funds
◦ Primary and Secondary Markets Primary Market- a market for selling financial assets that
can be redeemed only by the original holder Secondary Market – a market for reselling financial
assets
Bonds and Other Financial Assets
Shares – a portion of a stock Benefits of Buying Stock
◦ Dividends – portion of company profit (quarterly)◦ Capital Gains – sell for more than purchased
Capital loss
Buying Stock
Types of Stock◦ Income Stock◦ Growth Stock
or- Common Stock- Preferred Stock
Stock Splits- Split single shares to lower price of single stock
Buying Stock
Risks of Buying Stock◦ Company may lose money
Dividend is smaller, stock price drops◦ If Company goes bankrupt, shareholders are paid
last
Buying Stock
Stockbroker – person who links buyers and sellers of stock
Brokerage Firm – a business that specializes in trading stocks
Stock Exchange◦ The market for buying and selling stock◦ NYSE, Nasdaq
How Stocks Are Traded
Futures and Options◦ Futures – contracts to buy or sell commodities at a
particular date in the future at a price specified today
◦ Options – contracts that give investors the right to buy or sell stock and other financial assets at a particular price until a specified future date
◦ Call/Put Option – contract to buy/sell stock at a particular price until a future date
Day Trade??????
How Stocks Are Traded
Bull and Bear Markets◦ Bull Market – a steady rise in the stock market
over a period of time◦ Bear Market – a steady drop or stagnation in the
stock market over a period of time Dow Jones Industrial Average
◦ 30 large companies in various industries◦ Meant to represent the whole market
S&P 500◦ 500 stocks to measure performance
Measuring Stock Performance