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Smart InvestingEmmet O’Neal LibraryMountain Brook, AL
Introduction to Financial Markets
Objectives
• Understand relationship between risk and return
• Learn about U.S. financial markets and investment products
• What affects market prices
• Government regulation of financial markets
Risk and Reward
• The bigger the risk the bigger the potential payoff.
Investment Risks• Interest Rate risk
– Risk of change in asset value due to change in interest rates• Business Failure risk
– Risk that the business will fail • Market Price risk
– Risk that the market price of the investment drops• Inflation risk
– Risk that return on an investment will lose purchasing power• Political risk
– Risk of government actions negatively affecting the value of the investment
• Fraud risk– Investment is designed to deceive or misrepresent facts
How Financial Markets Work• Financial markets is where people and money
come together
• Supply and demand─ Demand is the quantity of goods that consumers want to
purchase─ Supply is the quantity of goods available for consumers
to purchase─ If supply outweighs demand the price of a good will go
down and vice versa
Exchanges• Exchanges serve as central locations
where buyers and sellers meet• Can be a physical location or a network of
computers• Several exchanges make up the stock
market− New York Stock Exchange (NYSE)− Nasdaq stock market
• Private companies are not traded on exchanges
The Market Meets the Web
• Investing can take place online• Need to be informed
– Know the investment you purchase– Know the ground rules of the market– Know the level of risk
• It’s easier to lose than to make money through a click of a button
Saving• Returns for saving at a bank are low, so is the risk• Most accounts are insured by the FDIC or NCUA• Certificates of deposit (CD)
– Specific amount of money at a fixed interest rate over a specified period of time
– The longer the time frame the higher the interest rate– CDs are insured up to a certain amount if the financial
institution where they were purchased is a member of the FDIC or NCUA
Stocks• Stocks represent a partial ownership of a company• Common stocks versus preferred stocks
– Common stock carries a voting right– Preferred stock does not carry a voting right, but normally
receive a fixed dividend– Preferred shareholders need to be paid before common
shareholders
• Stock price– Amount paid for one share of stock
• Dividends– Distribution of a company’s profit– Generally paid quarterly
Different Kinds of Stock• Different size classifications:
• Growth stocks• Income stocks• Blue chips• Value stocks
Classification Market Capitalization Example Mega Cap Greater than $200 Billion Exxon Mobil Large Cap Greater than $10 Billion IBM Mid Cap Between $2 Billion and $10 Billion Vulcan Materials
Small Cap Less than $2 Billion Panera Bread Company Micro Cap Between $50 Million and $300 Million Reddy Ice
Nano Cap Less than $50 Million Autobytel
Bonds• Loans given to a company or a governmental entity• Bond prices fluctuate with interest rates• Types of bonds
– Municipal bonds– Treasury bonds– Federal agency bonds– Corporate bonds– Asset backed securities
• Bonds are traded in the over the counter market• Quoted in percent of face value
Mutual Funds• Invests pooled money in various types of
investments– Fund manager buys and sells on behalf of the fund’s
shareholders– The price of a share of a(n) (open end) mutual fund is
called its net asset value (NAV)
• Benefits of mutual funds– Diversification– Professional management– Liquidity
• Commissions and fees– “12(b)-1 fee”
Derivatives
• Financial instrument whose value depends on the value of a another asset
• Speculative investment• Need to be a knowledgeable investor who is willing
to take high risk• Have to be prepared to lose all of their investment
Moving Markets• Values of investment securities rise and fall
• Five important factors– Investor action– Business conditions – Government actions– Economic indicators– International events and conditions
Regulation of Financial Markets• State regulation• Federal regulation
– Securities and Exchange Commission (SEC)– Security Investors Protection Corporation (SIPC)– Commodity Futures Trading Commission (CFTC)
• Self Regulatory Organizations (SRO)– Financial Industry Regulatory Authority (FINRA)– National Futures Association (NFA)