Chapter 11 Financial Markets 1. 2. 3.

Savings and Investing Bonds and Financial Assets The Stock Market

How do your savings and investments affect your future?

1. Savings and Investing 

What is your investment? Right now!

Investing and Free Enterprise 

Investing - the act of redirecting resources from being consumed today so that it may create benefits in the future

I really want that new phone, but I would rather save for my car.

The Financial System 



The network of structures and mechanisms that allow the transfer of money between savers and borrowers Financial Assets – a claim on the property or income of a borrower

WHAT DO YOU OWN? An IPOD, a baseball card, a car, a home

Financial Intermediaries   

  

Helps channel funds from savers to borrowers Banks, Savings and Loans, Credit Unions Mutual Funds -organization that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets Hedge fund – private investment that employs risky strategies Life insurance companies -financial protection to families Pension Funds -money received after retirement

Sharing Risk and Providing Information   

Diversification – spreading out investments Portfolios -a collection of financial assets Prospectus – investment report provides information to potential investors

Liquidity, Return, and Risk  



Liquidity -ability to use cash Return – the money an investor receives beyond the sum of invested Risk – higher risks greater chance of failure or success

“The risk/return tradeoff could easily be called the ‘ability –to-sleepat-night test.’ While some people can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb the financial ladder without a secure harness. Deciding what amount of risk you can take while remaining comfortable with your investments is very important. . . .” Forbes, “The Risk-Return Tradeoff”

Which investment has greater liquidity, a saving account or a certificate of deposit?

Types of Risks Name

Description

Credit Risk

Borrowers may not pay back the money they have borrowed, or they may be late in marking period.

You lend $20 to your cousin, who promises to pay you back in two weeks. When your cousin fails to pay you on time, you don’ don’t have money for the basketball tickets you had planned to buy.

Liquidity Risk

You may not be able to convert the investment back into cash quickly enough for your needs

Your MP3 player is worth $100. You need cash to buy concert tickets, so you decided to sell your MP3 player. To convent your MP3 player into cash on short notice, you have to discount the price to $75.

Inflation Rate Risk

Inflation rate erodes the value of your assets

Ricardo lends Jeff $1,000 for one year at 10 percent interest. If the inflation rate is 12 percent, Ricardo loses money.

You may have to pass up better opportunities for investment

Lili invests $100 in May’ May’s cleaning business to be repaid at 5 percent interest for one year later. Six months later, Lili is unable to invest in Sonia’ Sonia’s petpet-sitting business, which pays 10 percent interest, because she has already invested her savings.

Time Risk

Example

2. Bonds and other Financial Assets 

Why are bonds bought and sold? Helps the government finance big projects

No, not Barry Bonds!

As Financial Assets-Three components 

  

Coupon Rate – the interest rate that a bond issuer will pay to the bondholder Maturity – the time at which payment to a bondholder is due Par Value- bond’s stated value, to be paid at maturity (Yield-the annual rate of return on a bond if held until maturity)

Types of Bonds    



Savings Bonds -low denomination bond issued by federal government Treasury Bonds -offer different lengths of maturity Municipal Bonds -state or local government to finance a public project Corporate Bonds – issued by a corporation to help raise money for expansion Junk Bonds -high risk and potential high yield

Other Types  

Certificate of Deposits (CDS) – most common form low risk Money Market Mutual Funds –medium risk (not covered by FDIC)

Treasury Bonds, Notes, and Bills Treasury Bond

Treasury Note

Treasury Bill

Term

Long term

Intermediate term

Short term

Maturity

30 years

2,5, or 10 years

4, 13, 26, or 52 weeks

Liquidity and safety

Safe

Safe

Liquidity and Safe

Minimum purchase

$100

$100

$100

Denomination

$100

$100

$100

Financial Asset Markets   



Capital Markets - money is lent for periods longer than a year Money Markets – money is lent for less than a year Primary Markets – selling financial assets that can be redeemed only by the original holder Secondary Markets – reselling financial assets

Average Bond Yields 

From the early 1990s to the early 2000s, bond yields dipped slightly for all three types of bonds shown. Which type of bond had the highest yield? Which of the three types of bonds would you expect to carry the least risk? Explain.

12 10

Corporate

8 6

20 year Treasury

4

Municipal

2 0 94 9 1

96 9 1

98 9 1

00 0 2

02 0 2

04 0 2

06 0 2

3. The Stock Market 

Let’s Play the Stock Game!

Well, Honey I lost my shirt, literally! Maybe you should give it a shot!

Buying Stock  

Shares – a portion of stocks Benefits of Stocks  Dividends  Capital Gains -financial gain; purchase price is higher than the selling price

Types of Stocks    

Income Stock - provides investors with income Growth Stock -pays a few dividends Common Stock – involved in voting Preferred Stock -get dividends back before common, but non voting

How Stocks Are Traded   

Stockbrokers – person who links buyers and sellers in stock Brokerage firms – a business that specializes in trading stocks Stock Exchange – a market for buying and selling stock (New York Stock Exchange and Nasdaq)

Futures and Options    

Futures – contract 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 and sell stock and other assets Call Option – buy stock at a price until a specified future date Put Option – sell stock at a price until a specified future date

Measuring Stock Performance  

Bull Market – steady rise in the market Bear Market –steady drop in the market

The Great Crash 





Speculation – practice of making high –risk investments with borrowed money in hopes of getting a big return October 29, 1928 –Black Tuesday 16.4 million shares sold starting the Great Depression Attitudes towards stock changed and many peoples felt it was too risky

Risk, Liquidity, and Return Risk

Liquidity

Return

Certificate of Deposit

Minimal Risk

Least liquidity

Potentially, least return

Bond

Minimal Risk

Must be held to maturity; however can be sold on bond market for current price

Greater return than CDs, but potentially less return than individual stocks and mutual funds

Individual Stocks

Greater Risk

Can be sold at Greatest potential current price on the return stock market

Mutual Funds

Less Risk than stocks; more than bonds

Cab be sold at current price on stock market

Potentially. Less return than stocks, more than bonds