Financial Markets Chapter 11. BELLRINGER What would you do if you suddenly received a cash payment of $100,000 that you were not expecting and didn’t

Financial Markets

Chapter 11

BELLRINGER

What would you do if you suddenly received a cash payment of $100,000 that you were not expecting and didn’t need to fulfill your daily expenses?

Section 1 – Saving and Investing

Investing in Free Enterprise The Financial System

Financial Assets The Flow of Savings and Investment

Financial Intermediaries Sharing Risk Providing Information Providing Liquidity

Risk, Liquidity, and Return Return and Liquidity Return and Risk

Investing and Free Enterprise

Investment: redirecting resources from being consumed today so that they may create benefits in the future. The use of assets to earn income or profit


Spend money today to earn money in the future Going to college to get a “better job” Expanding manufacturing for a new product Building a dam for a hydroelectric plant


Consumer spending vs Consumer savings People depositing money into savings accounts

so banks can lend to businesses to grow and expand

New jobs and better products are created

The Financial System

Financial System: a system in which there is a transfer of money between savers and borrowers

Financial Assets: claim on the property or income of a borrower A way to indicate ownership of owning a

money device


Savers Households, individuals, and businesses Make deposits to Financial Institutions Receive financial assets


Financial Institutions Banks, Credit Unions, Finance Companies, etc Make loans to investors


Investors The borrowers Government and Business Build roads, factories, homes etc Develop new products, markets, or services

Financial Intermediaries

You can obtain a direct link between savers in borrowers

Financial Intermediaries: institution that helps channel funds from savers to borrowers


Banks, Savings and Loan Associations and Credit Unions Take deposits from savers Lend out money to businesses and individuals

Finance Companies Higher risk lending companies People who typically cannot meet the standards

to borrow from a Bank, S&L or CU

Financial Intermediaries Mutual Funds

Pool savings of many and invest in stocks, bonds or other financial assets

Allow for a broad range of investments Diversification

Life Insurance Companies Financial protection for a family for the death of

a family member Customers pay “premiums” Lend premiums to investors for return


Pension Fund Income a retiree receives after working a

certain number of years Withholding of a portion of your pay


Why have Financial Intermediaries? Share Risk Provide information Provide liquidity


Sharing Risk 50% of new business fail Reduce the risk of losing your entire investment Diversification: spreading out investment to

reduce risk


Providing information Monitoring borrowers spending and income Classify borrowers based on risk of default Saves individuals the time to research

individual borrowers


Providing Liquidity Matching investors (bringing borrowers and

sellers together) Investing in mutual funds vs buying a Picasso Allow you to sell and receive cash upfront

instead of waiting for a buyer

Risk, Liquidity and Return

Tradeoffs in investing Placing money in a savings account for the

convenience and access, despite lower rate of return

Using a CD to earn a higher rate but having limited access in an emergency

Weighing the return against the loss of liquidity

Risk, Liquidity and Return Placing your money in a bank account that is

insured with a lower rate of return? Using your money to invest in a new business? Higher potential return, the greater the risk

Bonds as Financial Assets

A business can obtain money by borrowing When a business or government borrows

money, they issue bonds Bonds

Low risk Low interest rate (relatively)


Three Components of Bonds Coupon Rate Maturity Par Value

Bonds as Financial Assets Coupon Rate

Interest rate that a bond issuer will pay to a bondholder

Maturity The time at which payment to a bondholder is

due Par Value

The amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity


A business needs $1,000 The issue a bond for $1,000 Set an interest rate of 5% The Bond will mature in 10 years

Bonds as Financial Assets Mary takes $1,000 out of her savings account

paying 1% interest to buy a bond at 5% She will receive interest payments of $50 each

year (5% of $1,000) for 10 years At the end of 10 years, she will receive her final

payment of $50 + her initial investment of $1,000

In total, she will earn $500 in 10 years and get back what she put in of $1,000

Bonds as Financial Assets What was the coupon rate? What is the maturity? What is the Par Value?


Buying bonds at a discount Selling/Buying a bond less than par value Interest rate increase, sell/buy at a discount

If $1,000 bonds go from 5% to 6%, you would buy the 6% bond Selling/Buying at a discount is an incentive to

buy the lower rate bond

Bonds as Financial Assets Bond Ratings

A way to measure the risk of a bond AAA --- highest rating D --- Bond in Default

Triple A Bonds (AAA) pay lowest interest rate

May sell “above par” BBB bonds are riskier and pay higher

interest rate May sell “below par”


For an investor, bonds are relatively safe Advantages to the issuer

Locked in interest rate Does not give up ownership

Disadvantages to the issuer Must make fixed interest payments/cannot

change Poor financial health, bonds are downgraded

Types of Bonds

Savings Bonds Treasury Bonds, Bills and Notes Municipal Bonds Corporate Bonds Junk Bonds

Types of Bonds

Savings Bonds Low denomination bond issued by the US

Government Government issues to fund projects Does not have a “coupon” rate Purchase below par value then redeem for

face value at maturity

Types of Bonds

Treasury Bonds, Bills and Notes Government Issued debt for varying lengths of

maturity Treasury Bond (T-Bond)

10 – 30 Years

Treasury Note (T-Note) 2 – 10 Years

Treasury Bill (T-Bills) 3, 6 or 12 months

Types of Bonds

Municipal Bonds State and local governments “Safe” because of taxing authority Poor financial health? Tax Free (at federal level)

Types of Bonds

Corporate Bonds Business issued debt Can be riskier Depends on business strength to repay debt

Types of Bonds

Junk Bonds (High Yield) Lower rated, potentially higher paying bond Lower medium grade

Other Types of Financial Assets

Certificates of Deposit Money Market Mutual Funds

Financial Asset Markets

Capital Markets Market in which money is lent for periods

longer than a year

Money Markets Market in which money is lent for periods less

than a year

Financial Asset Markets

Primary Market Market for selling financial assets that can

only be redeemed by the original holder

Secondary Market Market for reselling financial assets

Section 3 – The Stock Market

Buying Stock Benefits of Buying Stock Types of Stock Stock Splits Risk of Buying Stock

How Stocks are Traded Stock Exchanges The New York Stock

Exchange The OTC Market NASDAQ Futures and Options Day Trading

Measuring Stock Performance Bull and Bear Markets

The Down Jones Industrial Average S & P 500

The Great Crash of 1929 Investing During the

1920’s Signs of Trouble The Crash The Aftermath of the Crash The Market Today

Buying Stock

Corporations can raise money by selling stock Represents ownership in the corporation Shares: portion of stock Equities: claims of ownership in a corporation

Buying Stock

How do you make money buying stock? Dividends Capital Gains

Buying Stock

Dividends Paid 4 times per year (quarterly) Payout based on profits Paid per share

Buying Stock

Capital Gains Selling the stock for more than the purchase

price Capital Gain: the difference between a higher

selling price and a lower purchase price resulting in a financial gain for the seller.

Capital Loss: the difference between a lower selling price and a higher purchase price resulting in a financial loss to the seller

Buying Stock

Types of Stock Income Stock: Pays dividends at regular times

during the year Growth Stock: Pays few or no dividends,

company reinvests to grow the company and make stock worth more

Buying Stock

Types of Stock Common Stock: owners of the company with

one vote. A vote is used to elect the directors of the company

Preferred Stock: Non voting owners of the company. First to receive a dividend, paid back first if business shuts down

Buying Stock

Stock Split: the division of a single share of stock into more than one share.

Does not increase % of ownership but doubles the number of shares. Owning 100 shares that are $100 each After a 2 for 1 split, 200 Shares at $50

Buying Stock

Risks of buying stock Smaller profits, smaller stock value May sell stock for less than the purchase Going out of business

Sell assets

Pay off debt Pay off preferred stock

Pay off common stock

How Stocks Are Traded

Contact a Stockbroker A person who links buyers and sellers of stocks Works for a brokerage firm: a business that

specializes in trading stocks

Buy stocks to sell at a premium to earn money on the “spread”


Stock Exchanges A market for buying and selling stocks NYSE (______ _______ _______ _____________) OTC Market National Association of Securities Dealers

Automated Quotations (___________)


New York Stock Exchange Began in 1792 as an informal outdoor

exchange Must have a “seat” on the exchange Handles stock and bond transactions for the

largest most established companies in the US Blue Chips – Large profitable companies that

are considered stable


Over the Counter (Electronic) Stocks and bonds that are not traded on the

NYSE Investors buy directly from a dealer or a

broker


Nasdaq Created in 1971 Bring the OTC market together No trading floor; sends out information

automatically through 360,000 computer terminals worldwide


Futures and Options Futures: contracts to buy or sell at a specific

date in the future at a price specified today For commodities New York Mercantile

How Stocks Are Traded Options

Contracts that give investors the choice to buy or sell stock and other financial assets

Call Options Buy shares of stock at a specified time in the

future Put Options

Sell shares of stock at a specified time in the future


Call Option Pay a fee for a call (example: $10) Gives you the right to buy stock at $100 per

share in a specific time period If stock is greater than $100 + the Call Fee,

you would exercise your Call Stock goes to $115 per share, you would buy

at $100 per share, plus your $10 per share fee, make a $5 per share profit

How Stocks Are Traded Put Option

Pay a fee for a call (example: $5) Gives you the right to sell stock at $50 per

share in a specific time period If stock is now $40 + the Put Fee, you would

exercise your Put Selling stock at $50 per share when the market

rate is $40 you make a $5 profit If stock is above $50 you can just sell above

that price


Day Trading Very Risky Trading stocks minute by minute instead of

holding for the long term

Measuring Stock Performance

Bull and Bear Markets Bull Market: Steady rise in the stock market

over a period of time Bear Market: Steady drop in the stock market

over a period of time

Measuring Stock Performance

The Dow Jones Industrial Average 30 Large Companies

The S & P 500 Tracks the price of 500 different stocks as a

measure of overall stock market performance

Documents

Financial Markets Chapter 11. BELLRINGER What would you do if you suddenly received a cash payment of $100,000 that you were not expecting and didn’t