Financial MarketsChapter 12 Economics

Goals & Objectives1. Saving & Capital Formation.

2. Financial System & transferring of funds.

3. Non-depository Institutions Role.

4. 4 Investment considerations.

5. 3 Characteristics of bonds & financial assets.

6. 4 views of markets.

7. Stock exchanges & market performance.

Savings and the Financial System1. Savings: dollars available when people abstain

from consumption.2. Financial System: Saver, investors & financial institutions.3. Certificate of Deposit: depositors interest bearing loan to a bank

1. Financial assets: bank claims on property & income of borrower.4. Financial Intermediaries: lends funds from savers to borrowers5. Credit Unions: Private depositor nonprofit institution.

1. Mutual Funds: company sells stock in itself2. Pension Funds: income security to retired persons3. REITS: Real Estate Investment Trust: home construction4. Finance Companies: High interest loans to consumers on behalf of

merchants.

Investment Strategies and Investment Strategies and Financial AssetsFinancial Assets

1. The Risk-Return Relationship: 1. Risk: uncertain outcome2. Simplicity: 3. Consistency: long period of time4. Investment Objectives:

2. 401K’s: tax-deferred savings or private pension. IRA: Individual Retirement Account

Risk-Return RelationshipRisk-Return Relationship

Bonds as Financial AssetsBonds as Financial Assets1. Bond Components: long term IOU

1. Coupon: Maturity: Par Value:2. Bond Prices:

1. Future interest rates, company default.3. Bond Yields:

1. Annual interest rate divided by purchase price.2. Credit-worthiness, financial health, not

insured, no guarantees to redeem.3. Default or Bankruptcy.

Bonds: Long & Short TermBonds: Long & Short Term

Bond RatingsBond Ratings1. Standard & Poor’s & Moody’s:

1. Rating Factors: 1. Financial health of issuer, ability to make

future coupon & principal payments & issuer’s credit history.

2. AAA-D3. August 2011: U.S. Bonds lowered for 1st

time in history from AAA to AA.

Characteristics of Financial Characteristics of Financial AssetsAssets

1. Certificates of Deposit: CD’s: loans to banks.2. Corporate Bonds: “Junk Bonds” have high par

values3. Municipal Bonds: Safe investments due to tax-

increase ability. (Lap-tops for students)1. Tax-exempt: federal gov’t does not tax

interest paid.4. Government Savings Bonds: risk free, low

rate of return5. Treasury Notes & Bonds: faith in the credit of

U.S. is only security. 1-30 year rate of return.

Characteristics of Financial Characteristics of Financial AssetsAssets

6. Treasury Bills: Short-term obligation of 13,26, or 52 weeks and a minimum of $1,000.– $9,300 investment for 52 weeks.– $10,000 payment for a $700 return or 7.5% interest

7. Individual Retirement Accounts: long term, tax-sheltered time deposits.– $5,000 for worker and unemployed spouse or $10,000 per year

with no income tax deductions. – Government deregulation to encourage savings.

Markets for Financial AssetsMarkets for Financial Assets• Capital Markets: loans for more than one year

– Long term CD’s & Gov’t Bonds

• Money Markets: loans for less than one year– Short term CD’s

• Primary Markets: – Government Savings bonds and IRA’s (nontransferable)

• Secondary Markets: – Traded to create liquidity

Organized Stock ExchangesOrganized Stock Exchanges1. (NYSE) New York Stock Exchange: 1,400 seats,

2,800+ companies1. Profitability & size requirements

2. (AMEX) American Sock Exchange:1. 750 listed stocks; 2nd largest

3. Regional Exchanges: Chicago, Pacific, Philadelphia, Boston, Memphis.

1. Smaller or newer companies.

4. Global Stock Exchanges: Sydney, Tokyo, Hong Kong, Singapore, Johannesburg, Frankfurt.

Over-the-Counter MarketsOver-the-Counter Markets• (OTC’s): electronic marketplace for securities not

traded on the exchange

1. (NASDAQ): National Association of Securities Dealers Automated Quotation.1. 80 countries, 4,000 large & small companies more than

NYSE & AMEX together.

Measures of Stock Measures of Stock PerformancePerformance

1. Dow-Jones Industrial Average: (DJIA), 30 stocks

2. Standard & Poor’s 500: (S&P 500)1. 500 representative companies

• Bull & Bear Markets: Strong and Mean markets

Bull & Bear MarketsBull & Bear Markets