The Financial System STOCKS, BONDS, MUTUAL FUNDS & OPTIONS ECONOMICS What Does It Mean To Me?

The Financial SystemThe Financial SystemSTOCKS, BONDS, MUTUAL STOCKS, BONDS, MUTUAL FUNDS & OPTIONSFUNDS & OPTIONS

The Financial SystemThe Financial SystemSTOCKS, BONDS, MUTUAL STOCKS, BONDS, MUTUAL FUNDS & OPTIONSFUNDS & OPTIONS

ECONOMICSECONOMICSWhat Does It Mean To Me?

CONTENT

Introduction to Stocks

b) Shorting a stock

c) Reading stock indexes

d) Stock Exchanges

e) Dow Jones Average

a) Terminology

f) Stock Market Crashes

g) World Stock Markets

Bonds & Other Financial Markets

a) Terminology

b) Who Issues Bonds?

c) Bond Ratings

d) Options

f) Financial Intermediaries

Considerations/Selecting a Stock

a)Analysis Terms

e) Mutual Funds

b) Firm Numbersc) Industry Considerationsd) The Economy

The Financial System The Financial System

The financial systemfinancial system consists of the group of institutions in the economy that help to match one person’s saving with another person’s investment.

It moves the economy’s scarce resources from savers to borrowers.

The financial systemfinancial system consists of the group of institutions in the economy that help to match one person’s saving with another person’s investment.

It moves the economy’s scarce resources from savers to borrowers.

FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY


The financial system is made up of financial institutions that coordinate the actions of savers and borrowers.

Financial institutions can be grouped into two different categories: financial markets and financial intermediaries.

The financial system is made up of financial institutions that coordinate the actions of savers and borrowers.

Financial institutions can be grouped into two different categories: financial markets and financial intermediaries.



Financial Markets Stock Market Bond Market

Financial Intermediaries Banks Mutual Funds

Financial Markets Stock Market Bond Market

Financial Intermediaries Banks Mutual Funds



Financial markets are the institutions through which savers can directly provide funds to borrowers.

Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.

Financial markets are the institutions through which savers can directly provide funds to borrowers.


Corporation:

A legal entity that can conduct business in its own name in the same way that an individual

does and that is owned by stockholders.

Financial Markets Financial Markets

The Stock Market Stock represents a claim to partial ownership in a

firm and a claim to the profits that the firm makes. The sale of stock to raise money is called equity

financing. Compared to bonds, stocks offer both higher

risk and potentially higher returns. The most important stock exchanges in the United

States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.

The Stock Market Stock represents a claim to partial ownership in a

firm and a claim to the profits that the firm makes. The sale of stock to raise money is called equity

financing. Compared to bonds, stocks offer both higher

risk and potentially higher returns. The most important stock exchanges in the United

States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.

Share of stock-- represents

ownership in a corporation or a claim

on the assets of a corporation.

Share of stock-- represents

ownership in a corporation or a claim

on the assets of a corporation.

Dividends -- optional payments of annual profits to stockholders.

Dividends -- optional payments of annual profits to stockholders.

Growth Stock -- stock where the dividends are reinvested into the stock.

Growth Stock -- stock where the dividends are reinvested into the stock.

Initial Public Offering (IPO) --when stock is initially offered to the public.

Initial Public Offering (IPO) --when stock is initially offered to the public.

ADVANTAGES OF A CORPORATION

•Corporations continue to exist even if one or more owners of the corporation sell their shares or die.

•Stockholders are not personally liable for the debts of the corporation; they have limited liability.

•Corporations are usually able to raise large sums of money by selling stock.

DISADVANTAGES OF CORPORATIONS

•Corporations are subject to double taxation. (corporate income tax and personal income tax)

•Corporations are difficult to set up.

What do the following companies have in common?

Kraft Foods

Lender’s Bagels

County Line

Tang

Cool Whip

Oscar Mayer

Jell-O

Minute Rice

Stove Top

Breyers Ice Cream

Breakstone Sour Cream

Philadelphia Cream Cheese

Cracker Barrel

Maxwell House

Crystal Light

Caprice

Tombstone Pizza

Toasties

Del Monte

Light-n-Lively

Sanka

Kool-Aid

Raisin Bran

Louis Rich

Miracle Whip

Log Cabin

Lowenbrau

Miller Beer

Shake-n-Bake

ANSWER:

More than 10% of the food items that tumble down the world’s supermarket check-out lines carry the

Philip Morris seal. Formally, Philip Morris is a holding company whose principal wholly owned

subsidiaries are: Philip Morris USA, Philip Morris International, Kraft Foods, Miller Brewing, and

Philip Morris Capital.

ALTRIA

(PHILIP MORRIS)

Stock Symbol: MO

CABLE HOLDINGS OF THE BIG NETWORKS

VIACOM <VIA> (CBS) DISNEY <DIS> (ABC) GE <GE> (NBC) NEWS CORP <NWS> (FOX)MTV ESPN CNBC Fox Movie ChannelVH1 ESPN2 MSNBC (50%) Fox NewsBET ESPN Classic A & E (partial) Fox SportsNickelodeon Disney Channel History Channel FXTV Land Family Channel National Geographic National Geographic

(partial) (partial)Showtime Soapnet Bravo STARMovie Channel Toon Disney Liberty Media (part) FUELCountry Music TV DirectTVComedy Central (50%)UPN

TimeWarner <TWX> Liberty Media <L>Cox Commun. <COX>

TNT DSCCNN Animal PlanetHBO DSC HealthTBS Travel ChannelAmerica Online DSC KidsWB BBC America

TLCUSA

Stock split -- when a stock’s high price is discouraging new investors, the company splits the stock to a lower price; thus creating more shares at a lower price.

Stock split -- when a stock’s high price is discouraging new investors, the company splits the stock to a lower price; thus creating more shares at a lower price.

For example:

100 shares at $50 per share equals

200 shares at $25 per share

For example:

100 shares at $50 per share equals

200 shares at $25 per share

Would you invest in this company?

Microsoft Corporation 1978

First Sep 21, 1987 2 for 1 Sep 18 = 114.50

Sep 21 = 53.50

Second Apr 16, 1990 2 for 1 Apr 12 = 120.75

Apr 16 = 60.75

Third Jun 27,1991 3 for 2 Jun 26 = 100.75

Jun 27 = 68.00

Fourth Jun 15, 1992 3 for 2 Jun 12 = 112.50

Jun 15 = 75.75

Fifth May 23, 1994 2 for 1 May 20 = 97.75

May 23 = 50.63

Sixth Dec 9, 1996 2 for 1 Dec 6 = 152.875

Dec 9 = 81.75

Seventh Feb 23, 1998 2 for 1 Feb 20 = 155.13Feb 23 = 81.63

First Sep 21, 1987 2 for 1 Sep 18 = 114.50

Sep 21 = 53.50


Apr 16 = 60.75

Third Jun 27,1991 3 for 2 Jun 26 = 100.75

Jun 27 = 68.00


Jun 15 = 75.75

Fifth May 23, 1994 2 for 1 May 20 = 97.75

May 23 = 50.63

Sixth Dec 9, 1996 2 for 1 Dec 6 = 152.875

Dec 9 = 81.75

Seventh Feb 23, 1998 2 for 1 Feb 20 = 155.13Feb 23 = 81.63

History of Microsoft Stock SplitsHistory of Microsoft Stock Splits Symbol:Symbol: MSFT MSFTIPO: IPO: March 13, 1986 March 13, 1986 Last updated:Last updated: August 18, 1998 August 18, 1998


First Sep 21, 1987 2 for 1 Sep 18 = 114.50

Sep 21 = 53.50


Apr 16 = 60.75

Third Jun 27,1991 3 for 2 Jun 26 = 100.75

Jun 27 = 68.00


Jun 15 = 75.75

Fifth May 23, 1994 2 for 1 May 20 = 97.75

May 23 = 50.63

Sixth Dec 9, 1996 2 for 1 Dec 6 = 152.875

Dec 9 = 81.75

SeventhFeb 23, 1998 2 for 1 Feb 20 = 155.13Feb 23 = 81.63


First Sep 21, 1987 2 for 1 Sep 18 = 114.50

Sep 21 = 53.50


Apr 16 = 60.75

Third Jun 27,1991 3 for 2 Jun 26 = 100.75

Jun 27 = 68.00


Jun 15 = 75.75

Fifth May 23, 1994 2 for 1 May 20 = 97.75

May 23 = 50.63

Sixth Dec 9, 1996 2 for 1 Dec 6 = 152.875

Dec 9 = 81.75

SeventhFeb 23, 1998 2 for 1 Feb 20 = 155.13Feb 23 = 81.63

2 shares = $107.00

4 shares = $243.00

6 shares = $408.00

9 shares = $681.75

18 shares = $910.74

36 shares = $2943.00

72 shares =

$5877.36$5877.36

What does it What does it mean to SHORT mean to SHORT

the stock?the stock?

What does it What does it mean to SHORT mean to SHORT

the stock?the stock?

Shorting stocks is a method of gambling on a stock whose price

you think will decline.

Instead of purchasing shares of a stock you think is going up in

price, you instead borrow shares, sell them immediately, wait for the

price to go down, and then buy them back at the lower price and return the shares to the broker.

The advantage of shorting stocks is that you can make a profit

without an initial cash investment.

For example, suppose you think the price of NOPE stock is going

down from its current price of $32.

You tell your broker that you want to short 200 shares of

NOPE stock. (You must have a margin account to short stocks.)

Your broker then borrows 200 shares of NOPE and sells them

for you, depositing $6400 in your account.

Now you hope the price goes down because eventually, you

need to return the 200 borrowed shares to your broker.

Suppose the price goes down to $25. You can now buy the 200

shares of NOPE for $5000, return the 200 shares to your broker, and

pocket the $1400 profit.

($6400 - $5000) minus the commission.

You have now made money without an initial cash investment.

However, shorting stocks is considered riskier than buying stocks because the price of the stock could go UP an unlimited amount, resulting in unlimited

losses.

At some point you need to buy the shares you borrowed to short

the stock.

For example, if the price of NOPE goes up to $40, you would have to pay $8000 to buy the 200 shares

owed to your broker.

In this case, you would lose $1600

($8000 - $6400) plus the commission

Buying your shares back and returning them to the broker is called covering a

short.

When an investor sells a stock for profit, it is called a CAPITAL GAINCAPITAL GAIN..

A A capital gaincapital gain is the difference is the difference between an asset’s purchase between an asset’s purchase

price and its’ selling price price and its’ selling price when the amount is positive. when the amount is positive.

Because shorting stocks involves unlimited risk, the SEC has special regulations requiring

brokers to issue a margin call when an investor’s losses reach

a certain point.

MARGINMARGIN is the amount of money a customer deposits with a broker when

borrowing from the broker for securities.

Example: If a broker has a 50% Example: If a broker has a 50% margin requirement and the customer margin requirement and the customer sells short 100 shares of XYZ at $50 a sells short 100 shares of XYZ at $50 a

share, how much equity must be share, how much equity must be maintained in the margin account?maintained in the margin account?

ANSWER: $2500ANSWER: $2500

Reading Stock Indexes

Reading Stock Indexes

Originally, prices were read in fraction form per share of stock:Originally, prices were read in fraction form per share of stock:

1/64= .0156 1/32 = .03 1/16 = .06 1/8 = .125 1/4 = .25 3/8 = .38 1/2 = .50 5/8 = .63 3/4 = .75 7/8 = .88

1/64= .0156 1/32 = .03 1/16 = .06 1/8 = .125 1/4 = .25 3/8 = .38 1/2 = .50 5/8 = .63 3/4 = .75 7/8 = .88

However, since September

2000, all stock exchanges converted

stock prices to decimal format.

Historical Note: The Spanish practice of

dividing the silver dollar into

eighths was largely

responsible for the prevalence

of fractions when describing stock

values.

The stocks listed are common stocks unless indicated otherwise. For example “pf” indicates a preferred stock.

The stocks listed are common stocks unless indicated otherwise. For example “pf” indicates a preferred stock.

The numbers to the left of the name of the corporation show the highest and lowest price at which the stock has traded during the previous 52 weeks.

The numbers to the left of the name of the corporation show the highest and lowest price at which the stock has traded during the previous 52 weeks.

The symbol column lists the stock’s ticker symbol.

The symbol column lists the stock’s ticker symbol.

The dividend column shows the current level of dividends that will be paid over one year to the owner of one share of stock. A dividend is the annual payment per share of a stock designated by a company for its stockholders.

The dividend column shows the current level of dividends that will be paid over one year to the owner of one share of stock. A dividend is the annual payment per share of a stock designated by a company for its stockholders.

The dividend yield shows the dividend as a percentage of stock closing price.

The dividend yield shows the dividend as a percentage of stock closing price.

The PE column lists the price/earnings ratio, which is the price of a share of stock divided by the company’s earnings (profits) per share of stock for the last 12-month period.

The PE column lists the price/earnings ratio, which is the price of a share of stock divided by the company’s earnings (profits) per share of stock for the last 12-month period.

The column marked volume lists the number of shares traded (in hundreds) during that day.

The column marked volume lists the number of shares traded (in hundreds) during that day.

The hi, lo, and close columns show the range of prices at which the stock traded during the day. The closing price is the price for the last transaction of the day.

The hi, lo, and close columns show the range of prices at which the stock traded during the day. The closing price is the price for the last transaction of the day.

The net change column shows the change between this closing price and the closing price the previous trading day.

The net change column shows the change between this closing price and the closing price the previous trading day.

STOCK STOCK EXCHANGESEXCHANGES

STOCK STOCK EXCHANGESEXCHANGES

1) NYSE --The New York Stock Exchange.1) NYSE --The New York Stock Exchange. Started with “Buttonwood Agreement” in 1792 Founded in 1817 Home to Dow Jones Industrial Average

Started with “Buttonwood Agreement” in 1792 Founded in 1817 Home to Dow Jones Industrial Average

Three U.S. stock exchanges are:

2) AMEX --The American Exchange.

3) NASDAQ --National Assn. Of Security Dealers Automated Quotation

Founded in 1920s

•Founded in 1976•Completely computerized quotations--no exchange floor

Regional Stock ExchangesRegional Stock Exchanges

Chicago * * Boston

Cincinnati PhiladelphiaSan Francisco

Los Angeles

The term "seat" is now synonymous with a membership

on the NYSE. NYSE memberships can be

purchased and sold. The all time high price paid for an NYSE

membership was $2,650,000 on August 23, 1999. The lowest price ever paid was $4,000 in 1876 and

again in 1878.

What is the origin of the term "Blue Chip Stock"?

This phrase first dates back to 1904 and has its origin from the blue, i.e., highest

denomination chips used in gambling. Today, Blue Chip stocks are thought of as being the most stable and safe investments available.

However, when the expression was first used, investors were evidently aware of the

similarities between gambling and investing.

The Dow Jones Average was started by Charles H. Dow and Edward Jones at a time when the stock market was not highly regarded. He began testing his Average in 1884 with 11 stocks, most of them railroads, which were the first great national corporations. In the spring of 1896, he introduced the 12-stock average to the nation.

The Dow Jones Average was started by Charles H. Dow and Edward Jones at a time when the stock market was not highly regarded. He began testing his Average in 1884 with 11 stocks, most of them railroads, which were the first great national corporations. In the spring of 1896, he introduced the 12-stock average to the nation.

Charles Dow

1852-1902

The original 12 stocks on the Dow Jones Average were:

American Cotton Oil

American Sugar

American Tobacco

Chicago Gas

Distilling & Cattle Feeding

General Electric

Laclede Gas

National Lead

North American

Tennessee Coal & Iron

US Leather preferred

US Rubber

In the autumn of 1896, he dropped the last non-railroad

stock from the original average and made the 20-stock railroad average. Today, this is called

the TRANSPORTATION AVERAGE.

In 1916, the Dow Jones industrial average was

increased to 20 stocks and on October 1, 1928, it was

expanded to 30--the number of stocks comprising the average

ever since.

In 1916, the Dow Jones industrial average was

increased to 20 stocks and on October 1, 1928, it was

expanded to 30--the number of stocks comprising the average

ever since.

Currently, the 30 stocks on the Dow Jones Industrial Average are:

Currently, the 30 stocks on the Dow Jones Industrial Average are:

Exxon/Mobil

General Electric

General Motors

Hewlett Packard

Home Depot

Honeywell International

IBM

Intel

Johnson & Johnson

JP Morgan Chase

McDonalds

Merck & Co.

Microsoft Corp

Pfizer

Proctor & Gamble

United Technologies

Verizon Communications

Wal Mart

3M

Alcoa

Altria (MO)

American Express

American Int’l Group

AT & T

Boeing

Caterpillar

Citigroup

Coca-Cola

Disney

Dupont

1000

2000

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11000

The Dow Jones Industrial Average opened at 40 in the

year 1884

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By 1920, the index had reached 100

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On September 3, 1929, the index reached a high of 381.

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October 28, 1929, the Dow fell 38 points (down 12.8%) and on

October 29, 1929, it fell 30 points (down 11.7%) to close at 230. This

was a 2-day percentage loss of 24.5%

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By July 8, 1932, the Dow closed at 41.

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So…………..

How long did it take the Dow to reclaim it’s all time high of 381 ??

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The answer : 1954 (22 years)

WHY?

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What year did it reach 1000?

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The answer : 1972 (18 years)

WHY?1972

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By January of 1987, the Dow reached 2000.

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1954

Then on October 19, 1987, the Dow went from 2240 to 1738. It

lost 507 points in its largest EVER one day percentage loss

of 22.6%.

1972

1987

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In 1991, the Dow reached 3000.

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In 1995, it hit 4000 in February and 5000 in November.

1972

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In 1997, it hit 7000 in February and 8000 in July.

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In 1999, it hit 10000 in March and 11000 in May.

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It finally reached a high of 11,722 in January 2000.

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Can you see why Alan Greenspan called the ninties a period of “irrational exuberance?”

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1972

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The following is a chart of the Dow (1900-present) as compared to the inflation adjusted Dow (1925-present).

A prolonged

period of fallingfalling

stock prices is called a

BEAR BEAR MARKET.MARKET.

A prolonged period of risingrising stock prices is called a BULL BULL MARKET.MARKET.

How many stock market crashes

have there been?

The largest single day market sell-off occurred on October 19, 1987 (Black

Monday) when the Dow Jones Industrial Average fell 22.6%.

The 1929 market crash actually occurred over a two-day period, when the Dow Jones Industrial Average fell 12.8% on

October 28, 1929 and 11.7% on October 29, 1929.

The largest one-day point drop occurred on October 27, 1997 when the Dow lost

554.26 points (7.18%).

A BEAR MARKETBEAR MARKET is defined as a prolonged decline in stock prices, e.g., greater than a 30%

decline over a 50-day trading period.

There were 30 bear markets in the 20th century. The worst ran from September 3, 1929 to July 8, 1932, when the Dow lost 89.1%. It took over 20 years for the Dow to trade above its pre-crash

levels.

The worst bear market in the 21st century ran from March 10, 2000 to October 9, 2002. During

this period, the Nasdaq Composite Index lost 77.9%. At current levels, the Nasdaq Composite is

trading 70% below its all-time high.

THE GREAT CRASH: What Happened?

1925: value of all stocks= $27b 1929: value of all stocks= $87b (rising $11.4b in 1928 alone)

*relatively small number of companies and people held much of the nation’s wealth

**farmers and workers were suffering

***ordinary people went into debt buying consumer goods such as refrigerators and radios on credit.

****industries were producing more goods than consumers could buy, developing large surpluses. (ie, Autos)

Additionally, investors were going into debt investing in the stock market. The incredible climb of the stock market encouraged SPECULATION, the practice of borrowing money to invest in high-risk investments hoping for a big return.

Small investors began using life savings to buy stocks. To encourage the less-wealthy, stockbrokers invented the practice of BUYING ON MARGIN, which allowed people to buy stocks for a fraction of the cost and borrow the rest from the brokerage.

*Worried investors began to sell and prices fell further.

*By Monday, October 28, 1929, stocks were selling for a fraction of what people had paid for them.

*On October 29, 1929, known as BLACK TUESDAY, a record 16.4 million shares were sold.

The GREAT CRASH had begun. . . . . .

*On September 3, 1929, the Dow reached an all time high of 381. After the prices began to fall, some brokers demanded repayment of loans.

*When the market opened on October 23, 1929, the Dow had dropped 21 points in an hour.

In 1932, President Roosevelt created reform measures in

response to the crash of 1929. He formed the

SECURITIES AND SECURITIES AND EXCHANGE COMMISSIONEXCHANGE COMMISSION

to regulate the stock market.

In charge of the SEC, he placed Joseph Patrick Kennedy, the father

of President John F. Kennedy.

WORLD WORLD STOCK STOCK

MARKETSMARKETS

WORLD WORLD STOCK STOCK

MARKETSMARKETS

World Stock MarketsWorld Stock Markets

Stock trading goes on around the world, around the clock, in an electronic global marketplace.

Stock trading goes on around the world, around the clock, in an electronic global marketplace.

Indexes --major stock exchanges around the globe express stock performance as indexes, which are statistical composits.

Indexes --major stock exchanges around the globe express stock performance as indexes, which are statistical composits.

U.S. Dow Jones Industrial Average Tokyo Average London FT 30-share Frankfurt FAZ Paris Cac-40

U.S. Dow Jones Industrial Average Tokyo Average London FT 30-share Frankfurt FAZ Paris Cac-40

BONDS and other BONDS and other FINANCIAL FINANCIAL MARKETSMARKETS

BONDS and other BONDS and other FINANCIAL FINANCIAL MARKETSMARKETS

Financial MarketsFinancial Markets

The Bond Market A bond is a certificate of indebtedness that

specifies obligations of the borrower to the holder of the bond.

Characteristics of a Bond Term: The length of time until the bond

matures. Credit Risk: The probability that the borrower

will fail to pay some of the interest or principal. Tax Treatment: The way in which the tax laws

treat the interest on the bond. Municipal bonds are federal tax exempt.

The Bond Market A bond is a certificate of indebtedness that

specifies obligations of the borrower to the holder of the bond.

Characteristics of a Bond Term: The length of time until the bond

matures. Credit Risk: The probability that the borrower

will fail to pay some of the interest or principal. Tax Treatment: The way in which the tax laws

treat the interest on the bond. Municipal bonds are federal tax exempt.

IOU

BondsBonds

Investor loans money to a government, municipality or corporation (borrower gets needed cash and lender earns interest)

Investor loans money to a government, municipality or corporation (borrower gets needed cash and lender earns interest)

Bonds allow expansion and help create jobs.

Bonds allow expansion and help create jobs.

Maturity -- time when loan expires or is due.

Maturity -- time when loan expires or is due.

Coupon Rate -- percentage of par value paid in interest to bondholder on a regular basis.

Par Value -- amount that an investor pays to purchase the bond and that will be replaced to the investor at maturity.

WHO ISSUESWHO ISSUES BONDS?BONDS?

Who issues bonds?Who issues bonds?

Corporations -- to raise money for expansion and operations.

Corporations -- to raise money for expansion and operations.

Who issues bonds?Who issues bonds?Municipalities

and local governments

-- for schools, highways,

stadiums, etc.

Municipalities and local

governments-- for schools,

highways,

stadiums, etc.


Government agencies -- for home mortgage associations, Federal Housing Administration (FHA)

Government agencies -- for home mortgage associations, Federal Housing Administration (FHA)


Foreign governments and corporations -- as a primary way to raise capital.

Foreign governments and corporations -- as a primary way to raise capital.


Federal Government -- in the form of SAVINGS BONDS, which are low-denomination bonds in amounts of $50 to $10,000.

Federal Government -- in the form of SAVINGS BONDS, which are low-denomination bonds in amounts of $50 to $10,000.


and theUnited States Treasury

Department -- for federally funded programs. These are issued in the form of Treasury Bills, Treasury Notes, and Treasury Bonds.

and theUnited States Treasury

Department -- for federally funded programs. These are issued in the form of Treasury Bills, Treasury Notes, and Treasury Bonds.

What is the difference between the Treasury Bill, Treasury Bond and

Treasury Note?

Treasury BondTreasury Bond Treasury NoteTreasury Note Treasury BillTreasury Bill

Term long-term intermediate short-term

Maturity 10 to 30 years 2 to 10 years 3, 6, or 12 months

Liquidity & Safety

safe safe liquid & safe

Minimum purchase

$1,000 $1,000 $1,000

Denomination $1,000 $1,000 $1,000

BOND RATINGSBOND RATINGSBOND RATINGSBOND RATINGS

Bond

Ratings

Bond

Ratings

Moody’s Standard& Poors

Meaning

Aaa AAA

Best quality, with the smallestrisk, issuers are exceptionallystable and dependable.

Aa AA

High quality, with a slightlyhigher degree of long-term risk.

A A

High-to-medium quality, withmany strong attributes butsomewhat vulnerable tochanging economic conditions

Baa BBB

Medium quality, currentlyadequate but perhaps unreliableover the long term.

I NVESTMENTGRADEBONDS

Ba BB

Some speculative element withmoderate security, but not wellsafeguarded.

B B

Able to pay now but at risk ofdefault in the future.

Caa CCC

Poor quality, clear danger ofdefault.

Ca CC

Highly speculative quality, oftenin default.

C C

Lowest rated, poor prospect ofrepayment, though may still bepaying.

__ D I n default.

JUN KBONDS

BONDS

BONDS

NOTE: Junk Bonds have been known to have interest rates as high as 12% at a time when government bonds were only 8%.

BUYING BONDS AT A DISCOUNT

Suppose Al buys a $1000 bond with a coupon rate of 5 percent. The person who buys the bond (Al) is called the “holder,” while the seller of the bond is called the “issuer.”

Interest rates go up to 6 percent, and Al needs to sell the bond. (noone wants to buy a 5 percent bond when the interest rate is 6 percent)

Al offers to sell the bond to Patsy “at a discount” for $950--taking $50 off the $1000 value of the bond.

Patsy now owns a par value $1000 bond for $950.

FINANCIAL MARKETS

Markets in which money is lent for periods longer than one year are called CAPITAL

MARKETS.

When money is lent for less than one year, it is called a MONEY MARKET. Money market

investments are NOT insured by FDIC (Federal Deposit Insurance Corporation).

FINANCIAL MARKETS

Financial assets that can only be redeemed by the original holder are sold on a PRIMARY

MARKET. (ex: savings bonds, small CDs)

Financial assets that can be resold are sold on SECONDARY MARKET. This option for

resale provides liquidity to investors.

**For example: if the mortgage on a house does not meet the banks’ criteria for sale on the secondary market, the borrower may have to pay a higher interest rate for their mortgage.

MUTUAL FUNDS

What Is A Mutual Fund?

A mutual fund is a professionally managed pool of money.A mutual fund is a professionally managed pool of money.

$$ Company “B”Company “B”Company “B”Company “B”

Company “C”Company “C”Company “C”Company “C”

Company “A”Company “A”Company “A”Company “A”

Mutual Funds – A collection of stocks,

bonds, or other securities bought by a group of investors and managed by a professional investment company.

Mutual Funds – A collection of stocks,

bonds, or other securities bought by a group of investors and managed by a professional investment company.

•Money is Professionally Managed.

•Diversified.

•Flexible.

•Marketable.

•You Have Control.

Why Own One?

Open-end funds –(most common)

the fund will sell as many shares as investors want. Cannot trade in stock market, only buy or sell through mutual fund company.

Closed-end funds -- have a limited number of shares for trading on an exchange or OTC.

Open-end funds –(most common)

the fund will sell as many shares as investors want. Cannot trade in stock market, only buy or sell through mutual fund company.

Closed-end funds -- have a limited number of shares for trading on an exchange or OTC.

Load funds -- includes a sales charge (usually 5%), + fees. Purchased through a broker.

No-load funds -- charge a management fee, not a commission.

Load funds -- includes a sales charge (usually 5%), + fees. Purchased through a broker.

No-load funds -- charge a management fee, not a commission.

Net Asset Value (NAV) –

The total value of the fund’s holdings divided by the number of shares. (= price per share)

Net Asset Value (NAV) –

The total value of the fund’s holdings divided by the number of shares. (= price per share)

A Hypothetical ExampleInvesting $100 per month with different rates of return

10 years 20 years 30 years 40 years

12%10%8%6%

10 years 20 years 30 years 40 years

12%10%8%6%

$1,188,240$1,188,240

$637,680$637,680$351,430$351,430$200,140$200,140

$200,140$200,140$351,430$351,430$637,680$637,680

$1,188,240$1,188,240

$100,950$100,950$150,030$150,030$227,930$227,930$352,990$352,990

$46,440$46,440$59,290$59,290$76,570$76,570$99,910$99,910

$16,470$16,470$18,420$18,420$20,660$20,660$23,230$23,230

6%6%8%8%

10%10%12%12%

Assumed RatesAssumed Rates 10 Years10 Years 20 Years20 Years 30 Years30 Years 40 Years40 Years

$100 Investment Per Month$100 Investment Per Month

The hypothetical illustration and the 6%, 8%, 10% and 12% nominal rates compounded monthly, are not guaranteed or intended to demonstrate the performance of any actual investment and assumes $100/month investment. Assumes payments are made at the beginning of the compounding period and are rounded to the nearest $10.

WhenYou Become Financially

Independent Depends on How Much Money

You Can Invest.

WhenYou Become Financially

Independent Depends on How Much Money

You Can Invest.

At age 65, could you live on $140,000 / Year?

At age 65, could you live on $140,000 / Year?

? 40 Year Plan --? 40 Year Plan -- Invest $120/Mo.

• 30 Year Plan -- Invest $400/Mo.

• 20 Year Plan -- Invest $1,400/Mo.

Invest $6,025/Mo.• 10 Year Plan --

@ 12% Average Rate of Return

To do that, you need to accumulate $1,400,000

The High Cost of Waiting

Cost to wait includes monthly contributions. This hypothetical example demonstrates compounding at specified rate and not Cost to wait includes monthly contributions. This hypothetical example demonstrates compounding at specified rate and not the performance of any actual program. No allowance for taxes, applicable fees or inflation. Rate of return is nominal, the performance of any actual program. No allowance for taxes, applicable fees or inflation. Rate of return is nominal, compounded monthly.compounded monthly.

Don’t Procrastinate!Don’t Procrastinate!

Cost to WaitCost to Wait

$ 61,590$ 61,590

$254,850$254,850

Total in 40 YearsTotal in 40 Years

$637,680$637,680

$576,090$576,090

$382,830$382,830

Begin SavingBegin Saving

NowNow

In One YearIn One Year

In Five YearsIn Five Years

Saving $100 per month at 10% returnSaving $100 per month at 10% return

The Best IRA Option for you The Best IRA Option for you Traditional IRATraditional IRA

ContributionsContributions

Contribution/Distribution age limitContribution/Distribution age limit

EarningsEarnings

Withdrawalsafter age 591/2Withdrawalsafter age 591/2

Up to $4,000Tax DeductibleUp to $4,000Tax Deductible

70 1/270 1/2

Tax-deferredTax-deferred

Roth IRA Roth IRA Up to $4,000Non-deductibleUp to $4,000Non-deductibleNo age limitNo age limit

Tax-deferredTax-deferred

Earnings tax-free if Roth IRA account has been open at least 5 years

Earnings tax-free if Roth IRA account has been open at least 5 years

All of the money will be taxable upon withdrawal

All of the money will be taxable upon withdrawal

Money taken will be taxable w/10% penalty

TAX FREE MONEYno matter how much is withdrawn!

Taxes before 59 1/2

Comparing IRA Income Participation Limits

Comparing IRA Income Participation Limits

Traditional IRA Full eligibility income limits for

retirement plan participants

Traditional IRA Full eligibility income limits for

retirement plan participants

Roth IRA Full eligibility income limits

(regardless of retirement plan participation)

Roth IRA Full eligibility income limits

(regardless of retirement plan participation)

Full EligibilityFull Eligibility

2006$80,000$50,000

2006$80,000$50,000

Married

Single

Married

Single

2006 and onMarried $150,000Single $95,000

2006 and onMarried $150,000Single $95,000

OPTIONSOPTIONSOPTIONSOPTIONS

OptionsOptions

The right, but not the obligation, to buy or sell a stock for a specified price on or before a specific date.

The right, but not the obligation, to buy or sell a stock for a specified price on or before a specific date.

OptionsOptions

Strike price -- selling price

Expiration date -- deadline to exercise the right to buy or sell. This occurs on the THIRD THIRD FRIDAYFRIDAY of each month.

Strike price -- selling price

Expiration date -- deadline to exercise the right to buy or sell. This occurs on the THIRD THIRD FRIDAYFRIDAY of each month.

Call: Call: normally represents 100 shares of underlying stock.Call: Call: normally represents 100 shares of underlying stock.

Buy -- right to buy a stock at a fixed price in the future.

Buy -- right to buy a stock at a fixed price in the future.

The buyer of an equity call option has purchased the right to buy 100 shares of the underlying stock at the stated exercised price.

Thus, the buyer of one XYZ June 110 call option has the right to purchase 100 shares of XYZ stock at $110 up until the June expiration (the third Friday in June).

Therefore, if XYZ stock increases in price to $120 per share, the value would increase $10 per share x 100 shares or $1000, minus the premium.

Put: Put: normally represents 100 shares of underlying stock.Put: Put: normally represents 100 shares of underlying stock.

Buy -- right to sell a stock at a fixed price in the future.

Buy -- right to sell a stock at a fixed price in the future.

The buyer of a put option has purchased the right to sell 100 shares of underlying stock at the contracted exercise price.

Thus, the buyer of one ZXY June 50 put option has the right to sell 100 shares of ZYX at $50 any time prior to the third Friday in June.

Therefore, if the price of ZXY decreases to $40 per share, the value would increase $10 per share x 100 shares, or $1000, minus the premium.

The buyer of a put option has purchased the right to sell 100 shares of underlying stock at the contracted exercise price.

Thus, the buyer of one ZXY June 50 put option has the right to sell 100 shares of ZYX at $50 any time prior to the third Friday in June.

Therefore, if the price of ZXY decreases to $40 per share, the value would increase $10 per share x 100 shares, or $1000, minus the premium.

The largest exchange for trading options is the CBOE, the Chicago Board of Options

Exchange.

FINANCIAL FINANCIAL INTERMEDIARIESINTERMEDIARIES

FINANCIAL FINANCIAL INTERMEDIARIESINTERMEDIARIES



Financial IntermediariesFinancial Intermediaries

Banks take deposits from people who want to

save and use the deposits to make loans to people who want to borrow.

pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

Banks take deposits from people who want to

save and use the deposits to make loans to people who want to borrow.

pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

Financial Intermediaries Financial Intermediaries

Banks Banks help create a medium of exchange by

allowing people to write checks against their deposits.

A medium of exchanges is an item that people can easily use to engage in transactions.

This facilitates the purchases of goods and services.

Banks Banks help create a medium of exchange by

allowing people to write checks against their deposits.

A medium of exchanges is an item that people can easily use to engage in transactions.

This facilitates the purchases of goods and services.

Financial IntermediariesFinancial Intermediaries

Mutual Funds A mutual fund is an institution that sells

shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both.

They allow people with small amounts of money to easily diversify.

Mutual Funds A mutual fund is an institution that sells

shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both.

They allow people with small amounts of money to easily diversify.

Financial Intermediaries Financial Intermediaries

Other Financial Institutions Credit unions Pension funds Insurance companies Loan sharks

Other Financial Institutions Credit unions Pension funds Insurance companies Loan sharks

CONSIDERATIONS CONSIDERATIONS FOR SELECTING A FOR SELECTING A

STOCKSTOCK

CONSIDERATIONS CONSIDERATIONS FOR SELECTING A FOR SELECTING A

STOCKSTOCK

ANALYSIS ANALYSIS TERMSTERMS

MARKET CAPITALIZATION

Value of a corporation valued by the market price of its issued and

outstanding stock.

price of stock x outstanding shares = market cap

EARNINGS PER SHARE

Portion of a company’s profit allocated to each share

Actual earnings / outstanding shares = EPS

BOOK VALUE

Value at which an asset is carried on a Balance Sheet. (also called net asset value when applied per

bond or per share)

cost of asset - depreciation = BV

DEBT TO EQUITY RATIO

This shows to what extent owner’s equity can cushion

creditor’s claims in the event of liquidation.

Total liabilities / total shareholders equity = d/e ratio

Over the Counter (OTC) -- an electronic marketplace regulated by the NASD (National Association of Securities Dealers).

Over the Counter (OTC) -- an electronic marketplace regulated by the NASD (National Association of Securities Dealers).

NASDAQ -- where OTC companies are listed (National Association of Securities Dealers Automated Quotation)

NASDAQ -- where OTC companies are listed (National Association of Securities Dealers Automated Quotation)

FIRM NUMBERSFIRM NUMBERS

PRICE/EARNINGS RATIO PRICE/EARNINGS RATIO (PE):(PE): A calculation that evaluates a A calculation that evaluates a stock’s relative performance and value.stock’s relative performance and value.

•Higher PE multiples suggest that investors are Higher PE multiples suggest that investors are more optimistic about a stock’s prospects than more optimistic about a stock’s prospects than comparable lower PE stocks.comparable lower PE stocks.

•Reason for high/low PE ratios also include the Reason for high/low PE ratios also include the company’s growth outlook, the company’s company’s growth outlook, the company’s industry, the company’s accounting policies, and industry, the company’s accounting policies, and whether the company is a start-up firm or more whether the company is a start-up firm or more established.established.

PE is calculated by dividing the PE is calculated by dividing the stock’s price by the company’s stock’s price by the company’s

earnings per share (EPS) for the earnings per share (EPS) for the most recent 4 quarters.most recent 4 quarters.

Stock price compared to “company’s Stock price compared to “company’s earnings” (EPS) reported in ratio. earnings” (EPS) reported in ratio.

This would indicate that aThis would indicate that a

LOW PE = better return on investment

Example:Example:

Stock AStock A Stock BStock B

PricePrice $10$10 $20$20

EPSEPS $2.00$2.00 $2.00$2.00

PE RatioPE Ratio 55 1010

Which is a better investment?

The answer is Stock A.The answer is Stock A.

Stock B is more expensive than Stock B is more expensive than Stock A in terms of earnings. For Stock A in terms of earnings. For Stock B, you must pay $20 to earn Stock B, you must pay $20 to earn $2, but for Stock A, you pay only $2, but for Stock A, you pay only

$10 to earn $2.$10 to earn $2.

The ratio is the number of times greater the stock price is as compared to the

corporate earnings.

P $1.00$1.00 == 11 PE

E $1.00$1.00

P $1.00$1.00 == 1010 PE

E .10.10

BETA:BETA: refers to risk refers to risk management or volatility of a stock management or volatility of a stock (I.e. the percentage change for the (I.e. the percentage change for the stock’s return compared to the stock’s return compared to the change in the return of the market)change in the return of the market)

When a market tends toward rapid and extreme fluctuations, it is said to

be VOLATILE.VOLATILE.

If the returns are the same, the ratio is If the returns are the same, the ratio is 1.0.1.0.

A beta of 1.00 means that the stock A beta of 1.00 means that the stock has the same percentage of change has the same percentage of change as the market.as the market.

Thus, if you want to perform better Thus, if you want to perform better than the market, a beta greater than than the market, a beta greater than 1.0 would be desired.1.0 would be desired.

A high beta # would indicate more A high beta # would indicate more volatility than the current market.volatility than the current market.

A high beta # would indicate more A high beta # would indicate more volatility than the current market.volatility than the current market.

When market indicators shift, the When market indicators shift, the high beta stock will move more in high beta stock will move more in

the direction that the stock is the direction that the stock is presently headed.presently headed.

For example, if a stock has a beta For example, if a stock has a beta of 1.35 and the market has of 1.35 and the market has changed 10%, how much has the changed 10%, how much has the stock changed in return?stock changed in return?

1.35 = X/10 percent1.35 = X/10 percent

X = 13.5 percentX = 13.5 percent

* the 13.5% stock return change * the 13.5% stock return change indicates that this stock has a indicates that this stock has a greater risk of change than the greater risk of change than the market.market.

DIVIDEND:DIVIDEND: indicates the annual payment per share of a stock designated by the company for stockholders. COMMON shares dividends vary with the business condition of the company and are evaluated regularly by a firm’s directors. PREFERRED stockholders are the first to get paid.

%YIELD:%YIELD: represents the dividend represents the dividend return an investor can expect on each return an investor can expect on each share of stock purchased.share of stock purchased.

It is calculated by dividing the dividend that It is calculated by dividing the dividend that each share pays by its current market each share pays by its current market value, expressed as a percentage.value, expressed as a percentage.

$1 dividend / $10 price = 10% yield$1 dividend / $10 price = 10% yield

$1 dividend / $5 price = 20% yield$1 dividend / $5 price = 20% yield

NEWS:NEWS: Strikes/scandals, Strikes/scandals, accidents/hazards, research & accidents/hazards, research & development, safety issues, new development, safety issues, new technology, management/labor, technology, management/labor, takeover bids, et. al. can all lead to takeover bids, et. al. can all lead to the price of a stock going up or down.the price of a stock going up or down.

TRADING VOLUME:TRADING VOLUME: shows the total number of shares traded for the day (listed in hundreds); thus 363 would mean 36,300.

When a “z” precedes the volume number, it refers to the actual number. For example, “z20” means 20 shares not 2000.

CURRENT DEBT RATIO:CURRENT DEBT RATIO: A A BALANCE SHEET sets forth the various BALANCE SHEET sets forth the various types of assets and liabilities of the firm.types of assets and liabilities of the firm.

An excess of current assets (cash, An excess of current assets (cash, inventory, accounts receivable) over inventory, accounts receivable) over current liabilities (accounts payable, short-current liabilities (accounts payable, short-term debt, etc.) is viewed as favorable.term debt, etc.) is viewed as favorable.

This information is expressed in a ratio. This information is expressed in a ratio.

A ratio of 1.0 means that assets are A ratio of 1.0 means that assets are equal to liabilities.equal to liabilities.

A ratio greater than 1.0 means that A ratio greater than 1.0 means that assets are greater than liabilities.assets are greater than liabilities.

A ratio less than 1.0 means that assets A ratio less than 1.0 means that assets are less than liabilities.are less than liabilities.

BROKER BROKER RECOMMENDATION:RECOMMENDATION: Financial ideas or suggestions are Financial ideas or suggestions are offered by brokerage firms or brokers offered by brokerage firms or brokers who act as intermediaries between a who act as intermediaries between a buyer and a seller.buyer and a seller.

FACTORS OF FACTORS OF PRODUCTION:PRODUCTION: what a firm uses what a firm uses as resources to produce their goods as resources to produce their goods should be considered when investing in a should be considered when investing in a company.company.

BOOK BOOK VALUE/OVERPRICED?: VALUE/OVERPRICED?: The difference between the firm’s The difference between the firm’s assets and liabilities which determines assets and liabilities which determines what the stockholder owns after all what the stockholder owns after all debts are paid.debts are paid.

To calculate book value use the To calculate book value use the following equation:following equation:

P = PE x EPSP = PE x EPS

P = 15 x 3P = 15 x 3

P = $45P = $45

If the current price of the stock is If the current price of the stock is over $45 per share, it is overpriced.over $45 per share, it is overpriced.

INDUSTRY INDUSTRY CONSIDERATIONSCONSIDERATIONS

INDUSTRY TYPE:INDUSTRY TYPE: A A group of companies that group of companies that produce or sell the same kind of produce or sell the same kind of product or service is called an product or service is called an industry.industry.

GROWTH PROSPECTS:GROWTH PROSPECTS: A common stock that has increased A common stock that has increased in earnings, year-after-year, would in earnings, year-after-year, would indicate that the company is growing. indicate that the company is growing. One hopes that the company will One hopes that the company will continue to grow so that the earnings continue to grow so that the earnings will increase.will increase.

GOVERNMENT POLICIES GOVERNMENT POLICIES AND REGULATIONS:AND REGULATIONS: these may these may encourage or discourage corporate encourage or discourage corporate expansion and growth.expansion and growth.

For example: if the government decides to For example: if the government decides to spend money on defense items, those spend money on defense items, those companies that produce defense-related companies that produce defense-related goods are guaranteed work and usually goods are guaranteed work and usually long-term profits.long-term profits.

LIFE CYCLE:LIFE CYCLE: The firm may be The firm may be young, growing, maturing or failing. young, growing, maturing or failing. Management may use a merger, Management may use a merger, acquisition, new technology, human acquisition, new technology, human resource development and resource development and diversification to revive and renew the diversification to revive and renew the firm if it is in a mature or failing state.firm if it is in a mature or failing state.

THE ECONOMYTHE ECONOMY

INTEREST RATE:INTEREST RATE: the the amount paid for borrowing amount paid for borrowing someone else’s money. It is someone else’s money. It is usually expressed as anusually expressed as an Annual Annual Percentage Rate (APR)Percentage Rate (APR)

INFLATION (CPI):INFLATION (CPI): an an increase in the amount of money in increase in the amount of money in circulation that lowers the value of circulation that lowers the value of money. Inflation results in higher money. Inflation results in higher prices paid for goods and services.prices paid for goods and services.

TheThe CONSUMER PRICE INDEX CONSUMER PRICE INDEX (CPI)(CPI) is used to measure the current is used to measure the current inflation rateinflation rate..

UNEMPLOYMENT:UNEMPLOYMENT: Failure of Failure of the economy to fully employ its labor the economy to fully employ its labor force. The unemployed are people in the force. The unemployed are people in the civilian labor force who do not have jobs civilian labor force who do not have jobs but are actively seeking work.but are actively seeking work.

It is important to note whether unemployment is cyclical, frictional or

structural.

BUSINESS CYCLE (GDP):BUSINESS CYCLE (GDP): the business cycle is divided into four the business cycle is divided into four phases of the economy (peak, phases of the economy (peak, recession, trough, recovery). Therecession, trough, recovery). The GROSS DOMESTIC PRODUCT (GDP)GROSS DOMESTIC PRODUCT (GDP) is a good reference of measurementis a good reference of measurement.

MONETARY POLICY:MONETARY POLICY: considers considers whether the current monetary policy favors whether the current monetary policy favors contraction or expansion of the money contraction or expansion of the money supply. supply.

AA CONTRACTIONARYCONTRACTIONARY policy is when the discount policy is when the discount rate goes up, when the reserve requirement goes rate goes up, when the reserve requirement goes up, or the Fed sells government securities.up, or the Fed sells government securities.

AnAn EXPANSIONARYEXPANSIONARY policy is when the discount policy is when the discount rate goes down, when the reserve requirement rate goes down, when the reserve requirement goes down, or the Fed buys government securities.goes down, or the Fed buys government securities.

FISCAL POLICY:FISCAL POLICY: consider consider whether the current fiscal policy favors whether the current fiscal policy favors contraction or expansion.contraction or expansion.

AA CONTRACTIONARYCONTRACTIONARY policy is when tax policy is when tax rate goes up and/or federal government rate goes up and/or federal government spending goes down.spending goes down.

AnAn EXPANSIONARYEXPANSIONARY policy is when tax rates policy is when tax rates go up and/or federal government spending go up and/or federal government spending goes up.goes up.

THE ENDTHE END

Compiled by:

Virginia Meachum, Economics Teacher

Coral Springs High School

Broward County, Florida

Documents

The Financial System STOCKS, BONDS, MUTUAL FUNDS & OPTIONS ECONOMICS What Does It Mean To Me?