Financial Markets

1

• Financial Markets

Chapter 11
2
The Financial System

• Bear Market
• Investors generally sell because they are
  expecting lower profits
• Bull Market
• Investors usually buy because they are expecting
  higher profits
• Financial Assets
• When savers invest, they receive documents known
  as financial assets.

3
Financial Intermediaries
Financial intermediaries are institutions that
help channel funds from savers to borrowers.
Banks, Savings and Loan Associations Take in
deposits from savers and then lend some of these
funds to various businesses Credit
Unions Member-owned organization to make money
for its members, usually considered
community-based and more interested in doing the
right thing Finance Companies Make loans to
consumers and small businesses, but charge
borrowers higher fees and interest rates to cover
possible losses Mutual Funds Pool the savings of
many individuals and invest this money in a
variety of stocks and bonds usually diversified
with less risk Life Insurance Companies Provide
financial protection to the family, or other
beneficiaries, of the insured. The premium is
usually paid monthly Pension Funds Are set up by
employers who withhold a certain percentage of a
workers salary to deposit in a fund distribute
for payment when the worker retires usually
covers many years
4
Investing

• Financial Planning- financial plans include
  spending and saving plan, investment plan,
  retirement plan, estate plan.
• Important factors in financial planning
• Budget- list of fixed and flexible expenses.
• Fixed Expenses- remain constant from month to
  month.
• Flexible Expenses- can vary from month to month.

5
Your investment Plan

• Stocks are pay the highest reward, but have the
  greatest risk
• You dont want to be risking your money as you
  get older
• The general rule is to subtract your age from 110
  to find the percentage of stocks you should have
  in your portfolio(110 30 80 or 110 55
  55)

Stocks Fixed Income Cash Ave return since 1970
Conservative (50 ) 20 50 30 7.9
Moderate (35-50) 60 35 5 9.8
High risk (under 35) 95 0 5 10.4
6
Risk and Return

• Return and Liquidity
• Savings accounts have greater liquidity, but in
  general have a lower rate of return.
• Certificates of deposit usually have a greater
  return but liquidity is reduced.
• Liquidity is important if you might need quick
  access to the funds

• Return and Risk
• Investing in a friends Internet company could
  double your money, but there is the risk of the
  company failing.
• In general, the higher potential return of the
  investment, the greater the risk involved.

7
Bonds as Financial Assets

• Bonds are basically loans, or IOUs, that
  represent debt that the government or a
  corporation must repay to an investor. Bonds
  have three basic components
• 1. The coupon rate the interest rate that the
  issuer will pay the bondholder.
• 2. The maturity the time when payment to the
  bondholder is due.
• 3. The par value the amount that an investor
  pays to purchase the bond and that will be repaid
  to the investor at maturity.
• Not all bonds are held to maturity. Sometimes
  bonds are traded or sold and their price may
  change. Economists therefore refer to a bonds
  yield, which is the annual rate of return on the
  bond if the bond were held to maturity.

8
How Bonds Work

• Eagle Corporation sells a 4, 20-year, 1,000
  par value bond that pays interest semiannually
• The coupon payment to the holder is 20 every 6
  months (.04 x 1,000, divided by 2)
• When the bond reaches maturity after 20 years the
  debt is retired and the holder gets the par value
  of 1,000
• Bonds can be compared by using the current yield
• (annual interest divided by the purchase price)

9
Bond Ratings

• Standard Poors and Moodys rate bonds on a
  number of factors, including the issuers ability
  to make future payments and to repay the
  principal when the bond matures.
• A high bond rating usually means that the bond
  will sell at a higher price, and that the firm
  will be able to issue the bond at a lower
  interest rate.

10
Advantages and Disadvantages to Bond Issuers

• Bonds are desirable from the issuers point of
  view for two main reasons
• 1. Once the bond is sold, the coupon rate for
  that bond will not go up or down.
• 2. Unlike stock, bonds are not shares of
  ownership in a company so they have a very small
  risk defaulting is the big risk!

• Bonds also pose two main disadvantages to the
  issuer
• 1. The company must make fixed interest payments,
  even in bad years when it does not make money.
• 2. If the issuer does not maintain financial
  health, its bonds may be downgraded to a lower
  bond rating. This makes it harder to sell future
  bonds unless a discount or higher interest rate
  is offered.

11
Types of Bonds

• Savings Bonds
• Savings bonds are low-denomination (50 to
  10,000) bonds issued by the United States
  government. Savings bonds are purchased below
  par value (a 100 savings bond costs 50 to buy),
  interest is paid when bond matures.
• Treasury Bonds, Bills, and Notes
• These investments are issued by the United States
  Treasury Department. The absolute least amount
  of risk!
• Municipal Bonds
• Municipal bonds are issued by state or local
  governments to finance such improvements as
  highways, state buildings, libraries, and
  schools.
• Corporate Bonds
• Issued by a corporation to raise money to expand
  its business.
• Junk Bonds
• Junk bonds are lower-rated, potentially
  higher-paying bonds. (High Risk!!!).

12
Other Types of Financial Assets

• Money Market Mutual Funds
• Investors receive higher interest on a money
  market mutual fund than they would receive from a
  savings account or a CD. However, assets in
  money market mutual funds are not FDIC insured.

• Certificates of Deposit
• Certificates of deposit (CDs) are available
  through banks, which use the funds deposited in
  CDs for a fixed amount of time.
• CDs have various terms of maturity, allowing
  investors to plan for future financial needs.

13
Mutual Funds

• A mutual fund pools investors money.
• The fund puts its investors money into the
  markets on their behalf.
• In effect, investors own small amounts of many
  different assets - diversified.
• Mutual funds enable investors to avoid risk that
  comes from owning any one asset. In other words,
  mutual funds make it easy to diversify.

14
Roth IRA/401(K)

• A Roth IRA is an Individual Retirement Account
  that is usually not taxed
• Must be 59.6 years to withdraw tax-free money
• In 2013-14 tax year0-49 years can contribute -
  5,50050 years can contribute - 6,500
• 401(K) a pension plan in which money is deducted
  from a paycheck before tax (and sometimes by
  employer). Tax is not paid until it is
  withdrawnAnnual pre-tax limit (2013) IS 17,500

15
Stock Exchanges

• The New York Stock Exchange (NYSE)
• The NYSE is the countrys largest stock exchange.
  Only stocks for the largest and most established
  companies are traded on the NYSE.
• NASDAQ-AMEX
• NASDAQ-AMEX is an exchange that specializes in
  high-tech and energy stock.
• The OTC Market
• The OTC market (over-the-counter) is an
  electronic marketplace for stock that is not
  listed or traded on an organized exchange.
• Daytrading
• Daytraders use computer programs to try and
  predict minute-by-minute price changes in hopes
  of earning a profit.

16
Stock Exchanges

• Every country has a stock exchange
• On the NYSE movement is measured by the Dow Jones
  Industrial Average (Dow).

17
How Stocks Are Traded

• Stockbroker is a person who links buyers and
  sellers of stock.
• Stockbrokers work for brokerage firms, or
  businesses that specialize in trading stock.
• Speculation involves picking high-risk
  investments in the hope of a high reward
• Odd lot 1-99 shares
• Portfolio is a collection of financial assets
• Diversification is the key!!!!!

18
(No Transcript)
19
Futures

• Trading of various types of products.
• Ex. wheat, soybeans, oats, corn, steel, coal,
  gold, silver, diamonds, etc.
• High risk investments.
• Contracts where investors give money today for
  the promise of a commodity delivered at a later
  date. Investor hopes that price of the commodity
  will rise and the contract can be resold for a
  profit.

20
Regulating the Market

• Congress is the top regulator
• SEC- securities and exchange commission- set up
  after big stock market crash - 1929 - requires
  that companies who sell stock must meet rigorous
  standards - supply detailed information including
  a prospectus.