Chapter 26

Saving, Investment, and the

Financial System

I. O. UI Owe YouPromises

Name Amount

DateSignature

Promissory Note

Trading paper for paper

I.O. U.

10 SARDr. Gale

Financial System

Institutions that match people who save

money with people who need money

Financial Instruments

I.O.UsSimple to Complex

RelationshipContract

Financial System

Two categories

Financial Markets

Financial Intermediaries

Financial Markets

Bond Market

Stock Market

Financial Markets

Bonds - Borrow - Debt

Stocks - Sell OwnershipsEquity

Bond Markets

What is a Bond?

Certificate of Indebtedness

Riyadh Pizza Company

Saudi Style Supreme

Riyadh Pizza Company

Borrowor

Sell ownership shares

Riyadh Pizza Company

Bond

100Riyals

Dr. GaleCEO

10% 2023

Pays 10 Riyals each yearPays 100 riyals at maturity

2014Coupon

2015Coupon

2016Coupon

2017Coupon

2018Coupon

2019Coupon

2020Coupon

2021Coupon

2022Coupon

2023Coupon

Bond

Term - Length of time

Credit Risk - chance of default

Tax - How is the interest or profit taxed

Stock

Ownership ShareCompany sells once

Then resold to other buyersLimited Liability

No promises of profitEquity position

Riyadh Pizza Company

Need to raise 1,000 SAR

Create 1,000 shares and sell for 1 SAR each

Each share is worth 1/1,000 of the company

Riyadh Pizza Company

Stock Certificate

One Share

Dr. GaleCEO

Current Share Owner: Prince Alwaleed

Stock Markets

“Circulation”169 Companies

http://en.wikipedia.org/wiki/Tadawulwww.tadawul.com

Stock Valuation

Share PriceDividend

Price-Earnings Ratio

Share Price

Every time a share sells it sets the current price

Share prices go up and down

Dividend

Company Earnings or Profits

Declare dividendKeep - Retained Earnings

Dividend

Earnings: 500Dividend: 300Retained Earnings: ?

Price - Earnings Ratio

P/E Ratio

Current Share Pricedivided by

Earnings last year

P/E Ratio

Current Share Price: 75

Earnings last year: 5

P/E Ratio: ?

P/E RatioPrice

Last SaleEarnings

Last 12 monthsP/E

Ratio

Equation Earnings x P/E Ratio Price ÷ P/E Ratio Price ÷ Earnings

Apple 460 44

Google 792 24.8

STC 12.4

10.45

31.93

62

Financial Intermediaries

Banks

Mutual Funds

Banks

SaversBorrowe

rs

Bank Pays5%

Bank Charges7%

Make moneyon spread

7% - 5% = 2%

We are rich today because

people yesterday were willing to save and not consume

Mutual Funds

Allows small investors to pool and diversify

their savings

460 792 40

smallsavers

323

smallsavers

323

smallsavers

323

smallsavers

323

Mutual FundTotal:1292

Index Fund

Buy one share of all the companies in the

market

Tadawul All Share Index (TASI)

Exchange IndexesDow Jones Industrial Average

(DJIA)30 biggest U.S. Companies

S&P 500500 biggest U.S. companies

Tadawul All Share Index (TASI)

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

0 100 200 300 400 500 600 700 800 900 1000

InterestProfitRate

%

Loanable Funds

Supply

Demand

Market for Loanable Funds

Intellectual

Financial Physical

Human

Culture

Entrepreneur

trust knowledge skills personality health relationships

natural resources time buildings equipmentthings than make things

money and risksavers and borrowers time is money

(1+r)n

insurance   limited liability corporations

ideas technologymethods