C H A P T E R 1 1

FINANCIAL MARKETS

SAVING AND INVESTINGSECTION ONE

A FINANCIAL INTERMEDIARY HELPS CHANNEL FUNDS FROM SAVERS TO

BORROWERS.

ADVANTAGES OF FINANCIAL INTERMEDIARIES

• Share risk (Diversification): they pool your money with other people’s investments to reduce the risk that you lose all of your investment.• Provide information: give investors a

report called a prospectus that shares information about potential investments• Provide liquidity: An investor’s assets

can be easily turned into cash

RISK, LIQUIDITY, AND RETURN

Savings Account

• Liquid

• Low Risk

• Low Return

Certificate of Deposit (CD)

• Not Liquid

• Low Risk

• Medium Return

Investing in a New Business

• Not Liquid

• High Risk

• High Potential

Return

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• Banks, Savings & Loans, Credit Unions: take deposits from savers, then lend some of the funds to businesses and individuals

• Finance Companies: make loans to consumers and small businesses

• Mutual funds: pool the savings of many investors and invest in a variety of stocks, bonds, and other financial assets

• Life Insurance Companies: provide financial protection for the family or beneficiary of the insured; policies pay money to survivors; companies lend out part of the premiums they receive

• Pension funds: collect deposits and distribute payments; managers invest deposits; employees pay into such funds which provide income after retirement

BONDS AND OTHER FINANCIAL ASSETS

SECTION TWO

THREE COMPONENTS OF BONDS

• Coupon rate: the interest rate paid to the bondholder•Maturity: time at which payment to the bondholder is due• Par value: amount an investor pays to purchase a bond, and that will be repaid at maturity

WHY DO COMPANIES ISSUE BONDS?

Advantages

• Coupon rate will not change once the bond is sold.• Bondholders do not own part of the company, so they will not have to share profits

Disadvantages

• Company must make fixed interest payments even if they don’t do well• Bonds may be downgraded to a lower rating making them harder to sell

OTHER FINANCIAL ASSETS

•Certificate of Deposit: attractive to small investors because they cost as little as $100.•Money Market Mutual Funds: offer higher interest than savings accounts, but are not protected by FDIC insurance

THE STOCK MARKETSECTION THREE

BUYING STOCK

Advantages• Dividends• Capital gains • Stock splits

Disadvantages• Lower profits than

expected• Capital loss• Bankruptcy

(Stockholders paid last)