Financial Markets

Saving and Capital Formation

•Saving money makes economic growth possible

•One’s person savings can represent another person’s loan

•Savings make investments possible

Financial Assets and the Financial System

•Consist of a network, including –Savers –Investors–Financial institutions –Work together to Transfer savings to investors

•Financial assets –Claims on the property and the income of the borrower

–Open a Savings accounts –Certificates of deposits–Government bonds –Corporate bonds

Financial Assets and the Financial System

• Financial Intermediaries– Financial institutions that bring together

savers and lenders • Commercial banks • Savings and loan Asso. • Savings bank • Mutual savings banks • Credit unions• Life insurance companies • Mutual funds • Pension Funds • Real Estate Investment Trust • Finance Companies

Financial Assets and the Financial System

Circular flow of funds: shows how funds are transferred from savers

to borrowers • Any part of the economy can supply

and borrow savings • Largest Borrowers = Government and

businesses

Nonbank Financial Intermediaries

• Non-depository institutions that channel savings to borrowers – Finance companies – Life Insurance – Mutual Funds – Pension Funds – Real Estate Investment Trust

Investment Strategies and Financial Assets

Basic Investment Considerations

•Risk: a situation in which the outcome is not certain but can be estimated –Higher risk = higher rate of return

–Low risk = lower rate of return

• Investments depends on goals of the investor – Consistent investment can yield

large returns– Avoid complex investments

•401K Plan: tax deferred investment plan that acts as a personal pension fund for employees

Basic Investment Considerations

Basic Investment Considerations

Bonds as Financial Assets

• Three main components – The Coupon: stated interest on debt – The Maturity: life of the bond – The par value: principal or the total amount

initially borrowed that must be repaid at maturity

• Prices are determined by supply and demand

• Yield = annual interest rate divided by the purchase price

Bond Ratings

• Rated on – the financial health of the investor– The ability to make future coupon – Principal payments – Issuer’s past credit history

• Range from D (lowest) to AAA (highest)

• Default = the issuer has not kept up with the interest of the par value payments

Financial Assets and Their Characteristics

• Most common form of investment = Certificates of deposit

• Corporate Bonds– Issued by corporations– Usually used for long term

investment

• Municipal bonds – Issued by the state and local gov’t – Safe, tax exempt investment

• Savings bonds – Low-denomination, non-

transferable – Issued by federal gov’t – Virtually no risk

• Treasury and Bonds– Long-term obligations – Issued by fed gov’t – Safest of all financial assets

Financial Assets and Their Characteristics

• Treasury Bills – Short-term obligations – Issued by federal gov’t

• Individual Retirement Accounts (IRA’s) – Long-term – Tax sheltered time deposits – Intended for retirement

Financial Assets and Their Characteristics

Markets for Financial Assets

• Capital markets: money is loaned for more than one year

• Money Markets: money is loaned for more less one year

• Primary Markets: only the original issuer can repurchase or redeem a financial asset

• Secondary Markets: financial assets can be resold to new owners

Figure 12.6Financial Assets and Their MarketsFigure 12.6Financial Assets and Their Markets

Markets for Financial Assets

Investing in Equities, Futures, and Options

Market Efficiency

• Efficient Market Hypothesis (EMH)– Argument that stocks are always

priced about right and that bargains are hard to find

– It is not possible to “beat the market” regularly

– Investors should diversify their portfolios

– Or enlist the assistance of a stock broker

Organized Stock Exchanges

• New York Stock Exchange (NYSE)– List share of 2,800 large companies – 1,400 seats or memberships

• American Stock Exchange (AMEX)– List shares of 750 companies

• Regional Stock Exchanges– list shares too small or to new to be

listed on NYSE or AMEX

• Global Stock Exchange– Include stock exchanges around the world

Over the Counter Markets (OTC)

• Electronic Marketplace for securities not traded on an organized exchange – I.E. National Association of

Securities Dealers Automated Quotation (NASDAQ)

– List information on companies traded on (OTC)

Measure of Stock Performance

• Dow-Jones Industrial Average (DJIA)– Index made up of 30 stocks – Most popular and widely publicized

measure of stock market performance on the NYSE

• Standard & Poor’s 500– Index made up of 500 representative

stocks• Bull Market: prices are rising • Bear Market: prices are falling

Trading in the Future

• Spot Market – “Spot” meaning immediate – Transactions are made at the

prevailing price– Futures contract– Futures market

Trading in the Future

• Option Market – Put and Call options are bought

and sold – Call option

•Gives the owner the right to buy at a specific price in the future

– Put option •Gives the owner the right to sell at a specific price in the future