Financial MarketsFinancial Markets

Chapter 12Chapter 12

Savings and the Financial SystemSavings and the Financial System

Section 1Section 1

Saving and Capital FormationSaving and Capital Formation

Saving money makes economic growth Saving money makes economic growth possible.possible.

One person’s savings can represent One person’s savings can represent another person's loan.another person's loan.

Savings make investments possible.Savings make investments possible.

Financial Assets and the Financial Financial Assets and the Financial SystemSystem

A financial system consists of a network of A financial system consists of a network of savers, investors, and financial institutions savers, investors, and financial institutions that work together to transfer savings to that work together to transfer savings to investors.investors.Financial assets include savings accounts, Financial assets include savings accounts, certificates of deposit, and government certificates of deposit, and government and corporate bonds. and corporate bonds. Financial assets represent claims on the Financial assets represent claims on the borrower.borrower.

Financial intermediaries are financial Financial intermediaries are financial institutions that bring together savers and institutions that bring together savers and lenders.lenders.The circular flow of funds shows how The circular flow of funds shows how funds are transferred from savers to funds are transferred from savers to borrowers.borrowers.Any part of the economy can supply and Any part of the economy can supply and borrow savings, but governments and borrow savings, but governments and businesses are the largest borrowers.businesses are the largest borrowers.

Nonbank Financial IntermediariesNonbank Financial Intermediaries

Nonbank financial institutions are nondepository Nonbank financial institutions are nondepository institutions that channel savings to borrrowers. institutions that channel savings to borrrowers.

Finance companies buy installment contracts Finance companies buy installment contracts from merchants, who sell goods on credit, and from merchants, who sell goods on credit, and make the loans directly to consumers.make the loans directly to consumers.

Many finance companies offer bill consolidation Many finance companies offer bill consolidation loans to consumers who use these loans to pay loans to consumers who use these loans to pay off other bills immediately, and then pay off the off other bills immediately, and then pay off the finance company over time.finance company over time.

Life insurance companies can then invest Life insurance companies can then invest these funds with institutions.these funds with institutions.

Mutual funds are companies that sell Mutual funds are companies that sell shares of their own stock to individual shares of their own stock to individual investors and invest the money they investors and invest the money they receive in corporate stocks and bonds.receive in corporate stocks and bonds.

Mutual funds give people the ability to Mutual funds give people the ability to invest in the market at low risk.invest in the market at low risk.

Pension funds receive money from Pension funds receive money from employers and invest the money in employers and invest the money in corporate stocks and bonds to be corporate stocks and bonds to be disbursed among the employees eligible disbursed among the employees eligible for retirement, old-age, or disability.for retirement, old-age, or disability.

Real estate investment trusts (REIT) Real estate investment trusts (REIT) borrow money from banks and lend to borrow money from banks and lend to construction companies that build homes.construction companies that build homes.

Investment Strategies and Investment Strategies and Financial AssetsFinancial Assets

Section 2Section 2

Basic Investment ConsiderationsBasic Investment Considerations

High risk investments pay higher rates of High risk investments pay higher rates of return than low risk investments.return than low risk investments.

The type of investment chosen depends The type of investment chosen depends on the goals of the investor.on the goals of the investor.

Consistent investing can yield large Consistent investing can yield large returns/returns/

Investors should avoid complex Investors should avoid complex investments they do not understand.investments they do not understand.

A 401 (k) plan is a tax-deferred investment A 401 (k) plan is a tax-deferred investment plan that acts as a personal pension fund plan that acts as a personal pension fund for employees.for employees.

Bonds as Financial AssetsBonds as Financial Assets

Bonds have three main components: the Bonds have three main components: the coupon, the maturity, and the par value.coupon, the maturity, and the par value.

Bond prices are determined by supply and Bond prices are determined by supply and demand.demand.

The current yield on a bond is the annual The current yield on a bond is the annual interest rate divided by the purchase interest rate divided by the purchase prince. prince.

Bond RatingsBond Ratings

Most bonds are rated on the financial health of Most bonds are rated on the financial health of the issuer, the ability to make future coupon and the issuer, the ability to make future coupon and principal payments, and the issuer’s past credit principal payments, and the issuer’s past credit history.history.

Bond ratings, ranging from D (lowest) to AAA Bond ratings, ranging from D (lowest) to AAA (highest), indicate the quality of the bond.(highest), indicate the quality of the bond.

If a bond is in default, it means the issuer has If a bond is in default, it means the issuer has not kept up with the interest or the par value not kept up with the interest or the par value payments.payments.

Financial Assets and Their Financial Assets and Their CharacteristicsCharacteristics

Certificates of deposit are issued by financial Certificates of deposit are issued by financial institutions and are the most common form of institutions and are the most common form of investments available.investments available.

Corporate bonds are issued by corporations and Corporate bonds are issued by corporations and are usually used for long-term investment are usually used for long-term investment because they can be liquidated quickly.because they can be liquidated quickly.

Municipal bonds are bonds issued by state and Municipal bonds are bonds issued by state and local governments and are regarded as a safe, local governments and are regarded as a safe, tax-exempt investment.tax-exempt investment.

Savings bonds are low-denomination, Savings bonds are low-denomination, nontransferable bonds issued by the federal nontransferable bonds issued by the federal government and are very attractive because government and are very attractive because they have a virtually no risk of default.they have a virtually no risk of default.

Treasury notes and bonds are large long-term Treasury notes and bonds are large long-term obligations issued by the federal government obligations issued by the federal government and are seen as the safest of all financial assets.and are seen as the safest of all financial assets.

Treasury bills are large short-term obligations Treasury bills are large short-term obligations issued by the federal government.issued by the federal government.

Individual Retirement Accounts (IRAs) are Individual Retirement Accounts (IRAs) are long-term, tax-sheltered time deposits long-term, tax-sheltered time deposits intended for retirement.intended for retirement.

Markets for Financial AssetsMarkets for Financial Assets

Capital markets are markets in which money is Capital markets are markets in which money is loaned for more than one year.loaned for more than one year.

Money markets are markets in which money is Money markets are markets in which money is loaned for less than one year.loaned for less than one year.

Primary markets are markets in which only the Primary markets are markets in which only the original issuer can repurchase or redeem a original issuer can repurchase or redeem a financial asset.financial asset.

Secondary markets are markets in which Secondary markets are markets in which financial assets can be resold to new owners.financial assets can be resold to new owners.

Investing in Equities, Futures, and Investing in Equities, Futures, and OptionsOptions

Section 3Section 3

Market EfficiencyMarket Efficiency

The Efficient Market Hypothesis states The Efficient Market Hypothesis states that it is not possible to “beat-the-market” that it is not possible to “beat-the-market” regularly.regularly.

Instead of trying to beat the market, Instead of trying to beat the market, investors should diversify their portfolios investors should diversify their portfolios by holding a large number of stocks, or by holding a large number of stocks, or enlist the assistance of a stockbroker.enlist the assistance of a stockbroker.

Organized Stock ExchangesOrganized Stock Exchanges

The New York Stock Exchange (NYSE) lists the The New York Stock Exchange (NYSE) lists the shares of more than 3,000 large companies, and shares of more than 3,000 large companies, and has 1,400 seats or memberships with access to has 1,400 seats or memberships with access to the trading floor.the trading floor.The American Stock Exchange (AMEX) lists the The American Stock Exchange (AMEX) lists the shares of about 1,000 companies. Regional shares of about 1,000 companies. Regional stock exchanges list shares that are too small or stock exchanges list shares that are too small or too new to be listed on the NYSE or the AMEX.too new to be listed on the NYSE or the AMEX.Global stock exchanges include stock exchange Global stock exchanges include stock exchange around the world.around the world.

The Over-the-Counter MarketThe Over-the-Counter Market

Most shares are not traded on exchanges Most shares are not traded on exchanges but in electronic over-the-counter (OTC) but in electronic over-the-counter (OTC) trades. trades.

NASDAQ lists information on companies NASDAQ lists information on companies traded OTC.traded OTC.

Measures of Stock PerformanceMeasures of Stock Performance

The Dow-Jones Industrial Average is an The Dow-Jones Industrial Average is an index made up of 30 stocks.index made up of 30 stocks.

Standard and Poor’s 500 is an index made Standard and Poor’s 500 is an index made up of 500 representative stocks.up of 500 representative stocks.

A bull market is a market in which prices A bull market is a market in which prices are rising; a bear market is a market in are rising; a bear market is a market in which prices are falling.which prices are falling.

Trading the FutureTrading the Future

A spot market is a market in which A spot market is a market in which transactions are made at the prevailing transactions are made at the prevailing price.price.

A futures market is a market in which A futures market is a market in which futures contracts are bought and sold.futures contracts are bought and sold.

Futures contracts are agreements to sell Futures contracts are agreements to sell at a specific date at a predetermined price.at a specific date at a predetermined price.

An options market is a market in which put An options market is a market in which put and call options are bought and sold.and call options are bought and sold.

A call option gives the owner the right to A call option gives the owner the right to buy a share of stock at a specified price buy a share of stock at a specified price some time in the future.some time in the future.

A put option gives the owner the right to A put option gives the owner the right to sell a share of stock at a specified price in sell a share of stock at a specified price in the future.the future.