Smart InvestingEmmet O’Neal LibraryMountain Brook, AL

Introduction to Financial Markets

Objectives

• Understand relationship between risk and return

• Learn about U.S. financial markets and investment products

• What affects market prices

• Government regulation of financial markets

Risk and Reward

• The bigger the risk the bigger the potential payoff.

Investment Risks• Interest Rate risk

– Risk of change in asset value due to change in interest rates• Business Failure risk

– Risk that the business will fail • Market Price risk

– Risk that the market price of the investment drops• Inflation risk

– Risk that return on an investment will lose purchasing power• Political risk

– Risk of government actions negatively affecting the value of the investment

• Fraud risk– Investment is designed to deceive or misrepresent facts

How Financial Markets Work• Financial markets is where people and money

come together

• Supply and demand─ Demand is the quantity of goods that consumers want to

purchase─ Supply is the quantity of goods available for consumers

to purchase─ If supply outweighs demand the price of a good will go

down and vice versa

Exchanges• Exchanges serve as central locations

where buyers and sellers meet• Can be a physical location or a network of

computers• Several exchanges make up the stock

market− New York Stock Exchange (NYSE)− Nasdaq stock market

• Private companies are not traded on exchanges

The Market Meets the Web

• Investing can take place online• Need to be informed

– Know the investment you purchase– Know the ground rules of the market– Know the level of risk

• It’s easier to lose than to make money through a click of a button

Saving• Returns for saving at a bank are low, so is the risk• Most accounts are insured by the FDIC or NCUA• Certificates of deposit (CD)

– Specific amount of money at a fixed interest rate over a specified period of time

– The longer the time frame the higher the interest rate– CDs are insured up to a certain amount if the financial

institution where they were purchased is a member of the FDIC or NCUA

Stocks• Stocks represent a partial ownership of a company• Common stocks versus preferred stocks

– Common stock carries a voting right– Preferred stock does not carry a voting right, but normally

receive a fixed dividend– Preferred shareholders need to be paid before common

shareholders

• Stock price– Amount paid for one share of stock

• Dividends– Distribution of a company’s profit– Generally paid quarterly

Different Kinds of Stock• Different size classifications:

• Growth stocks• Income stocks• Blue chips• Value stocks

Classification Market Capitalization Example Mega Cap Greater than $200 Billion Exxon Mobil Large Cap Greater than $10 Billion IBM Mid Cap Between $2 Billion and $10 Billion Vulcan Materials

Small Cap Less than $2 Billion Panera Bread Company Micro Cap Between $50 Million and $300 Million Reddy Ice

Nano Cap Less than $50 Million Autobytel

Bonds• Loans given to a company or a governmental entity• Bond prices fluctuate with interest rates• Types of bonds

– Municipal bonds– Treasury bonds– Federal agency bonds– Corporate bonds– Asset backed securities

• Bonds are traded in the over the counter market• Quoted in percent of face value

Mutual Funds• Invests pooled money in various types of

investments– Fund manager buys and sells on behalf of the fund’s

shareholders– The price of a share of a(n) (open end) mutual fund is

called its net asset value (NAV)

• Benefits of mutual funds– Diversification– Professional management– Liquidity

• Commissions and fees– “12(b)-1 fee”

Derivatives

• Financial instrument whose value depends on the value of a another asset

• Speculative investment• Need to be a knowledgeable investor who is willing

to take high risk• Have to be prepared to lose all of their investment

Moving Markets• Values of investment securities rise and fall

• Five important factors– Investor action– Business conditions – Government actions– Economic indicators– International events and conditions

Regulation of Financial Markets• State regulation• Federal regulation

– Securities and Exchange Commission (SEC)– Security Investors Protection Corporation (SIPC)– Commodity Futures Trading Commission (CFTC)

• Self Regulatory Organizations (SRO)– Financial Industry Regulatory Authority (FINRA)– National Futures Association (NFA)