Chapter 11
Financial Markets and
Investing
Investing
 Investing
– the act of redirecting
resources from consumption today
so that they may create additional
benefits in the future
 Investment sacrifices spending
today to have more in the future
 In
Saving
the end, saving your money is
really lending it to others
 The people you place your money
with are called financial
intermediaries – they channel
funds from savers to borrowers
Types of Financial Intermediaries
 Banks,
S&Ls, and Credit Unions –
take deposits and loan out the
money
Types of Intermediaries
 Mutual
Funds – take the savings
of many individuals and place
them in a variety of stocks and
bonds
 Life Insurance Companies –
collect premiums (fees) from
many savers, and guarantee
financial protection to family
members who lose someone
Types of Intermediaries

Pension Funds – collect funds from many
employees, then pay pensions to
employees who retire


These funds usually invest the money paid in
401(k) – Retirement account where you
save and invest part of your paycheck

Employers will usually match what you put in,
to a certain point
Sharing Risk
 It’s
a bad idea to place all of your
financial faith in one place – you
might lose everything!
 Diversification – spreading out
investments to reduce risk
Typical Risk Model
80
70
60
50
Stocks
Bonds
Banks
40
30
20
10
0
20
40
60
Other Key Terms
 Portfolio
– collection of financial
assets
 Prospectus – an investment report
provided by your intermediary
 Liquidity – the ease with which
you can convert assets into cash
 Return – money you make on the
investment
 Many
Return vs. Liquidity
times, investment decisions
depend on what you value more
of the two
 Assets that can become cash
easily often have a low return
 Assets that have a high return are
difficult to convert into cash
quickly
Return vs. Risk
 Assets
that have a high potential
return are usually very risky
 Assets that have low risk usually
provide a low potential return
Bonds
 Bond
– a piece of paper signifying
a loan given to the government or
a corporation
 Bonds pay the investor (or lender)
a fixed interest rate for a certain
amount of time
 Generally low risk, low return
3 Components of Bonds
Coupon Rate – interest rate the bond
issuer will pay
 Maturity – the time at which payment to
the bondholder is due (usually 10 to 30
years)
 Par Value – the amount the investor
pays to purchase the bond, to be paid
back upon maturity

Bond Ratings
Standard & Poor’s and Moody’s rate
bonds based on their assessment of
the issuer’s ability to repay the loan
 Letter grade system: AAA is best, D
means company is in default
 Higher risk bonds usually offer a
higher interest rate

That’s all well and
good, but how do
bonds work?
How Bonds Work
2
different ways
 Corporate bonds, treasury
bonds, and municipal bonds
Pay you the % interest of the
bond each year, then give you
the par value at maturity
How Bonds Work
2
different ways
 Savings bonds
Bond grows in value over time
and can be redeemed for
twice the value at maturity
Types of Bonds
 Savings
Bonds – issued by the
U.S. government to finance their
debt
 Treasury Bonds – like a corporate
bond from the U.S. government,
and tax free
Types of Bonds
Municipal Bonds – issued by the city to
pay for parks or libraries, etc.
 Corporate Bonds – cannot guarantee
repayment, but have a higher interest
rate than U.S. gov’t bonds
 Junk Bonds – Higher risk, higher
return corporate bonds (rated BBB or
lower)

 Still
lower risk than most stocks, though
With Members of the U.S. Congress
How do you Profit?
2
Ways to Profit:
 Dividends – some corporations pay
part of their profits out to
stockholders quarterly (4 times a
year)
 Capital Gains – selling the stock for
more than you paid for it
How do you Profit?
 If
you are interested in receiving
dividends, you should buy income
stock
 If
you’re more interested in capital
gains, you should buy growth stock –
pays no dividend
Stock Split
 Companies
can decide to split
stocks – double the number of
shares, while cutting their value in
half
 50 shares worth $20 each
becomes 100 shares worth $10
each
 In both situations, the stock is
worth a total of $1,000
How do you buy Stock?

Must go through a
brokerage firm –
they are licensed by
the SEC to conduct
stock trades

Stockbroker – a
person who links
buyers and sellers of
stock
Examples of Brokerage Firms


Examples: Charles
Schwab, Edward Jones,
Merrill Lynch, Smith
Barney, AIG
Online Brokerages: TD
Ameritrade, Scottrade,
ETrade, Fidelity (do it
yourself, but reduced
commission)
Stock Exchanges
Stock Exchange – market for buying
and selling stock
 Newspapers and websites publish
information on what happens in the
major stock exchanges

Major Stock Exchanges
 New
York Stock Exchange (NYSE)
– largest and most powerful
companies
 NASDAQ – specializes in tech
companies, usually higher risk
than NYSE
Major Stock Exchanges
 The
OTC Market – “over the
counter”
 Not
an actual stock exchange
 Traded through an electronic
marketplace
 Mostly new and growing companies
 Most stocks traded this way
Futures and Options
 Futures
– contracts to buy or sell
a particular commodity on a
specific date in the future at a
price set today
 Investors may buy futures now,
hoping the price of the
commodity will rise before they
must sell it
Futures and Options
 Options
– contracts that give
investors the choice to buy or sell
stock and other financial assets
LATER for TODAY’S price
 Call Option – choice to buy
 Put Option – choice to sell
Measuring Stock Performance
 “Bull
Market” – stock market is
rising steadily
 “Bear Market” – stock market is
falling
 1980’s and 1990’s were the
longest sustained bull markets in
U.S. history
The Dow Jones Industrial Average
What is the
deal with the
Dow?
 Shows the
performance of 30
stocks from various
industries as a
representation of the
whole market
The S&P 500
 Just
like the Dow Jones, but uses
500 different companies
 Mostly NYSE stocks, but also
some from NASDAQ-AMEX and
OTC