Financial Markets
Overview
IEMS 326
Why this Lecture?
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Goals:
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financial literacy
financial numeracy
Will this be on the exam?
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Yes.
Know definitions
Primary vs. Secondary markets
Stocks vs. Flows vs. Trades
Know orders of magnitude, relative sizes.
Market functions
Debt versus Budget
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What’s bigger, the debt or deficit of the US?
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U.S. federal debt: over $11T
U.S. federal deficit 2009: about $1½T
In general, distinguish among 3 things:
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stocks—e.g. how much has been invested?
flows—an increase or decrease in stocks
trades—exchanges of ownership
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(may not affect the real economy)
Debt, Deficit, Bonds
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The U.S. federal debt is a…
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The U.S. federal deficit is a…
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stock—total amount borrowed
flow—this year’s increase in the debt
When I buy a U.S. Treasury bond, it’s a…
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trade—if I buy it from you
flow—if I buy it from the U.S. Treasury
Budgets
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The U.S. federal budget is…
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about $3T
about twice the U.S. federal deficit
about $10K per person (population ~300M)
Illinois has population ~13M and its state
budget is…
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about $50B
about $4K per person
Budgets
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The City of Evanston’s budget is…
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$191M
about $2.5K per person (population ~75K)
Northwestern’s budget is…
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$1.6B
about $100K per student (~16K students)
Values of Investments
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What’s worth more, American Airlines or
Northwestern’s endowment?
Our endowment: about $6B (~$400K/student)
American Airlines (AMR):
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market capitalization $2.1B
= (# shares of stock)*(price of a share)
= 333M shares * $6.33/share
Shareholding and Market Cap
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If I buy 333 shares of American Airlines…
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If NU tries to buy all 333M shares…
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a trade on the NYSE stock exchange
…I’ll own 1 millionth of the corporation
the price would probably go up
Market capitalization: valuation of the whole
company based on small trades now.
Typical share prices
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From $1 to $100s
Not too low…
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(penny stocks)
…or too high!
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Berkshire Hathaway
How to make money in stocks
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buy low
sell high
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When the share price goes up, (trade)
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…or collect dividends
the company is more expensive
shareholders are happy
real economy vs. financial trades
Primary&Secondary Equity Market
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primary equity market: (flow)
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e.g. initial public offering (IPO)
Google issued new shares
sold them to investors for $30B
invested $30B in cool stuff
secondary equity market (exchanges): (trade)
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$36.6T total
shares and $$ change hands
brokers get ¢ (~0.1% of value)
Bond Market
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primary bond market:
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U.S. Treasury or G.E.
borrows money by issuing
bonds to investors
secondary bond market:
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bonds and $$$ change hands
brokers get $ (1-2% value)
trades: $1T/day
Global Bond Market
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$80T oustanding
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(stock)
about $13K/person
Foreign Exchange Market
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currency: trade $ for euros
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trades: about $3T/day
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open 24/7
about $500/person/day
about $200K/person/year
purposes:
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international trade
hedging
speculation
Foreign Exchange Market
Commodities Markets
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spot vs. futures
exchanges:
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pork bellies
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CME/CBoT
NYMEX, etc.
20 tons, frozen
physical delivery
hedging, speculation
Derivatives
Backup slides
How companies make money
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successful business projects…
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create positive earnings
increase book value
make it possible to pay higher dividends
real economy vs. financial trades
Bonds issued
Nationality of bond issuer
Nationality of bond holder
Government Bonds
Bond market
Foreign Exchange Market: What?
Foreign Exchange Market: Where?