Financial Markets
Chapter 11
BELLRINGER

What would you do if you suddenly received a cash
payment of $100,000 that you were not expecting
and didn’t need to fulfill your daily expenses?
Section 1 – Saving and Investing
Investing in Free Enterprise
 The Financial System

 Financial
Assets
 The Flow of Savings and Investment

Financial Intermediaries
 Sharing
Risk
 Providing Information
 Providing Liquidity

Risk, Liquidity, and Return
 Return
and Liquidity
 Return and Risk
Investing and Free Enterprise

Investment: redirecting resources from being
consumed today so that they may create
benefits in the future. The use of assets to
earn income or profit
Investing and Free Enterprise

Spend money today to earn money in the
future
 Going
to college to get a “better job”
 Expanding
 Building
manufacturing for a new product
a dam for a hydroelectric plant
Investing and Free Enterprise

Consumer spending vs Consumer savings
 People
depositing money into savings accounts
so banks can lend to businesses to grow and
expand

New jobs and better products are created
The Financial System

Financial System: a system in which there is a
transfer of money between savers and
borrowers

Financial Assets: claim on the property or
income of a borrower
A
way to indicate ownership of owning a
money device
The Financial System

Savers
 Households,
 Make
individuals, and businesses
deposits to Financial Institutions
 Receive
financial assets
The Financial System

Financial Institutions
 Banks,
 Make
Credit Unions, Finance Companies, etc
loans to investors
The Financial System

Investors
 The
borrowers
 Government
 Build
and Business
roads, factories, homes etc
 Develop
new products, markets, or services
Financial Intermediaries

You can obtain a direct link between savers in
borrowers

Financial Intermediaries: institution that helps
channel funds from savers to borrowers
Financial Intermediaries


Banks, Savings and Loan Associations and
Credit Unions
 Take
deposits from savers
 Lend
out money to businesses and individuals
Finance Companies
 Higher
risk lending companies
 People
who typically cannot meet the standards
to borrow from a Bank, S&L or CU
Financial Intermediaries

Mutual Funds
 Pool
savings of many and invest in stocks, bonds
or other financial assets
 Allow for a broad range of investments
 Diversification

Life Insurance Companies
 Financial
protection for a family for the death of a
family member
 Customers pay “premiums”
 Lend premiums to investors for return
Financial Intermediaries

Pension Fund
 Income
a retiree receives after working a certain
number of years
 Withholding
of a portion of your pay
Financial Intermediaries

Why have Financial Intermediaries?
 Share
Risk
 Provide
information
 Provide
liquidity
Financial Intermediaries

Sharing Risk
 50%
of new business fail
 Reduce
the risk of losing your entire investment
 Diversification:
reduce risk
spreading out investment to
Financial Intermediaries

Providing information
 Monitoring
 Classify
 Saves
borrowers spending and income
borrowers based on risk of default
individuals the time to research individual
borrowers
Financial Intermediaries

Providing Liquidity
 Matching
together)
 Investing
 Allow
investors (bringing borrowers and sellers
in mutual funds vs buying a Picasso
you to sell and receive cash upfront instead
of waiting for a buyer
Risk, Liquidity and Return

Tradeoffs in investing
 Placing
money in a savings account for the
convenience and access, despite lower rate of
return
 Using
a CD to earn a higher rate but having
limited access in an emergency
 Weighing
the return against the loss of liquidity
Risk, Liquidity and Return

Placing your money in a bank account that is
insured with a lower rate of return?

Using your money to invest in a new business?

Higher potential return, the greater the risk
Bonds as Financial Assets

A business can obtain money by borrowing

When a business or government borrows
money, they issue bonds

Bonds
 Low
risk
 Low
interest rate (relatively)
Bonds as Financial Assets

Three Components of Bonds
 Coupon
Rate
 Maturity
 Par
Value
Bonds as Financial Assets

Coupon Rate
 Interest
rate that a bond issuer will pay to a
bondholder

Maturity
 The
due

time at which payment to a bondholder is
Par Value
 The
amount that an investor pays to purchase a
bond and that will be repaid to the investor at
maturity
Bonds as Financial Assets

A business needs $1,000
 The
issue a bond for $1,000
 Set
an interest rate of 5%
 The
Bond will mature in 10 years
Bonds as Financial Assets




Mary takes $1,000 out of her savings account
paying 1% interest to buy a bond at 5%
She will receive interest payments of $50 each year
(5% of $1,000) for 10 years
At the end of 10 years, she will receive her final
payment of $50 + her initial investment of $1,000
In total, she will earn $500 in 10 years and get back
what she put in of $1,000
Bonds as Financial Assets

What was the coupon rate?

What is the maturity?

What is the Par Value?
Bonds as Financial Assets

Buying bonds at a discount
 Selling/Buying
 Interest

a bond less than par value
rate increase, sell/buy at a discount
If $1,000 bonds go from 5% to 6%, you would
buy the 6% bond
 Selling/Buying
at a discount is an incentive to
buy the lower rate bond
Bonds as Financial Assets

Bond Ratings
A
way to measure the risk of a bond
 AAA --- highest rating
 D --- Bond in Default
Triple A Bonds (AAA) pay lowest interest
rate
 May sell “above par”
 BBB bonds are riskier and pay higher
interest rate
 May sell “below par”

Bonds as Financial Assets

For an investor, bonds are relatively safe

Advantages to the issuer
 Locked
 Does

in interest rate
not give up ownership
Disadvantages to the issuer
 Must
make fixed interest payments/cannot
change
 Poor
financial health, bonds are downgraded
Types of Bonds

Savings Bonds

Treasury Bonds, Bills and Notes

Municipal Bonds

Corporate Bonds

Junk Bonds
Types of Bonds

Savings Bonds
 Low
denomination bond issued by the US
Government
 Government
 Does
issues to fund projects
not have a “coupon” rate
 Purchase
below par value then redeem for
face value at maturity
Types of Bonds

Treasury Bonds, Bills and Notes
 Government
maturity
 Treasury
 10
Note (T-Note)
– 10 Years
 Treasury
 3,
Bond (T-Bond)
– 30 Years
 Treasury
2
Issued debt for varying lengths of
Bill (T-Bills)
6 or 12 months
Types of Bonds

Municipal Bonds
 State
and local governments
 “Safe”
 Poor
 Tax
because of taxing authority
financial health?
Free (at federal level)
Types of Bonds

Corporate Bonds
 Business
 Can
issued debt
be riskier
 Depends
on business strength to repay debt
Types of Bonds

Junk Bonds (High Yield)
 Lower
rated, potentially higher paying bond
 Lower
medium grade
Other Types of Financial Assets

Certificates of Deposit

Money Market Mutual Funds
Financial Asset Markets

Capital Markets
 Market
in which money is lent for periods longer
than a year

Money Markets
 Market
in which money is lent for periods less
than a year
Financial Asset Markets

Primary Market
 Market
for selling financial assets that can only
be redeemed by the original holder

Secondary Market
 Market
for reselling financial assets
Section 3 – The Stock Market

Buying Stock





Benefits of Buying Stock
Types of Stock
Stock Splits
Risk of Buying Stock
How Stocks are Traded






Stock Exchanges
The New York Stock
Exchange
The OTC Market
NASDAQ
Futures and Options
Day Trading

Measuring Stock
Performance


The Down Jones Industrial
Average


Bull and Bear Markets
S & P 500
The Great Crash of 1929





Investing During the 1920’s
Signs of Trouble
The Crash
The Aftermath of the Crash
The Market Today
Buying Stock

Corporations can raise money by selling
stock
 Represents
 Shares:
ownership in the corporation
portion of stock
 Equities:
claims of ownership in a corporation
Buying Stock

How do you make money buying stock?
 Dividends
 Capital
Gains
Buying Stock

Dividends
 Paid
4 times per year (quarterly)
 Payout
 Paid
based on profits
per share
Buying Stock

Capital Gains
 Selling
price
the stock for more than the purchase
 Capital
Gain: the difference between a higher
selling price and a lower purchase price resulting
in a financial gain for the seller.
 Capital
Loss: the difference between a lower
selling price and a higher purchase price
resulting in a financial loss to the seller
Buying Stock

Types of Stock
 Income
Stock: Pays dividends at regular times
during the year
 Growth
Stock: Pays few or no dividends,
company reinvests to grow the company and
make stock worth more
Buying Stock

Types of Stock
 Common
Stock: owners of the company with
one vote. A vote is used to elect the directors
of the company
 Preferred
Stock: Non voting owners of the
company. First to receive a dividend, paid
back first if business shuts down
Buying Stock

Stock Split: the division of a single share of
stock into more than one share.

Does not increase % of ownership but
doubles the number of shares.
 Owning
 After
100 shares that are $100 each
a 2 for 1 split, 200 Shares at $50
Buying Stock

Risks of buying stock
 Smaller
 May
profits, smaller stock value
sell stock for less than the purchase
 Going
 Sell
out of business
assets
 Pay
off debt Pay off preferred stock
 Pay
off common stock
How Stocks Are Traded

Contact a Stockbroker
A
person who links buyers and sellers of stocks
 Works
for a brokerage firm: a business that
specializes in trading stocks

Buy stocks to sell at a premium to earn
money on the “spread”
How Stocks Are Traded

Stock Exchanges
A
market for buying and selling stocks
 NYSE
 OTC
(______ _______ _______ _____________)
Market
 National
Association of Securities Dealers
Automated Quotations (___________)
How Stocks Are Traded

New York Stock Exchange
 Began
 Must
in 1792 as an informal outdoor exchange
have a “seat” on the exchange
 Handles
stock and bond transactions for the
largest most established companies in the US
 Blue
Chips – Large profitable companies that are
considered stable
How Stocks Are Traded

Over the Counter (Electronic)
 Stocks
NYSE
and bonds that are not traded on the
 Investors
buy directly from a dealer or a broker
How Stocks Are Traded

Nasdaq
 Created
 Bring
 No
in 1971
the OTC market together
trading floor; sends out information
automatically through 360,000 computer
terminals worldwide
How Stocks Are Traded

Futures and Options
 Futures:
contracts to buy or sell at a specific
date in the future at a price specified today
 For
commodities
 New
York Mercantile
How Stocks Are Traded

Options
 Contracts
that give investors the choice to buy
or sell stock and other financial assets

Call Options
 Buy
shares of stock at a specified time in the
future

Put Options
 Sell
shares of stock at a specified time in the
future
How Stocks Are Traded

Call Option
 Pay
a fee for a call (example: $10)
 Gives
you the right to buy stock at $100 per
share in a specific time period
 If
stock is greater than $100 + the Call Fee, you
would exercise your Call
 Stock
goes to $115 per share, you would buy at
$100 per share, plus your $10 per share fee,
make a $5 per share profit
How Stocks Are Traded

Put Option
 Pay
a fee for a call (example: $5)
 Gives you the right to sell stock at $50 per share in
a specific time period
 If stock is now $40 + the Put Fee, you would
exercise your Put
 Selling stock at $50 per share when the market
rate is $40 you make a $5 profit
 If stock is above $50 you can just sell above that
price
How Stocks Are Traded

Day Trading
 Very
Risky
 Trading
stocks minute by minute instead of
holding for the long term
Measuring Stock Performance

Bull and Bear Markets
 Bull
Market: Steady rise in the stock market over
a period of time
 Bear
Market: Steady drop in the stock market
over a period of time
Measuring Stock Performance

The Dow Jones Industrial Average
 30

Large Companies
The S & P 500
 Tracks
the price of 500 different stocks as a
measure of overall stock market performance