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The Last Word: No homework
Savings and
Investment
Chapter 11:
Financial Markets
Sections 1 and 2
Savings and Investment:
 Savings is
income not used
for
consumption.
 Investment is
the use of
income today
that allows for a
future benefit.
Savings and Investment:
The Financial System
 The financial system,
which consists of
institutions such as
banks, insurance
markets, bond
markets, and stock
markets, allows for
the transfer of funds
between savers an
investors.
Financial Intermediaries
 Sometimes savers and
borrowers come together
directly in a financial
market.
 However, many transactions
involve a financial
intermediary, an institution
that collects funds from
savers and invests them in
financial assets.
Financial intermediaries can include commercial banks,
S&Ls, and credit unions.
Other common intermediaries:
a mutual fund – an investment company that gathers
money from individual investors and purchases a
range of financial assets.
The Financial System
Savings and Investment:
Pension Funds
 A pension fund – allows
employees to save for
retirement sometimes
with the help of their
employer;
 the fund pools together
contributions and invests
them in order to provide
workers more money
when they retire.
Financial Asset Markets
 Economists classify markets based on 2 factors:
 Time, and
 Whether financial assets can be resold.
 Based on time, there are:
 The capital market – the market for buying and selling
long-term financial assets
 (ex. stocks, bonds, mortgages)
 The money market - the market for buying and selling
short-term financial assets
 (ex. short term CDs, Treasury bills)
Financial Asset Markets
 Based on resalability, there are:
 The primary market – the market for buying newly
created financial assets directly from the issuing entity.
 (ex. savings bonds, small denomination CDS)
 The secondary market - the market where financial
assets are resold
 (ex. stocks, bonds)
Investing in a Market Economy:
Why are you investing?
 When investing, it is important to define your
own investment objective – a financial goal
used to determine if an investment is
appropriate.
 It should consider:
 Time: short-term vs. long term goal
 Income: how much can be invested?
Investing in a Market Economy:
Risk and Return
 Once an investor
defines their financial
objective, they need to
consider the risk and
return involved in an
investment.
 Risk is the possibility for
loss on an investment.
 Return is the profit or
loss made on an
investment.
Investing in a Market Economy:
Risk and Return
 Risk and return have a
direct relationship – the
higher the risk of the
investment, the greater
the possible return.
 Ex. US Govt. Bonds – low
risk, low return
 Stocks – high risk, high
return
 Most investors try to
balance risk and return
through diversification,
the practice of
distributing investments
among different financial
assets to maximize return
and limit risk.
Calculating Interest