Financial Markets
Saving and Capital Formation
• Saving money makes
economic growth possible
• One’s person savings can
represent another person’s loan
• Savings make investments
possible
Financial Assets and the
Financial System
• Consist of a network, including
–Savers
–Investors
–Financial institutions
–Work together to Transfer
savings to investors
Financial Assets and the
Financial System
• Financial assets
– Claims on the property and the
income of the borrower
– Open a Savings accounts
– Certificates of deposits
– Government bonds
– Corporate bonds
Financial Assets and the
Financial System
• Financial Intermediaries
– Financial institutions that bring together savers and
lenders
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Commercial banks
Savings and loan Asso.
Savings bank
Mutual savings banks
Credit unions
Life insurance companies
Mutual funds
Pension Funds
Real Estate Investment Trust
Finance Companies
Circular flow of funds: shows how funds are
transferred from savers to borrowers
• Any part of the economy can supply and borrow
savings
• Largest Borrowers = Government and businesses
Nonbank Financial Intermediaries
• Non-depository institutions that
channel savings to borrowers
– Finance companies
– Life Insurance
– Mutual Funds
– Pension Funds
– Real Estate Investment Trust
Investment Strategies
and Financial Assets
Basic Investment Considerations
• Risk: a situation in which the
outcome is not certain but can
be estimated
–Higher risk = higher rate of
return
–Low risk = lower rate of return
Basic Investment Considerations
• Investments depends on goals of the investor
– Consistent investment can yield large
returns
– Avoid complex investments
• 401K Plan: tax deferred investment
plan that acts as a personal pension
fund for employees
Basic Investment Considerations
Bonds as Financial Assets
• Three main components
– The Coupon: stated interest on debt
– The Maturity: life of the bond
– The par value: principal or the total amount initially
borrowed that must be repaid at maturity
• Prices are determined by supply
and demand
• Yield = annual interest rate
divided by the purchase price
Bond Ratings
• Rated on
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the financial health of the investor
The ability to make future coupon
Principal payments
Issuer’s past credit history
• Range from D (lowest) to AAA (highest)
• Default = the issuer has not kept up
with the interest of the par value payments
Financial Assets and
Their Characteristics
• Most common form of investment =
Certificates of deposit
• Corporate Bonds
– Issued by corporations
– Usually used for long term investment
• Municipal bonds
– Issued by the state and local gov’t
– Safe, tax exempt investment
Financial Assets and
Their Characteristics
• Savings bonds
– Low-denomination, non-transferable
– Issued by federal gov’t
– Virtually no risk
• Treasury and Bonds
– Long-term obligations
– Issued by fed gov’t
– Safest of all financial assets
Financial Assets and
Their Characteristics
• Treasury Bills
– Short-term obligations
– Issued by federal gov’t
• Individual Retirement Accounts (IRA’s)
– Long-term
– Tax sheltered time deposits
– Intended for retirement
Markets for Financial Assets
• Capital markets: money is loaned for more
than one year
• Money Markets: money is loaned for more
less one year
• Primary Markets: only the original issuer
can repurchase or redeem a financial asset
• Secondary Markets: financial assets can be
resold to new owners
Markets for Financial Assets
Figure 12.6
Financial Assets and Their Markets
Investing in Equities, Futures,
and Options
Market Efficiency
• Efficient Market Hypothesis (EMH)
– Argument that stocks are always priced about
right and that bargains are hard to find
– It is not possible to “beat the market” regularly
– Investors should diversify their portfolios
– Or enlist the assistance of a stock broker
Organized Stock Exchanges
• New York Stock Exchange (NYSE)
– List share of 2,800 large companies
– 1,400 seats or memberships
• American Stock Exchange (AMEX)
– List shares of 750 companies
• Regional Stock Exchanges
– list shares too small or to new to be listed on NYSE or
AMEX
• Global Stock Exchange
– Include stock exchanges around the world
Over the Counter Markets (OTC)
• Electronic Marketplace for securities not
traded on an organized exchange
– I.E. National Association of Securities Dealers
Automated Quotation (NASDAQ)
– List information on companies traded on (OTC)
Measure of Stock Performance
• Dow-Jones Industrial Average (DJIA)
– Index made up of 30 stocks
– Most popular and widely publicized
measure of stock market performance on the
NYSE
• Standard & Poor’s 500
– Index made up of 500 representative stocks
• Bull Market: prices are rising
• Bear Market: prices are falling
Trading in the Future
• Spot Market
– “Spot” meaning immediate
– Transactions are made at the
prevailing price
– Futures contract
– Futures market
Trading in the Future
• Option Market
– Put and Call options are bought
and sold
– Call option
• Gives the owner the right to buy
at a specific price in the future
– Put option
• Gives the owner the right to sell
at a specific price in the future