Financial Markets
Chapter 11
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Example: Nonbank Financial
Intermediaries
◦ Finance companies make small loans to
households, small businesses
◦ Mutual funds let individuals own many assets;
managers make decisions
◦ Pension funds invest employees’ money, so will
have more at retirement
◦ Life insurance companies invest income in
financial assets
 let people save by building cash values,
protect them against loss
Financial Intermediaries
 Financial
Markets
◦ Financial markets categorized according to
time, resalability
◦ Capital market—for buying and selling longterm financial assets
◦ Money market—for buying and selling shortterm financial assets
◦ Primary market—for financial assets that
original buyer must redeem
◦ Secondary market—where financial assets are
resold
Financial Asset Markets
Life Insurance & Finance Companies
Life Insurance
•Premiums paid on life insurance is collected by the company. When
these funds exceed the benefits paid out the company lend these funds
to others.
•Finance Companies
•Loan money for small to medium size purchases. Merchants use
finance companies to finance sales to customers.
Financial Intermediaries
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Mutual Fund is a company that sells
stock in itself to individual investors
and then invests the money it
receives in stocks and bonds issued
by corporations or the government.
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Pension Funds are set up for retirees
and collect payments and then
disburse them to retirees. Excess
revenues are invested in stocks,
bonds and other investments
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Bonds as Financial Assets
•Bonds are long-term obligations that
pay a stated rate of interest for a
specific number of years.
▫Issued by governments and companies to
borrow funds for long periods of time.
Coupon–stated interest rate
Maturity–life of the bond
Par-Value–The initial amount
borrowed
Discounted- bonds sold for less than
par
 Resalability
◦ Primary markets—financial assets can
be redeemed only by original buyer
 include savings bonds, small denomination
CDs
 also market where first issue of stock sold
through investment bankers
◦ Secondary markets—resale markets;
offer liquidity to investors
 include stocks, bonds
Financial Asset Markets

What Kind of Risk Are You Willing to Take?
◦ Risk usually means loss of part of initial
investment, or principal
 no-risk investments: insured savings and
CDs, U.S. government bonds
◦ Safe investments risk interest rate may
not keep up with inflation
◦ Return on riskier investments depends
on how profitable company is
 bonds less risky than stocks; bondholders
paid off first
Risk and Return

What Kind of Return Do You Want?
◦ Safe investments have lowest return
through fixed interest rates
◦ Stocks, bonds—no guaranteed rates;
stocks—higher return over time
◦ If investing over long period, can risk
losses in stock some years
 if less time and money, may want safer
investment
◦ Diversification gives better chance of
offsetting a loss with a gain
Risk and Return
STOCKS AND EXCHANGES
 Why
Buy Stock?
◦ Buy to earn dividends, share of
company profits
 investors who want income, want
dividends
◦ Buy to earn capital gains through
resale of stock
 investors who want growth look for
potential for capital gains
The Stock Market
 Types
of Stock
◦ Common stock—gives shareholders
voting rights, share of profits
 one vote per share owned to elect board of
directors
◦ Preferred stock—gives shareholders
share of profits, no voting rights
 investors get guaranteed dividends, paid off
first if company closed
 dividends do not increase if stock increases in
value
The Stock Market
 Organized
Stock Exchanges
◦ New York Stock Exchange (NYSE) on
Wall Street; oldest, largest in U.S.
 traditionally, each stock auctioned from
trading post on exchange floor
 today, hand-held computers used to execute
many trades
 2006 merger with Archipelago Exchange
allowed electronic trades
◦ American Stock Exchange (AMEX)
companies smaller than on the NYSE
Trading Stock
 Electronic
Markets
◦ Over-the-counter (OTC) market for
stocks not traded on NYSE or AMEX
◦ NASDAQ is centralized computer system
for OTC trading
 second largest exchange in world in number
of companies, shares traded
 companies from many sectors of U.S.
economy, most in technology
◦ OTC Bulletin Board is electronic market
for smaller companies
Trading Stock
 Recent
Developments
◦ 1990s regulations allow any firm to
trade stocks in any exchange
◦ Through electronic communications
networks (ECNs), 24-hour trading
◦ Investors access Internet; huge growth
in online brokerage companies
 lower commissions than traditional brokers
 computer technology matches buyers, sellers
automatically; rapid trades
Trading Stock
 Stock
Indexes
◦ U.S. indexes: DJIA, Standard & Poor’s
500, NASDAQ Composite
Global indexes: Hang Seng, DAX, Nikkei
225, TSE 300, FTSE 100
◦ Since 1896, Dow Jones Industrial
Average changed with U.S. economy
 includes most successful companies in most
important economic sectors
 uses points to measure changes in prices at
which stocks traded
Measuring How Stocks Perform
 Tracking
the Dow
◦ Bull market—prices rise steadily over a
relatively long period
◦ Bear market—prices decline steadily
over a relatively long period
◦ 1972 to 2000 longest bull market in
history; most last two to three years
◦ Dow affected by previous close, Fed,
foreign indexes, trade balance
◦ About 21 stock markets overseas with
over 1,000 large companies each
Measuring How Stocks Perform
 Certificates
of Deposit
◦ CDs offered primarily by banking
institutions; have maturity date
◦ Pay fixed or variable interest, reinvested
for compound interest
 longer maturity dates pay higher interest
rates
◦ Federal government insures funds up to
$100,000
◦ Risks: can lose interest, some principal
if funds withdrawn early
Other Financial Instruments
 Money
Market Mutual Funds
◦ MMMFs’ financial assets have maturities
of one year or less
◦ Give higher yield than savings accounts
with similar liquidity
 can redeem shares by check, phone,
electronic transfer
◦ Funds not insured but tightly regulated,
so principal considered safe
◦ Yield varies based on yield of assets in
fund
Other Financial Instruments