Financial Market Chapter Eleven Saving and Investing Section

Financial Market Chapter Eleven

Saving and Investing Section One:

Investing in Free Enterprise • Investment – The act of redirecting resources from being consumed today to create future benefits. • Investment promotes economic growth and contributes to a nation’s wealth. • Businesses use investments to expand hire new workers. • They then create new and better products to be consumed.

Markets Assets • Asset – A claim on the income or security of a borrower • If a borrower fails to pay back a loan, the assets can be claimed as repayment Flow of Savings • Financial Intermediaries act to link people who want to save money with those who want to borrow. • They include banks, finance companies, mutual funds, insurance companies and pension funds.

Financial Intermediaries

Types of Risk • Credit Risk – The borrower might not pay back the money or may make late payments • Liquidity Risk – You may not be able to convert the investment back to cash quickly enough • Inflation Risk – Inflation will erode the value of your investment • Time Risk – You may have to pass up on better investment opportunities

Sharing Risk • The strategy of spreading around risk to reduce risk is called diversification • Don’t put all of your eggs in one basket • Mutual funds automatically reduce the risk to investors by spreading around the risk.

Providing Information Portfolio – a collection of financial assets Prospectus – a report to investors that details potential risk and return to an investor

Risk and Return • Return is the money an investor receives beyond their original investment • The greater the risk of an investment, the greater the potential return • Low Risk Investment – Depositing money in an insured savings account or an insured Certificate of Deposit • High Risk Investment – Purchasing stock in a volatile company

Bonds and Other Financial Assets Section Two:

Bonds • Bonds – Are basically loans or IOU’s that represent debt by the government or a corporation. • Bonds are generally a a low risk investment • The more safe or stable the company or government, the lower the potential interest rate

The Three Components of Bonds 1. Coupon Rate – The interest rate that the bond issuer will pay the bond holder 2. Maturity – The time at which payment for the bond is due. -A Call Date offers the bond issuer the opportunity to repay the loan prior to the maturity date. 3. Par Value – the amount that an investor pay to purchase the bond

Rating Bonds • Two companies rate bonds based on credit worthiness • Moody’s and Standard and Poor’s • The higher the bond rating, the lower the interest rate

Types of Bonds Savings Bonds • Low denominations < $10, 000 issued by the US government to help pay for public works projects • Often given as gifts • You do NOT receive periodic interest payments Treasury Bonds • Higher denomination long term bonds backed by the full faith and credit of the US Government. • Generally considered to be the safest form of bond

Types of Bonds Municipal Bonds • Issued by municipal and state governments • Usually a fairly safe investment • Muni’s are tax exempt by both the federal and state level. Corporate Bonds • Corporations borrow money just like governments. • Corporate bonds are a more risky investment than government bonds because the have no tax base. • A special type of high risk corporate bond is a Junk Bond

Other Types of Financial Assets • Certificates of Deposit are similar to bonds but they are issued by banks • They come in a wide variety of values and lengths of time • CD’s have the added feature of being insured by the FDIC. • Money Market Funds are similar to savings accounts but are not insured by the FDIC. • In exchange for the increased risk, Money Markets pay a considerably higher rate of return than savings accounts.

The Stock Market Section Three:

Benefits of Buying Stock Dividends • Corporations pay out quarterly shares of the company’s profits • Income stocks pay dividends on a regular basis. Capital Gains • Growth stocks do not pay out dividends. They reinvest the profits into the company. • Because of the reinvestment, the company’s stock value should increase. • The shareholder makes a profit when he or she sells the stock.

Stock Splits • When the value of a single share of stock gets too high, the companies board of directors may split the stock • Divide up the stock into two or more less valuable shares • Bill Gates and Microsoft.

Risk of Buying Stock • Buying stock is a risky proposition because the firm cannot necessarily guarantee profits • Because individual companies are risky investment, they often pay much higher yields than bonds

Stock Terms • Stock Broker – Links buyers and sellers of stocks • Stock Exchange – A Market for the buying and selling of stock • NYSE – The New York Stock Exchange the largest stock market in the world • NASDAQ – Focuses on selling younger more high tech companies • OTC Markets – any other stock exchange

Stock Terms II • Bull Market – a steady rise in the stock market over time • Bear Market – a steady fall in the stock market over time • The Dow-Jones Industrial Average – An index of 30 large companies that is supposed to show the market as a whole is doing • The S & P 500 – An index of 500 large companies that illustrate how the market as a whole is doing.

Stock Terms III • Beta-Coefficient – a measure of a stocks volatility • P/E Ratio – A companies price per share divided by its earnings per share • Volume – the number of stocks traded during a given day.

The Great Crashes 1929, 1987 & 2008

The Great Crash 1. Buying on the margin – Using credit to purchase stocks 2. Margin Call – Required cash payments to cover debts 3. Bank involvement – Banks were deeply involved in the stock market

The Great Crash II 1. October 28, 1929 – Black Tuesday 2. The Crash did not cause the great depression but it did aggravate many of the problems.

Outcomes of the Crash • SEC – Securities and Exchange commission formed - Responsible for regulating stock market • Margin buying limited • Banks no longer allowed to invest in stock market