Financial Markets Chapter 12 The Financial System Financial

Financial Markets Chapter 12

The Financial System • Financial system = savers, investors, and institutions that work together to transfer savings to investors. • You can save in different ways: – 1) open a savings account – 2) buy a certificate of deposit (CD) - a loan to a bank that earns interest – 3) government bonds

• Financial intermediaries = institutions that lend funds that savers provide to borrowers – They include: • • • Banks Savings & Loans Credit unions Life insurance companies Pension funds

Nonbank Financial Intermediaries • Finance company = makes loans directly to consumers or buys installment contracts from merchants who sell on credit – Many businesses can’t afford for a consumer to take years to pay off an account (ex: car) – So they “sell” the account to a finance company for a lump sum

• Life insurance companies = provides financial protection for survivors • Premium = amount that a person pays monthly to have insurance – Insurance companies often loan surplus funds to others

• Mutual funds = a company that sells stock in itself to investors and then invests that money in stocks and bonds. – Stockholders receive dividends earned from these investments – This lets people “play the market” without having all their money invested in one or a few companies

• Pension funds = a regular payment of income security to someone who has worked a certain number of years, a certain age, or has a certain injury – It collects portions of a person’s income and then disburses payments later – Sometimes the company a person works for also contributes funds

Basic Investment Considerations • Risk = a situation in which the outcome is not certain, but probabilities can be estimated – Buying stocks can be risky – A person has to determine how much risk they can tolerate – They may just want some interest added to their money, or may be willing to risk it all buying sketchy stocks

• Most people build wealth because they invest consistently over a long period of time • 401 K Plans = tax deferred investment and savings plan that acts as a pension fund – Payroll deductions are taken out and invested in mutual funds approved by their companies – Many employers match their employees contribution – Relatively safe way to save

• Bonds = long term obligations that pay a stated rate of interest after a specified number of years – a “relatively” safe way to save and make money but will not make you rich – Types of bonds: • 1) corporate (a little risky and taxable) • 2) municipal (safe and tax-exempt) • 3) savings bonds (government, safe, taxable)

• Individual Retirement Account (IRA) – Long term deposits that employees can set up as part of a retirement plan – Up to $3, 000 per year can be deposited – Will have to pay taxes on it when you retire

Stock Market • Equities = stocks that represent ownership shares in corporations – Competitive because there are many buyers and sellers – Investor confidence is necessary for market stability (so it won’t crash)

• Stock Exchanges: – New York Stock Exchange (NYSE) - oldest, largest and most prestigious in US • Lists stocks from about 3, 000 companies • The largest and most profitable in the US – American Stock Exchange (AMEX) – also in NY • Has about 750 companies • The companies are smaller and more speculative

– Regional stock exchanges exist in Chicago, California, Boston, etc. • Many stocks are listed on both regional and the NYSE – Global stock exchanges exist in Tokyo, Hong Kong, London, Frankfurt, etc • Computer technology links these markets to traders around the world

– NASDAQ • World’s largest electronic stock market • Has over 4, 000 companies listed • Connects investors in over 80 countries

Measures of Stock Performance • Dow Jones Industrial Average (DJIA) – Most popular measure of how much a stock is worth – Only used on companies on the NYSE • Standard & Poor’s 500 (S & P 500) – Uses price changes of 500 representative stocks as an indicator of overall market performance – Reports on NYSE, AMEX and NASDAQ

• Bull Market v. Bear Market: – Bull market = “strong” market with prices moving up for several months or years in a row – Bear market = a “mean” market with prices of stocks falling sharply for several months or years in a row