Chapter 12: Financial Markets

1. Chapter 12: Financial Markets

2. Objectives • Explain the difference between saving & savings and why saving is important for capital formation. • Explain how the financial system works to transfer funds from savers to borrowers. • Understand the role of the major nondepository financial institutions. • Identify 4 important investment considerations • Define the 3 characteristics of bonds • Describe the types of major financial assets. • Describe the major stock exchanges • Explain how stock market performance is measured.

3. Saving vs. Savings • Saving: absence of spending • Savings: $ that becomes available for investors when others save • Businesses borrow the savings to produce new goods & services, build new plants & equipment, and create more jobs • Savings makes economic growth possible (does spending too?)

4. Copy Savings Diagram on Focus Transp. 42 Copy and answer Questions 1 and 2

5. The Financial System • Financial system: network of savers, investors & financial institutions that work together to transfer savings to investors • Made up of funds, financial assets, savers, borrowers, and institutions • Financial intermediaries: financial institutions that lend funds that savers provide to borrowers

6. Copy Figure 12.1: Overview of the Financial System/ Circular Flow of Funds (p. 315)

7. Depository Financial Institutions Savings banks Credit unions Commercial banks Savings associations Nonbank Financial Institutions Finance companies Life insurance companies Mutual funds Pension funds Real estate investment trusts Financial Intermediaries

8. Investment Strategies • Investing – the active redirection of resources, from being consumed today, to creating benefits in the future • To invest wisely, investors should have a basic understanding of investment considerations • 4 factors to consider when you invest:(list them p. 318)Leave a couple of spaces after each one

9. Relationship between risk & return • Higher risk yields higher return; safer risk yields lower return • Depends on your comfort level • Personal goals/reasons for investing • Simplicity of investing/avoid some investments • Too complicated • Too good to be true • Consistency of investing • Amount not as important as investing on a regular basis (SAVE SOMETHING!)

10. There is a wide range of financial assets (assets are any item of economic value owned by an individual or corporation, especially that which could be converted to cash) one may invest in. They include: • Savings accounts & certificates of deposit (specific term & interest rate) • 401(k) plans • Bonds • Treasury notes & bonds • Treasury bills • Individual retirement accounts (IRA’s)

11. Types of Investments • 401(k) plan – a tax-deferred investment & savings plan that acts as a personal pension fund for employees (mainly employer-sponsored plans) • Don’t pay income taxes on $ you contribute until you withdraw it • Many employers will match your contribution by 25% to 100%

13. Bonds – long-term obligations that pay a stated rate of interest for a specified # of years (low-risk) • 3 main components: • Coupon – stated interest on the debt • Maturity – life of the bond • Par value – principal/amount borrowed that must be repaid at maturity • Types of bonds: • Corporate bonds (raise $ to expand) • Municipal bonds (issued by city/local) • Govt savings bonds • Treasury bonds (30-yr maturity)

15. Individual Retirement Account (IRA) – a long-term time deposit, with annual contributions of up to $3000 per year not taxed until withdrawal during retirement • Roth IRA – an IRA whose contributions are made after taxes so no taxes are taken out at maturity (fewer withdrawal restrictions & requirements)

16. The Stock Market • In addition to financial assets, investors may buy equities – stocks representing ownership shares in corporations • Markets are competitive because there are a large # of buyers & sellers • Investor confidence is important for market stability – stocks tend to be much higher risk investments • Stock prices can vary considerably from one company to the next ($.01 to hundreds of $$!)

17. Investors must decide which equities to buy & which to avoid • The Efficient Market Hypothesis states that stocks are always priced about right & that bargains are hard to find because they are closely watched by so many investors • Many use portfolio diversification – holding a large # of different stocks so that increases in some can offset unexpected declines in others

18. Explain the2 ways to purchase equities(p. 329)

19. A number of organized securities exchanges exist – places where buyers & sellers meet to trade securities • These have members who must pay a fee to join & trades may only take place on the floor • They can be classified into 4 main exchanges:

20. What does NYSE stand for? (p. 329) • Where is it located? • Why is it significant? • How many seats/memberships does it have? • It lists stocks from how many companies? • What is AMEX? (p. 330) • Where is it located? • It has how many listed stocks?

22. 3) Where are the major regional stock exchanges located? (p. 330) 4) Where are the major global stock exchanges located? (P. 330)

23. Most stocks are traded on the over-the-counter market – an electronic marketplace for securities that aren’t traded on an organized exchange • What does NMS stand for? What is it? (p. 331) • Members of the OTC market belong to the __. • What does NASDAQ stand for? What is it?

24. History of NASDAQ

25. Investors consult 2 indicators to check their stocks’ performances: • What does DJIA stand for? (p. 332) • Why is it significant? • Its sample consists of how many stocks? • What does S & P stand for? • It uses the price changes of how many stocks? • Unlike the DJIA, it reports on stocks listed where?

26. Dow Jones Industrial Average

27. Terms describing the movement of the market: • “Bull” market – a “strong” market where stock prices move up for several months or years in a row (1995, 2000) • “Bear” market – a “mean” market where stock prices move down for several months of years in a row (1998)