Financial Markets Chapter 11

1. Financial MarketsChapter 11 Ms. Eraqi

2. TYPES OF INVESTMENTS • Includes banks, S&Ls, credit unions • also finance companies, pension funds, life insurance companies • Mutual fund—pools individuals’ money to buy range of financial assets • investors own shares of entire fund Financial Intermediaries

3. 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

4. Financial Markets • Financial markets categorized according to time, resalability • Capital market—for buying and selling long-term financial assets • Money market—for buying and selling short-term financial assets • Primary market—for financial assets that original buyer must redeem • Secondary market—where financial assets are resold Financial Asset Markets

5. Time • Capital markets—assets held for over a year • include stocks, bonds, mortgages, long-term CDs • Money markets—loans made for less than a year • include short-term CDs, Treasury bills Financial Asset Markets

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. Stock Indexes • U.S. indexes: DJIA, Standard & Poor’s 500, NASDAQ CompositeGlobal 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

15. 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

16. 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

17. 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