Saving and Investing

Saving and Investing Chapter 11, Section 1

Financial Intermediaries • The in between for borrowers and savers • Banks, savings and loan associations, credit unions, finance companies • Mutual funds: pools the savings of many individuals and invests this money into a variety of stocks and bonds. • Hedge funds: private investment organization that employs risky strategies that often made huge profits for investors. • Life insurance companies: main function is to provide financial protection for the family or other people named as beneficiaries. • Pension Funds: income received by retirees. Disappearing!

Sharing Risk • As a saver, you may not want to invest your entire life savings. Instead of investing all of your money into one place it is important to spread it out. • This is called diversification.

Liquidity and Return • Your everyday money most likely will be located within a savings or checking account that are liquid—or fairly easy to use and get cash from. • If you have extra money, perhaps you inherited $5,000, then you can put that excess money into a CD which makes 4% interest, much higher than your savings account. However, CDs are less liquid than savings accounts and that is a drawback of a CD.

Return and Risk • CDs are very safe investments because they are insured by the federal government. (up to $250,000) • What if you decide to invest in your friend’s new company? If the company succeeds, you could double your investment. However, it usually takes years to see if a company is successful. • If it fails, you could lose all or part of the money you invested • You may benefit from the rewards of a good investment, but you face the risk of a bad one.

Bonds and Other Financial Assets Chapter 11, Section 2

Bonds as Financial Assets • Bonds are basically loans that represent debt that the government or corporation must repay to an investor. • Bonds are considered very safe but also have a low rate of return. • Three components: • Coupon rate- interest rate the bond issuer will pay the bondholder • Maturity- time at which payment to the bondholder is due • Par value- the amount that an investor pays to purchase the bond and that will be repaid to the investor at maturity

Advantages and Disadvantages of Bonds • Advantages: • 1. once a bond is sold, the coupon rate does not go up or down. • 2. Bondholders do not own part of a company therefore the company does not have to share profits with its bondholders. • Disadvantages: • 1. company must make fixed interest payments, even in bad years when it does not make money • 2. If the firm does not maintain financial health, its bonds may be downgraded to a lower bond rating

Types of Bonds • Savings Bonds • Treasury Bonds, Bills, and Notes • Municipal Bonds • Corporate Bonds • Junk Bonds

Savings Bond • Often given as a gift. • Savings bonds are smaller bonds issued by the government. The gov’t uses these to help pay for public works • Purchaser buys the savings bonds at half the par value. • Ex: if you buy a $50 savings bond, you are only paying $25. When the bond matures, you will receive the $25 plus $25 in interest

Treasury Bonds, Bills, and Notes • The Treasury Department issues these at different lengths of maturity • Among the safest investment in terms of default risk • Many people invested in government bonds after September 2001

Municipal Bonds • State and local governments issue these to finance such improvements as highways, libraries, parks, and schools.

Corporate Bonds • Corporations issue these to help raise money to expand their business. • Issue fairly large denominations, such as $1,000, $5,000, and $10,000. • Corporations have no tax base to help guarentee their ability to repay their loans so these bonds have MODERATE risk.

Junk Bonds • Lower-rated, higher-paying bonds. • Junk bonds have been known to pay over 12 percent interest!! • HOWEVER, investors face a STRONG possibility that some issuing firms will default on their debt. • RISKY

Other Types of Financial Assets • Certificates of Deposit (CD): available through banks, which lend out funds deposited in CDs for a fixed amount of time such as 6 months or a year. • Money Market Mutual Funds: intermediaries buy short-term financial assets. Investors receive higher interest on these than a savings account. However, these are not covered by the FDIC insurance. Slightly risky! • The FDIC insurance protects bank deposits up to $100,000 per account

Financial Asset Markets • Capital Markets: markets in which money is lent for periods longer than a year. Include long-term CDs and corporate/gov’t issued bonds that take longer than a year to mature. • Money Markets: market in which money is lent for periods less than a year. Include short-term CDs, treasury bills, and money market mutual funds.

Financial Asset Markets Continued • Primary Markets: financial assets that can be redeemed only by the original holder • Ex. savings bond, small CDs • Secondary Markets: financial assets that can be resold • Option for resale provides liquidity to investors

Saving and Investing