Financial Markets Chapter 11

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Financial MarketsChapter 11
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Financial Intermediaries

• 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

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Financial Asset Markets

• Financial Markets
• Financial markets categorized according to time,
  resalability
• Capital marketfor buying and selling long-term
  financial assets
• Money marketfor buying and selling short-term
  financial assets
• Primary marketfor financial assets that
  original buyer must redeem
• Secondary marketwhere financial assets are
  resold

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Financial Intermediaries
Life Insurance Finance Companies Life
Insurance Premiums paid on life insurance is
collected by the company. When these funds exceed
the benefits paid out the company lend these
funds to others. Finance Companies Loan
money for small to medium size purchases.
Merchants use finance companies to finance sales
to customers.
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• Mutual Fund is a company that sells stock in
  itself to individual investors and then invests
  the money it receives in stocks and bonds issued
  by corporations or the government.

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• Pension Funds are set up for retirees and collect
  payments and then disburse them to retirees.
  Excess revenues are invested in stocks, bonds and
  other investments

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• Bonds as Financial Assets
• Bonds are long-term obligations that pay a
  stated rate of interest for a specific number of
  years.
• ?Issued by governments and companies to borrow
  funds for long periods of time.
• ?Couponstated interest rate
• ?Maturitylife of the bond
• ?Par-ValueThe initial amount borrowed
• Discounted- bonds sold for less than par

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Financial Asset Markets

• Resalability
• Primary marketsfinancial 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 marketsresale markets offer liquidity
  to investors
• include stocks, bonds

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Risk and Return

• 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

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Risk and Return

• What Kind of Return Do You Want?
• Safe investments have lowest return through fixed
  interest rates
• Stocks, bondsno guaranteed rates stockshigher
  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

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STOCKS AND EXCHANGES
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The Stock Market

• 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

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The Stock Market

• Types of Stock
• Common stockgives shareholders voting rights,
  share of profits
• one vote per share owned to elect board of
  directors
• Preferred stockgives 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

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Trading Stock

• 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

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Trading Stock

• 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

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Trading Stock

• 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

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Measuring How Stocks Perform

• Stock Indexes
• U.S. indexes DJIA, Standard Poors 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

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Measuring How Stocks Perform

• Tracking the Dow
• Bull marketprices rise steadily over a
  relatively long period
• Bear marketprices 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

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Other Financial Instruments

• 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

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Other Financial Instruments

• 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