Financial MarketsFinancial MarketsChapter 11 Chapter 11

Ms. Eraqi

Financial IntermediariesFinancial Intermediaries

TYPES OF INVESTMENTS◦Includes banks, S&Ls, credit unionsalso 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 IntermediariesFinancial 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

Financial Asset MarketsFinancial Asset Markets

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 MarketsFinancial Asset Markets

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 MarketsFinancial Asset Markets

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

Risk and ReturnRisk 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

Risk and ReturnRisk and Return

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

The Stock MarketThe 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

The Stock MarketThe Stock Market

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

Trading StockTrading 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

Trading StockTrading 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

Trading StockTrading 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

Measuring How Stocks PerformMeasuring How Stocks Perform

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 PerformMeasuring How Stocks Perform

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

Other Financial InstrumentsOther 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

Other Financial InstrumentsOther 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