Chapter 11 – Financial Markets Financial System: The system that allows transfers of money between savers and borrowers. Investment: 1. The use of assets to earn an income or profit; 2. The redirection of resources from being consumed today so they can provide increased benefits in the future.

Financial Assets Financial Assets are the claim on the property or income of a borrower, so the loans banks make are “assets.” These assets sometimes go bad, and when the assets are highly unlikely to be paid they are now called “toxic assets.” Toxic assets can destroy banks and other financial institutions.

Investment and Risk Individually, stocks are a financial asset that create a lot of risk, so some financial intermediaries created “mutual funds,” a diverse group of stocks that spread the risk of individual stocks around. Mutual funds will sometimes own stocks, bonds and Treasuries. This strategy is known as “diversification.”

How a Mutual Fund works Your profit: 5 percent You invest $1,000 in a mutual fund portfolio of 500 stocks 300 of the stocks earn an average of 8 percent profit (though some more than double in value) 200 of the stocks earn an average of 2 percent loss (though some go out of business and are a 100 percent loss) Your profit: 5 percent (after averaging the return)

Mutual Fund Pluses and Minuses Risk is diversified No dramatic losses from collapse of a particular stock Usually strong growth Historically good growth over many decades Minuses No dramatic gains Loss of control in which stocks are purchased You will probably still lose money in a bear market

Major Market Indicators Dow Jones Industrial Average: 60 “blue chip” - i.e., top quality – corporate stocks, which has been tracked since 1896. Standard and Poors 500: A blend of 500 stocks – also blue chip – that has been published since 1957 (though back-dated since the early 1900s); traded as a mutual fund under the name SPDR. Russell 3000: “Small cap” index of smaller stocks

Market terms Bull Market: A stock market that is rising Bear Market: A stock market that is falling Futures: Contracts to buy or sell a stock or commodity at a specific price and date in the future. Options: The ability to buy shares of stock at a specified price at some specified time in the future. It's “call options” if it is the ability to buy stocks and “put options” if it is to sell stocks.

Market Terms Stock split: When a stock rises to value above the company's desired selling price and the shares split into two shares equaling half the price before the split.

Stock Indexes New York Stock Exchange: Largest Stock Exchange in nation, formed in 1819. NASDAQ: Second largest stock exchange, focuses on technology, acquired American Stock Exchange in 1990s (Formed in 1970s) Chicago Mercantile Exchange: Sells commodities, such as raw cocoa, gold, other futures.