Chapter Eleven

ObjectiveTo learn how the components of a financial system work together to transfer savings to investors Objective – To learn how the components of a financial system work together to transfer savings to investors

In your groups….. In your groups….. – Identify and describe methods of investing and savings that you are familiar with Create a table listing each method and also how they work Create a table listing each method and also how they work – Why do you think the governments and institutions would want participants in a market to save and invest their money?

What is saving? What is saving? – Savings is the action of not spending – While savings is what is accumulated by not spending

Savers and Financial Assets Savers and Financial Assets – How can you save? Savings account, bonds, CD(Certificate of Deposit) – Investor has made a loan, interest paying, to the bank Savings account, bonds, CD(Certificate of Deposit) – Investor has made a loan, interest paying, to the bank – All of these are called Financial assets – claims on the property and the income of the borrower – Stocks can also be purchased…..ownership claims on a company

We need a financial system to use the savings of others – We need a financial system to use the savings of others – – A network of savers, investors, and financial institutions that work together to transfer savings to investors

Financial system has three parts 1. Funds that a saver transfers to a borrower 2. Financial assets that certifies conditions of the loan 3. The organizations that bring the surplus funds and financial assets together

Financial Intermediaries - Are the institutions that lend the funds that the savers provide -Inter = Between or among -Mediate = To work between two parties -Banks, credit unions, life insurance companies, pension funds, or any other funds that channel savings to borrowers. -Help the small savers – limited funds to deposit

Financing Capital Formation Financing Capital Formation – Any sector of the economy can borrow Sector = Government, businesses, households, individuals Sector = Government, businesses, households, individuals Corporations borrows from savers or through financial intermediaries Corporation issues bonds or other financial assets to lender Corporations borrows from savers or through financial intermediaries Corporation issues bonds or other financial assets to lender Government borrows issues government bonds or other financial assets to lender Government borrows issues government bonds or other financial assets to lender

Financing Capital Formation Financing Capital Formation – In terms of savings, households and businesses are the biggest source – Capital formation depends on saving and borrowing – When households borrow invest some of money in homes – When businesses borrow funds invested in tools, machinery, equipment – When governments borrow funds invested in hospitals, highways, universities, etc.

Financing Capital Formation Financing Capital Formation – Answer this question in your groups….. – How does the financial system benefit both the borrowers and the savers?

These are non-depository institutions that also channel savings to borrowers These are non-depository institutions that also channel savings to borrowers Three prime examples Three prime examples – Finance companies – Life Insurance Companies – Pension Funds

Finance Companies Finance Companies – A firm that specializes in making loans to consumers. – Buys installment contracts from merchants that sell goods on credit. Easy for company to sell products Easy for company to sell products FC assumes risk with loan FC assumes risk with loan – Makes direct loans – some risky, higher interest rates to consumer.

Life Insurance Companies Life Insurance Companies – Provide financial protection for insured people – Collects a lot of cash – Premium – money paid on a regular basis for policy – Can also act as lenders as well

Pension Funds Pension Funds – Basic security for when you retire from the workforce. – Pension is the payment, a pension fund is used for monetary disbursement. – Can be company pensions or private pension funds.

Four basic considerations Four basic considerations – Consistency Invest over long length of time Invest over long length of time – Simplicity Keep it simple Keep it simple Ignore anything too complicated Ignore anything too complicated Go with what you know Go with what you know – Risk-Return Relationship Risk is degree to which outcome is uncertain Risk is degree to which outcome is uncertain All investments have risk although degrees vary All investments have risk although degrees vary – Investment Objectives What is reason for investing? What is reason for investing? Retirement vs. more immediate funds…. Retirement vs. more immediate funds….

In what type of situation might an investor seek an investment with a high level of risk? In what type of situation might an investor seek an investment with a high level of risk?

Bonds as Financial Assets Bonds as Financial Assets – Most are long term investments – Government Bonds $ US Saving Bond $ US Saving Bond Purchase Price - $50.00 Purchase Price - $50.00 Maturity – 20 years Maturity – 20 years Money accrued – Predetermined interest from time of purchase to maturity + the Par Value of bond (total value at Purchase) Money accrued – Predetermined interest from time of purchase to maturity + the Par Value of bond (total value at Purchase) – Corporate Bonds Example – 20 year, $ Par Value 6% interest Example – 20 year, $ Par Value 6% interest Interest paid semi-Annually Interest paid semi-Annually.06 x 1000/2 = $30.00 paid twice a year for length of maturity.06 x 1000/2 = $30.00 paid twice a year for length of maturity After 20 years – Par Value is paid back to investor After 20 years – Par Value is paid back to investor 60 x 20 = $ $ (par value) = $ x 20 = $ $ (par value) = $

Bonds yields Bonds yields – Comparing bonds = computing current yield Annual interest divided by purchase price Annual interest divided by purchase price $60.00/$ = 6.32% $60.00/$ = 6.32% $60.00/$ = 5.45% $60.00/$ = 5.45% Interest received and price paid determine the actual current yield Interest received and price paid determine the actual current yield All bonds have ratings – Great companies = great ratings & vice versa All bonds have ratings – Great companies = great ratings & vice versa Standard and Poor's and Moody’s publish bond ratings Standard and Poor's and Moody’s publish bond ratings Using your phones…as a group, look up the top and bottom 5 bond rated companies from each of the above mentioned bond rating companies Using your phones…as a group, look up the top and bottom 5 bond rated companies from each of the above mentioned bond rating companies

Certificates of Deposit (CD’S) Certificates of Deposit (CD’S) – Most common form of investment – As low as $500 - $1000 – Investor can select length of maturity, tailored for just about anything…college, car, house, etc. – FDIC insured as well! Corporate Bonds Corporate Bonds – Long term investments – $1,000 - $10,000 – Prices are lower than par value – Use bond ratings to decide which to invest in – Junk Bonds, very risky, can produce a high yield, but high possibility of default

Municipal Bonds (Munis) Municipal Bonds (Munis) – Bonds issued by state and local governments – Finance items at state or local level – Very safe, tax-exempt – no federal taxation Government Saving Bonds Government Saving Bonds – Low-denomination nontransferable bonds – Paper/Paperless – Paper $50 - $10,000 – 30 year maturity – Interest + Par Value $50 - $10,000 – 30 year maturity – Interest + Par Value – Paperless Purchased directly from treasury via internet Purchased directly from treasury via internet Pay face value Pay face value Interest added monthly and compounded semi-annually Interest added monthly and compounded semi-annually Bond will double every 20 years Bond will double every 20 years

Treasury Notes and Bonds Treasury Notes and Bonds – T-Notes Matures in 2-10 years Matures in 2-10 years – T-Bonds – Denominations of $1, – Issued electronically – Periodic interest is added automatically to your account – Safest of all financial assets

Treasury Bills Treasury Bills – T-Bills – Very short-term investment 4,13, or 26 weeks 4,13, or 26 weeks Do not pay interest directly Do not pay interest directly Price discounted at purchase – par value at maturity Price discounted at purchase – par value at maturity $ Paid - $ after maturation $ Paid - $ after maturation Individual Retirement Accounts Individual Retirement Accounts – IRA’S – Long-term tax sheltered time deposits – All taxes deferred – Will be paid upon withdrawal – Penalties for early withdrawal – Great retirement option

All financial assets are grouped into different markets based on two factors: All financial assets are grouped into different markets based on two factors: – Maturity – Liquidity

Money Market < one yearCapital Market > one year Primary Market – Only original issuer can sell or repurchase a financial asset. *Money market mutual funds *Small CDs *Government saving bonds *IRAs *Money market mutual funds *Small CDs Secondary Market-Existing financial assets can be resold to new owners *Jumbo CDs *Treasury bills *Corporate bonds *International bonds *Jumbo CDs *Municipal bonds *Treasury bonds *Treasury notes

We know that Government bonds are the safest investment, however, they have the lowest return We know that Government bonds are the safest investment, however, they have the lowest return Equities and Futures are the riskiest, but could have a large reward. Equities and Futures are the riskiest, but could have a large reward.

Stocks and Efficient markets Stocks and Efficient markets – Shares of common stock are called Equities – Represent ownership of corporations – Share Values Can purchase shares via a stockbroker – Buys or sells equities for clients Can purchase shares via a stockbroker – Buys or sells equities for clients Internet account can allow investor, you, to buy, sell, and monitor Internet account can allow investor, you, to buy, sell, and monitor Value is determined by profitability of the company Value is determined by profitability of the company Goes up and down daily Goes up and down daily

Stocks and Efficient markets Stocks and Efficient markets – Reading a listing – Page 306 DIV – Annual dividend paid in four equal installments DIV – Annual dividend paid in four equal installments Yld% - Dividend divided by the closing price Yld% - Dividend divided by the closing price PE – Price-Earnings ratio – Stocks closing price divided by annual earnings of each share of common stock outstanding. PE – Price-Earnings ratio – Stocks closing price divided by annual earnings of each share of common stock outstanding. NET CHG – Where the stock closes today versus the day prior NET CHG – Where the stock closes today versus the day prior

Stocks and Efficient markets Stocks and Efficient markets – Using your phone….look up the share price of the following common stocks: Apple – Apple – Google - Google - Microsoft – Microsoft – Alibaba – Alibaba – GE – GE – Heinz – Heinz – Ebay – Ebay – Facebook – Facebook – - Then, using your technology, determine which stock would you determine to be the most profitable in your opinion - Then, using your technology, determine which stock would you determine to be the most profitable in your opinion

Stocks Market Efficiency Stocks Market Efficiency – Nothing is guaranteed in the market – Rise and fall – Efficient Market Hypothesis (EMH) Stocks are usually priced correctly and bargains are hard to find due to the competitive nature of investors. Stocks are usually priced correctly and bargains are hard to find due to the competitive nature of investors. They, investors, constantly analyze the market for any fluctuations They, investors, constantly analyze the market for any fluctuations – Portfolio Diversification Being diverse, allows you to make up for losses by gaining in other stocks at the same time Being diverse, allows you to make up for losses by gaining in other stocks at the same time Don’t put all of your money into one stock!!!!! Don’t put all of your money into one stock!!!!!

Mutual Funds Mutual Funds – A company that sells stock in itself to individual investors – Then invests money it receives into other company’s stock and sometimes bonds – Mutual fund stockholders receive dividends from their investments – Net Asset Value NAV – Market value of a mutual fund share Allows for diversification – invested in many companies Allows for diversification – invested in many companies 401K 401K – A tax deferred investment and savings plan that acts as a personal pension fund for employees – Contribute via payroll deductions – Lowers your taxable income – do not pay taxes on it until you withdraw

401K 401K – Simple, safe way for employees to save – Employer usually matches your contribution based on a certain %

Stock Markets and Performance Stock Markets and Performance – Most stocks are traded in a stock exchange (securities) – Members pay a fee to join, then can trade openly – NYSE – New York Stock Exchange – Oldest, largest, exchange in U.S – Wall Street – lists stock from around 2,700 companies – AMEX – American Stock Exchange New York City New York City Deals with smaller companies Deals with smaller companies Regional exchanges as well – Chicago, Philadelphia, etc. Regional exchanges as well – Chicago, Philadelphia, etc.

– OTC – Over the Counter Markets Electronic marketplace for securities not traded in an exchange Electronic marketplace for securities not traded in an exchange Most stocks in world traded this way Most stocks in world traded this way NASDAQ – National Association of Security Dealers Automated Quotation NASDAQ – National Association of Security Dealers Automated Quotation World’s largest automated electronic stock market World’s largest automated electronic stock market Connected to 80 countries Connected to 80 countries