Financial Markets Overview IEMS 326

Why this Lecture?  Goals: financial literacy financial numeracy  Will this be on the exam? Yes. Know definitions Primary vs. Secondary markets Stocks vs. Flows vs. Trades Know orders of magnitude, relative sizes. Market functions

Debt versus Budget  What ’ s bigger, the debt or deficit of the US? U.S. federal debt: over $11T U.S. federal deficit 2009: about $1½T  In general, distinguish among 3 things: stocks—e.g. how much has been invested? flows—an increase or decrease in stocks trades—exchanges of ownership  (may not affect the real economy)

Debt, Deficit, Bonds  The U.S. federal debt is a… stock—total amount borrowed  The U.S. federal deficit is a… flow—this year ’ s increase in the debt  When I buy a U.S. Treasury bond, it ’ s a… trade—if I buy it from you flow—if I buy it from the U.S. Treasury

Budgets  The U.S. federal budget is… about $3T about twice the U.S. federal deficit about $10K per person (population ~300M)  Illinois has population ~13M and its state budget is… about $50B about $4K per person

Budgets  The City of Evanston ’ s budget is… $191M about $2.5K per person (population ~75K)  Northwestern ’ s budget is… $1.6B about $100K per student (~16K students)

Values of Investments  What ’ s worth more, American Airlines or Northwestern ’ s endowment?  Our endowment: about $6B (~$400K/student)  American Airlines (AMR): market capitalization $830M = (# shares of stock)*(price of a share) = 335M shares * $2.48/share

Groupon IPO Reuters “Groupon Inc raised $700 million after increasing the size of its initial public offering, becoming the largest IPO by a U.S. Internet company since Google Inc raised $1.7 billion in The global leader in "daily deals" is now valued at almost $13 billion after saying it increased the offering by 5 million shares to 35 million in total and pricing them at $20 each, above an initial range of $16 to $18.”

Typical share prices  From $1 to $100s  Not too low… (penny stocks)  …or too high! Berkshire Hathaway

How to make money in stocks  buy low  sell high …or collect dividends  When the share price goes up, (trade) the company is more expensive shareholders are happy  real economy vs. financial trades

Primary&Secondary Equity Market  primary equity market: (flow) e.g. initial public offering (IPO) Google issued new shares sold them to investors for $30B invested $30B in cool stuff  secondary equity market (exchanges): (trade) $36.6T total shares and $$ change hands brokers get ¢ (~0.1% of value)

Bond Market  primary bond market: U.S. Treasury or G.E. borrows money by issuing bonds to investors  secondary bond market: bonds and $$$ change hands brokers get $ (1-2% value) trades: $1T/day

Global Bond Market  $80T oustanding (stock)  about $13K/person

Foreign Exchange Market  currency: trade $ for euros open 24/7  trades: about $3T/day about $500/person/day about $200K/person/year  purposes: international trade hedging speculation

Foreign Exchange Market

Commodities Markets  spot vs. futures  exchanges: CME/CBoT NYMEX, etc.  pork bellies 20 tons, frozen physical delivery  hedging, speculation

Derivatives

Backup slides

How companies make money  successful business projects… create positive earnings increase book value make it possible to pay higher dividends  real economy vs. financial trades

Bonds issued

Nationality of bond issuer

Nationality of bond holder

Government Bonds

Bond market

Foreign Exchange Market: What?

Foreign Exchange Market: Where?