Financial Markets Chapter 11

Investment Act of redirecting resources from being consumed today so that they may create benefits

Financial Systems Includes savers and borrowers and allows the transfer of money between them Financial Assets: claim on the property of income of a borrower

Financial Intermediaries Banks, Savings and Loans, Credit Unions Finance companies Mutual Funds Life Insurance Pension funds Share risk diversification

Investment Portfolio Collection of financial assets Savings, stocks, bonds, real estate Prospectus Investment report to potential investors

Risk, Liquidity, and Return Return: money beyond basic investment Risk: danger of losing money Liquidity: ease which it converts to money

Bonds & other Financial Assets Bonds Components Coupon rate: interest rate on the bond Maturity: time at which payment to the bondholder is due Par value: amount that an investor pays to purchase a bond - face value or principal Buying bonds at a discount

Bond Rating Standard and Poor’s Moody’s Rate bonds Highest: AAA Lowest: D Interest rates related to bond rating

Bonds Issuer’s Point of View Bonds Advantages Rate steady Fixed payments Do not own company Bonds disadvantage Company must make fixed interest payment Cannot change interest rate Bonds can be downgraded; harder to sell

Types of Bonds Saving Bonds Treasury Bonds, Bills, Notes Municipal Bonds State Bonds Corporate Bonds (SEC) Junk Bonds: low ratings, high interest rates

Other Types of Financial Assets Certificates of Deposit Money market Mutual Funds

Financial Asset Markets Capital Markets: long term CD, government & corporate bonds Money markets: short term CD, Treasury Bills

Primary & Secondary Markets Primary markets: redeemed only by original holder Secondary markets: financial assets resold Shadow banking Collateralized debt obligations Trenches

Stock Markets Buy shares / equities Benefit: dividends Capital gains / capital loss

Types of Stock Common Stock Vote; no guaranteed dividend Preferred Stock No vote; guaranteed divided Income stock Growth stock Stock split

Trading Stock Stockbroker Brokerage firms Stock Exchanges New York Stock Exchange NASDAQ Over the Counter market (OTC): electronically traded

Futures & Options Futures: contracts to buy and sell at a specific date; at a specific price Options: contracts that give investors the choice to buy or sell stock and other financial assets Call options: buy stock shares at a specified time in the future Put option: option to sell shares of stock at a specified time in the future Daytrading

Measuring Stock Performance Bull market Bear market Dow Jones Industrial Average 1896 S& P 500

Great Crash of 1929 Investing during 1920 Signs of Trouble Speculation Crash Aftermath 4 million invested - lost money Monetary policy - tight money policy

Domestic Causes Great Depression 1929 Downturn in Spending 1930 New instability from credit-based spending Belt-tightening to avoid default Collapse of financial sector Loss of confidence in banks Deflation => rise in real debt burden International Aspects World commodity price fall 1930 The Gold Standard

International Factors in Great Depression Breakdown of International System War Debts and Reparations Loss of British Leadership World Deflationary Spiral Absence of (U.S.) Leadership? [Kindleberger] Gold Standard [Eichengreen and Temin] Smoot-Hawley Tariffs: 60%

Great Depressions 2 / Great Recession 2008 Faster policy response No protectionism Bank deposits safe Some safety-net in place: Social Security, Medicare More flexible labor markets