1. Chapter 11: Financial Markets Section 1

2. Investing and Free Enterprise
Investing is essential to the free enterprise system.
It promotes economic growth and contributes to a nation’s wealth.
People deposit money into a savings account and the bank lends this money to businesses.
Businesses can then increase production, which leads to expansion and growth.

3. The Financial System
Financial systems are established in an economy so investments can take place.
When people save money they are really loaning it to other people.
Savers receive a document, such as a passbook or a bond certificate, that confirms their purchase or deposit.
These documents represent the claims, or financial assets, of the borrower.

4. Savers and Investors
Financial systems bring together savers and investors, or borrowers, which fuels investment and economic growth.
Savers include:
Households
Individuals
Businesses
Investors include:
Government

5. Financial Intermediaries
Financial intermediaries, including banks and other financial institutions, accept funds from savers to make loans to investors.

6. Sharing Risk
Dealing with financial intermediaries offers three advantages:
Sharing risk
Providing information
Providing liquidity
Diversification allows you to spread out your investments so that you don’t put all of your money into one single investment.
Sharing risk helps ward against losing everything on a bad investment.

7. Types of Risk
Investors must weigh the risks of investment against the potential rate of return on their investment.
How does diversification lesson the risks described in the chart?
Answer: By spreading out your investments, or diversifying, you encounter less risk than if you put all of your money into one single investment.

8. Providing Information and Liquidity
By providing vital data, either in a portfolio or a prospectus, financial intermediaries reduce the costs in time and money that lenders and borrowers would pay if they had to get the information on their own.
Financial intermediaries also help people get access to their money when they need it, depending on how liquid the investment is.
Checkpoint Answer: Because financial intermediaries share in the investment risk, provide information to savers and investors, and provide liquidity to savers and investors.

9. Return and Risk
Some investments, like CDs, are very safe because they are insured by the government.
Investing in a new business is far more risky, but if the business is a success, the return could be very big.

10. Return and Risk, cont.
In general, the higher the potential return, the riskier the investment.
Whenever people evaluate their potential investments, they must balance the risks involved with the rewards they expect to gain.

11. Chapter 11: Financial Markets Section 2

12. Introduction Why are bonds bought and sold?
Bonds are sold by governments and or corporations to finance projects.
Bonds offer a higher return than savings accounts, although they are generally riskier than savings accounts.

13. Bonds as Financial Assets
Bonds are loans that represent debt that the seller must repay to the investor.
Bonds have three basic components:
Coupon rate - the interest rate that a bond issuer will pay to a bondholder
Maturity - the time at which payment to a bondholder is due
Par value - the amount to be paid to the bondholder at maturity

14. Discounts From Par
Investors can not only earn money from the interest on their bonds but they can also earn money by buying bonds at a discount, called a discount from par.
According to the chart, how do interest rates affect bond prices?
Answer: Rising interest rates can make it more difficult to sell a bond that was bought at a lower interest rate.

15. Bond Ratings
In order to decide which bonds to buy, investors can check bond quality through independent firms, such as Standard & Poor’s and Moody’s, which publish bond issuers’ credit ratings.
These firms rate bonds on the issuer’s financial strength, its ability to make future interest payments, and its ability to repay the principal when the bond matures.
A high grade, such as AAA, means that the bond is safe to invest in.

16. Advantages and Disadvantages
Once a bond is sold, the coupon rate remains the same.
The company does not have to share profits with bondholders if it is doing well.
Disadvantages
The company must make fixed interest payments and cannot change its interest payments.
A firm’s bonds may be given a low bond rating and be harder to sell when the firm is not doing well.

17. Types of Bonds Savings Bonds Treasury Bonds, Bills, and Notes
Low-denomination bonds issued by the U.S. government, who pays interest on the bonds.
Treasury Bonds, Bills, and Notes
The U.S. Treasury Department issue Treasury bonds, bills, and notes, which are among the safest investments in terms of default risk.
Answer: Treasury bill
Which of these three types of government securities is the most liquid?

18. Municipal Bonds
State and local governments issue municipal bonds to finance such projects as highways, libraries, parks, and schools.
These are attractive to long-term investments and are relatively safe.
Checkpoint Answer: Municipal bonds

19. Corporate and Junk Bonds
Corporate bonds are issued by corporation to help raise money to expand business.
These bonds have a moderate risk level because investors must depend on the corporation’s success.
Junk bonds are bonds with a high risk and a potentially high return.
Investors in junk bonds face a strong possibility that some of the issuing firms will default on their debt.

20. Other Types of Financial Assets
Certificates of Deposit
CDs are available through banks, which lend out funds deposited in CDs for a fixed amount of time.
Money Market Mutual Funds
Investors receive higher interest on a money market mutual fund than they would on a savings account. These funds, however, are not covered by FDIC insurance.

21. Financial Asset Markets
Bonds, CDs, and money market mutual funds are traded on financial asset markets.
One way to classify financial asset markets is according to the length of time for which the funds are lent.
Capital Markets
In these markets, money is lent for periods longer than a year, like in a CD.
Money Markets
In these markets, money is lent for periods of a year or less and include Treasury bills and money market mutual funds.

22. Financial Asset Market, cont.
Markets may also be classified according to whether or not assets can be resold to other buyers.
Primary Markets
In a primary market, financial assets can be redeemed only by the original holder. Examples include savings bonds and small CDs.
Secondary Markets
In a secondary market, financial assets can be resold, which provides liquidity to investors.
Checkpoint Answer: By the amount of time in which the funds are lent and by whether or not assets can be resold to other buyers.

23. Chapter 11: Financial Markets Section 3

24. Introduction How does the stock market work?
Stock, or shares in a company, are bought and sold on the stock market.
Stock brokers help individuals and businesses invest their money in the stock market.
Investors can keep track of the stock market by checking their local paper. When the market is doing well, people see a large return on the initial investment. When it is not doing well, people may lose a great deal of money.

25. Benefits of Buying Stock
In addition to selling bonds, corporations can raise money by selling stock shares in that corporation.
The benefits of buying stock include:
Dividends—part of the firm’s profits
Capital gains—selling the stock for more than you paid for it
Checkpoint Answer: Through dividends and capital gains.

26. Types of Stock
Stock may be classified by whether or not it pays dividends.
Income stock—provides investors with income by paying dividends
Growth stock—pays few or no dividends and earnings are reinvested in the company

27. Types of Stock, cont.
Stock is also classified by whether or not the holder has a voice in the company:
Common stock: These holders are voting members of the company.
Preferred stock: These holders are nonvoting members of the company.
Common stock owners may initiate a stock split when the price of a stock becomes to high.

28. Risks of Buying Stock
Buying stock is risky because the dividends are determined by how well a company is doing.
Because of the laws governing bankruptcy, stocks are riskier than bonds since bondholders are paid before stockholders when a company goes bankrupt.

29. How Stocks are Traded
If you want to buy stock, you would first contact a stockbroker to advise you on which stocks to buy.
You buy stocks on a secondary market known as a stock exchange.
The New York Stock Exchange is the country’s largest and most powerful exchange, handling stock and bond transactions for the top companies in the United States and the world.
The Nasdaq is the second largest securities market and the largest electronic market.

30. Futures and Options
Futures are contracts to buy or sell commodities at a particular date in the future at a specified price today.
Similarly, options are contracts that give investors the choice to buy or sell stock and other financial assets.
Most people who buy stock hold their investment for a significant period of time.
Day traders, on the other hand, trade stocks daily, which is very risky.

31. Measuring Stock Performance
When the stock market rises steadily over a period of time it is known as a bull market.
When the stock market falls or stagnates for a significant period it is a bear market.
The Dow Jones Industrial Average measures stock performance. It represents the average value of a particular set of stocks, and it is reported as a certain number of points.

32. The Great Crash In the 1920s, the stock market was soaring.
Speculation and buying on margin, however, led to a crash in the market that crippled the U.S. economy.
The Dow began steadily dropping in September, People began to sell their shares and companies couldn’t keep up with it. On October 29, 1929, a record million shares were sold and the market crashed.
Checkpoint Answer: When 16.4 million shares were sold on one day and the stock market crashed.

33. The Aftermath The Crash led to the Great Depression.
Many people lost everything—their homes, their jobs, and their farms.
After the Depression, many people saw stocks as risky investments and avoided them.
By the 1980s, with the development of mutual funds, Americans became more comfortable with stock ownership once again.
The stock market crashed again in 1987 but was able to recover much faster than in did in 1929.

34. Scandals & the Stock Market Today
By the 1990s, when people began once again to buy more stock, investors started to worry that many companies could not make enough money to justify their high stock prices.
The Enron scandal and others caused many investors to question how much they knew about the companies they invested in.
In 2008, the stock market began falling, causing a major economic crisis in the United States once again.