1. CH 12, Section 2: Risk a situation in which the outcome is not certain. – Probabilities for each possible outcome can be estimated Financial assets are “risky” – Prices may go up OR down. – Agency issuing bond, note, or bill, may not redeem and investor loses all investment Higher risk means higher interest rates demanded by investors.

2. 401(k) Plan an investment and savings plan that acts as a personal pension fund for employees tax-deferred (reduces annual income = reduces annual income tax) 401k vs. Pension 401K the risk of investment is put on the individual employee Pension the risk of investment is on the employer and the recipient receives a percent of income in retirement.

3. Components of Bonds Coupon – the stated interest on a bond debt Maturity – the life of a bond Par value the principal or the total amount initially borrowed that must be repaid to the lender at maturity

4. Current yield the annual interest divided by the purchase price of the bond.

5. Municipal bonds aka “munis” Bonds issued by state and local governments – Finance for…. Highways State buildings Schools Parks libraries Public works Considered safe because governments have – low chance of going out of business – power to tax – And they are …..

6. Tax-exempt the federal government does not tax the interest paid to investors owning municipal bonds.

7. Savings bonds low-denomination, non-transferable bonds Issued by the US government Through payroll savings plan Low risk Easy to obtain – Bought at a lower price than the face value, – Owner must wait for term to expire to collect that amount Ex: $50 bond is bought for $25, but recipient must wait a number of years before the bond is actually worth $50.

8. Treasury Notes US obligations with maturity of two to ten years.

9. Treasury Bonds US obligations with maturity of ten to thirty years. Smallest denomination is $1000

10. Treasury Bills aka “T-bill” Short-term obligation with a majority of 13, 26, or 52 weeks Minimum denomination of $1000 Sold on a “discount” basis, at auction.

11. Individual Retirement Account Aka “IRA” Long-term time deposit Set up for retirement Tax-sheltered Convenient for married couples Taxable when used at maturity.

12. Roth IRA an IRA whose contributions are made after taxes so that no taxes are taken out at maturity – Tax already paid each month.

13. Capital market a market where money is loaned for more than one year. Long-term CDs Corporate and government bonds

14. Money market A market where money is loaned for periods of less than one year. CD with maturity of one year or less Mutual funds

15. Primary market a market where only the original issuer can repurchase or redeem a financial asset Government savings bonds IRAs Small CDs

16. Secondary market market in which existing financial assets can be resold to new owners Liquidity to investors – Can be bought and sold faster – More competitive

17. Section 3 Equities stocks that represent ownership shares in corporations Large number of buyers and sellers – Well informed

18. Efficient Market Hypothesis aka “EMH” Argument that stocks are always priced about right that bargains are hard to find – because they are followed closely by so many investors

19. Portfolio diversification the practice of holding a large number of different stocks Increases in some will offset unexpected declines in others. Popular strategy

20. Diversification Energy Financials Materials Industrials Utilities Information Tech Telecommunications Consumer Discretionary Consumer Staples Health Care Exxon Mobil Goldman Sachs BHP Billiton Deere & Company First Energy Corp. Google Tellabs Inc. Wal-Mart Coca-Cola Johnson and Johnsons

21. stockbroker a person who buys or sells equities for clients. – Arranges stocks or bonds to be bought on the exchange floor by a trader – Also supplies the securities from an inventory – Buys them from some other broker

22. Securities exchange place where buyers and sellers meet to trade securities Members pay fee to join Trades can only take place on the floor of the exchange. – NYSE – AMEX

23. seats membership on an exchange – Ex: NYSE has 1400 seats – Only seat holders may trade on the exchange floor – Larger brokerage companies have more seats because they can afford them. – Each seat may cost several million dollars….. Fees vary with market Bidding process

24. Trading floor of NYSE

25. Over-the-counter market aka: OTC Electronic marketplace for securities that are not traded on an organized exchange. – NASDAQ

26. Dow-Jones Industrial Average the most popular and widely publicized measure of stock market performance on the NYSE. Covers 30 major stocks Various industrial/business sectors – Value of “point” varies due to – value of money traded and volume of stock Better way to evaluate performance is to look at percentage gained or lost Some criticize that 30 companies are not enough to judge the performance of thousands of companies being traded

27. Standard and Poor’s 500 uses the price changes of 500 representative stocks as an indicator of overall market performance. Total of all sales reduced to an easy to understand “index” number. Covers stocks on more than NYSE – AMEX – OTC

28. Bull market A “strong” market with the prices moving up for several months or years in a row. At time of text publishing, the DJIA peaked at 12,000 points, in 2000. Current DJIA is 18,000

29. Bear market A “weak” or “mean” market with the prices falling sharply for several months or years in a row. 2001-2003 market lost 30+% of it value

30. Spot market transactions are made immediately at the prevailing price. “spot” denotes – the current price in the city where the trade takes place, not a world average. – The current price at the moment of purchase, not in the future.

31. Futures contract agreement to buy or sell at a specific price at a specific date in the future. Regardless of market price at the specific date. Ex: airline buys aviation fuel at $3 a gallon, to be collected 1 year from now. – Market price of aviation fuel climbs to $5 a gallon in the course of that year. – Airline saves $2/gallon – Aviation fuel seller makes good money now and had got rid of stock of aviation fuel.

32. Futures market marketplace where futures contracts are bought and sold. Ex.: – Chicago Board of Trade/Chicago Mercantile Exchange/New York Mercantile Exchange (CME) – Intercontinental Exchange (ICE)

33. option contract that provides the right to purchase or sell commodities or financial assets at some point in the future. At an agreed upon price today. Either party may choose to back out.

34. Call-option the right to buy a share of stock at a specified price some time in the future. – Later price lower than purchase price, you can buy BELOW the call-option price. – If later price higher than purchase price, you can buy AT the call-option price.

35. Put option the right to sell a share of stock at a specified price some time in the future. – If you pay a price for the right to sell at a specified higher price and the actual future price is lower than that target price, you can require the buyer to pay the target price. You get back your initial fee And you get the difference – If the market price exceeded the target price, you could ignore the agreement with the other buyer and sell it yourself. You would get profit from the higher market price minus your initial fee.

36. Options market the markets where options are bought and sold.

37. Assessments: Checking for Understanding 1 What rules do many investors follow in regard to investment goals? Invest wisely Analyze the risk and return

38. Assessment 3 List four important investment considerations. Risk and return Personal investment goals Consistency simplicity

39. Assessment 4 Identify the three main characteristics of bonds. Coupon Maturity Par value

40. Assessment 5 Describe the characteristics of major financial assets. Ex: CDs cost as little as $100 and are a safe investment Investors select the length of maturity

41. Assessment 6 Differentiate between the four markets of financial assets. A capital market grants longer-term loans than does a money market. A primary market, the issuer only can redeem a financial asset A secondary market, previously owned securities are sold.

42. Assessments: Checking for Understanding 1 Quantity demanded greater than quantity supplied

43. Image, p. 319 Why do investors require higher returns for some investments? To compensate for greater risk

44. Image, p. 320 How much interest is earned after the first 10 years at 6 percent? $439

45. Image, p. 321 How much more would a traditional IRA earn over a basic savings plan? Approximately $42,000

46. Image, p. 322 How do bond ratings affect the price of bonds? Bonds prices are determined by supply and demand. Because low-rated bonds probably would be in less demand, prices would be lower.

47. Image, p. 325 Why do some financial assets, like CDs, appear in more than one market? Because they may have various long-term and short-term maturities

48. Image, p. 326 What is the difference between a capital market and a money market? A capital market is a market where money is loaned for periods of more than one year. A money market is a market where money is loaned for periods of less than one year.

49. Image, p. 329 What factors influence the price of equities? Number of outstanding shares to be traded Company profitability expectations

50. image, p. 330 Of the stocks shown, which made the biggest gain on this particular days? Ford Motor

51. Image, p. 332 What are the two most popular indicators of the market’s performance? The Dow-Jones Industrial Average and the Standard & Poor’s 500