ch. 11: financial markets
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Ch. 11: Financial Markets. What to do with money:. Make a list of as many places you can think of that you could invest money... . What to do with money:. Make a list of as many things you can think of to do with money… Spend it Savings account Certificate of Deposit Real Estate - PowerPoint PPT PresentationTRANSCRIPT
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Ch. 11: Financial Markets
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What to do with money:
• Make a list of as many places you can think of that you could invest money...
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What to do with money:
• Make a list of as many things you can think of to do with money…– Spend it– Savings account– Certificate of Deposit– Real Estate– Stock Market– Savings Bond– Mutual Fund– Business Loan
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Section 1: Saving and Investing
• Investors decide where to place their resources based on several factors.
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Investment
• Investment is the directing of resources to create future benefits.
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Financial Systems
• Any system that allows the transfer of money between savers and borrowers.
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Financial Intermediaries• Institutions that channel funds from savers to
borrowers. – Banks– Finance companies– Stock brokerages
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Risk and Reward
• Risk is the extent to which you could lose your investment.
• Reward is the extent to which your investment could be profitable. – High risk = high (potential) reward– Low risk = low reward
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Diversification• Diversification is spreading out investments to reduce
risk.– “Don’t put all your eggs in one basket”
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Diversification: Mutual Funds
• Mutual Funds are diversified pools of many different stocks and bonds. – Buying 1 share of a mutual fund means you are buying
100s (maybe 1000s) of different stocks and bonds. – Reduces risk
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Portfolio
• Portfolio is the compilation of an individual’s investments.
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Liquidity
• Can an investment easily be turned into spendable cash? If so- it is a “liquid” investment.
• Rank the liquidity of the following investments– Real Estate– Savings Account– Certificate of Deposit– Retirement Fund
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Return and Percentages
• Return in the amount received from an investment.
• Investors consider interest percentages to determine how profitable an investment is.
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Section 2: Bonds and Financial Assets
• Bonds are loans to organizations (government or business)
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Bonds vs. Stocks
• Buying stocks is buying a portion of a business• Buying bonds is loaning money to a business
or government– As a bond holder, you are not an owner– Means less risk/reward than stocks
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Bond Components
• Coupon Rate: the interest rate at which a bond is purchased (5%)
• Maturity: the amount of time a bond must be held before payment can be received (10 years)
• Par Value: amount the investor pays initially ($1,000)
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Problem: Compound Interest
• Assume the following bond example: – $1000 par value– 10% coupon rate– 10 year maturity
• How much will the bond holder get back at the end of the 10 years?
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Problem: Compound Interest
• Assume the following bond example: – $1000 par value– 10% coupon rate– 10 year maturity
• How much will the bond holder get back at the end of the 10 years?
• Answer: 2,593.74 - Why?
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Understanding Compound Interest
• If you clap now• Clap again in 1 second• Clap again in 2 seconds• Clap again in 4 seconds, in 8 seconds, 16
seconds…• How many times will you clap in a year?
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Understanding Compound Interest
• Compound interest applies the new interest to the old principal, making growth exponential…
• 25 by 25 scenario…– If you invest $25,000 by the age of 25… – With 10% interest, how much will it be at a
retirement age of 67 (42 years?)
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Rule of 72
• 72/Interest Rate = Years for Money to Double• 72/10 = 7.2– 0 years = 25,000– 7 years = 50,000– 14 years = 100,000– 21 years = 200,000– 28 years = 400,000– 35 years = 800,000– 42 years = 1,600,000
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500 Million Dollar Bet
• 2 Professors, experts in aging, made a bet. One believed someone currently alive will live to 150, the other disagreed.
• They bet 500 Million Dollars.• How?• http://discovermagazine.com/2003/nov/cover
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Types of Bonds
• US Savings Bonds: loans to the US government• Municipal Bonds: loans to state and local
governments. • Corporate Bonds: loans to corporations
(usually higher denominations $5,000-10,000)• Junk Bonds: low-rated corporate bonds that
are high yielding, but likely to fail
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Risk vs. Reward
Low Risk/Low Return High Risk/High Return
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Risk vs. Reward
Low Risk/Low Return High Risk/High Return
Savings AccountsCDs
US Savings Bonds
Real EstateHigh Risk Stocks/Individual Stocks
Low Risk Stocks/Mutual Funds
Junk Bonds
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Section 3: The Stock Market
• Stocks are ways to assume ownership of a corporation.
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Stocks & Shares
• Publicly traded corporations issue shares of stock, ownership, in their business.
• Shares are portions of stock (ownership)
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Dividends & Capital Gains
• Dividends are payments to shareholders. Usually quarterly (4x a year).
• Capital gain is when shareholders sell their stock for more than they bought it for.
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Types of Stock
• Income stock: stock that pays dividends throughout the year.
• Growth stock: the stock does not pay dividends, but reinvests earnings and stock value grows.
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Stock Splits
• A stock split is when companies split shares into more than one share.– 10 shares @ $10/share = 20 shares @ $5/share– OR 5 shares @ $20
• To understand how a corporation is valued- you need to look at the quantity of shares, not just the price.
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Trading Stocks• Stocks are purchased through stockbrokers who work
for brokerage firms.• Brokerage firms charge commission.– Online brokerages have become common, as they are
automated and charge less commission.
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Stock Exchanges
• Brokers trade through stock exchanges.• New York Stock Exchange (NYSE) and Nasdaq.
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Day Trading and Financial Engineering
• The stock market has become a playground that can resemble gambling more than investing.
• Through options, futures, short-sales, and complex indexes- you can bet on anything.– Businesses failing, the weather, entire countries.– Day traders hold shares for just one day.
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Bull and Bear Markets
• Bull Markets are markets that are on the rise; investors are buying.
• Bear Markets are markets that are falling; investors are selling.
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Dow Jones / S&P 500
• The Dow Jones takes 30 diverse corporations that represent the entire stock market, and average them.
• The S&P 500 takes 500 corporations• Both are designed to reflect overall trends of
the market.
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