chapter eleven. objectiveto learn how the components of a financial system work together to transfer...

Financial Markets

Chapter Eleven

Savings and the Financial System

• Objective – To learn how the components of a financial system work together to transfer savings to investors


• In your groups…..– Identify and describe methods of investing and

savings that you are familiar with• Create a table listing each method and also how they

work

– Why do you think the governments and institutions would want participants in a market to save and invest their money?


• What is saving?– Savings is the action of not spending– While savings is what is accumulated by not

spending

Savings and Economic Growth

• Savers and Financial Assets– How can you save?• Savings account, bonds, CD(Certificate of Deposit) –

Investor has made a loan, interest paying, to the bank– All of these are called Financial assets – claims on the

property and the income of the borrower– Stocks can also be purchased…..ownership claims on a

company

The Circular Flow of Finance

• We need a financial system to use the savings of others – – A network of savers, investors, and financial institutions

that work together to transfer savings to investors


Financial system has three parts1. Funds that a saver transfers to a borrower2. Financial assets that certifies conditions of the loan3. The organizations that bring the surplus funds and financial assets together


Financial Intermediaries-Are the institutions that lend the funds that the savers provide-Inter = Between or among-Mediate = To work between two parties-Banks, credit unions, life insurance companies, pension funds, or any other funds that channel savings to borrowers.-Help the small savers – limited funds to deposit


• Financing Capital Formation– Any sector of the economy can borrow

• Sector = Government, businesses, households, individuals• Corporations borrows from savers or through financial

intermediaries Corporation issues bonds or other financial assets to lender

• Government borrows issues government bonds or other financial assets to lender


• Financing Capital Formation– In terms of savings, households and businesses are the

biggest source– Capital formation depends on saving and borrowing– When households borrow invest some of money in

homes– When businesses borrow funds invested in tools,

machinery, equipment– When governments borrow funds invested in

hospitals, highways, universities, etc.


• Financing Capital Formation– Answer this question in your groups…..– How does the financial system benefit both the borrowers

and the savers?

Nonbank Financial Intermediaries

• These are non-depository institutions that also channel savings to borrowers

• Three prime examples– Finance companies– Life Insurance Companies– Pension Funds


• Finance Companies– A firm that specializes in making loans to consumers.– Buys installment contracts from merchants that sell goods

on credit.• Easy for company to sell products• FC assumes risk with loan

– Makes direct loans – some risky, higher interest rates to consumer.


• Life Insurance Companies– Provide financial protection for insured people– Collects a lot of cash– Premium – money paid on a regular basis for policy– Can also act as lenders as well


• Pension Funds– Basic security for when you retire from the workforce.– Pension is the payment, a pension fund is used for

monetary disbursement.– Can be company pensions or private pension funds.

Basic Investment Considerations

• Four basic considerations– Consistency

• Invest over long length of time

– Simplicity• Keep it simple• Ignore anything too complicated• Go with what you know

– Risk-Return Relationship• Risk is degree to which outcome is uncertain• All investments have risk although degrees vary

– Investment Objectives• What is reason for investing?• Retirement vs. more immediate funds….

Question?????

• In what type of situation might an investor seek an investment with a high level of risk?

Financial Assets and their Markets

• Bonds as Financial Assets– Most are long term investments– Government Bonds

• $100.00 US Saving Bond• Purchase Price - $50.00• Maturity – 20 years• Money accrued – Predetermined interest from time of purchase to maturity + the Par

Value of bond (total value at Purchase)

– Corporate Bonds• Example – 20 year, $1000.00 Par Value Bond @ 6% interest• Interest paid semi-Annually• .06 x 1000/2 = $30.00 paid twice a year for length of maturity• After 20 years – Par Value is paid back to investor• 60 x 20 = $1200.00 + $1000.00 (par value) = $2200.00

Financial Assets and their Markets

• Bonds yields– Comparing bonds = computing current yield

• Annual interest divided by purchase price• $60.00/$950.00 = 6.32%• $60.00/$1100.00 = 5.45%• Interest received and price paid determine the actual current yield• All bonds have ratings – Great companies = great ratings & vice

versa• Standard and Poor's and Moody’s publish bond ratings• Using your phones…as a group, look up the top and bottom 5

bond rated companies from each of the above mentioned bond rating companies

Financial Assets and their Characteristics

• Certificates of Deposit (CD’S)– Most common form of investment– As low as $500 - $1000– Investor can select length of maturity, tailored for just about

anything…college, car, house, etc.– FDIC insured as well!

• Corporate Bonds– Long term investments– $1,000 - $10,000 – Prices are lower than par value– Use bond ratings to decide which to invest in– Junk Bonds, very risky, can produce a high yield, but high

possibility of default


• Municipal Bonds (Munis)– Bonds issued by state and local governments– Finance items at state or local level– Very safe, tax-exempt – no federal taxation

• Government Saving Bonds– Low-denomination nontransferable bonds– Paper/Paperless– Paper

• $50 - $10,000 – 30 year maturity – Interest + Par Value– Paperless

• Purchased directly from treasury via internet• Pay face value• Interest added monthly and compounded semi-annually• Bond will double every 20 years


• Treasury Notes and Bonds– T-Notes

• Matures in 2-10 years– T-Bonds– Denominations of $1,000.00– Issued electronically– Periodic interest is added automatically to your account– Safest of all financial assets


• Treasury Bills– T-Bills– Very short-term investment

• 4,13, or 26 weeks• Do not pay interest directly• Price discounted at purchase – par value at maturity• $960.00 Paid - $1000.00 after maturation

• Individual Retirement Accounts– IRA’S– Long-term tax sheltered time deposits– All taxes deferred– Will be paid upon withdrawal– Penalties for early withdrawal– Great retirement option

Financial Asset Markets

• All financial assets are grouped into different markets based on two factors:– Maturity– Liquidity

Financial Asset Markets

Money Market < one year Capital Market > one year

Primary Market – Only original issuer can sell or repurchase a financial asset.

*Money market mutual funds*Small CDs

*Government saving bonds*IRAs*Money market mutual funds*Small CDs

Secondary Market-Existing financial assets can be resold to new owners

*Jumbo CDs*Treasury bills

*Corporate bonds*International bonds*Jumbo CDs*Municipal bonds*Treasury bonds*Treasury notes

Investing in Equities and Options

• We know that Government bonds are the safest investment, however, they have the lowest return

• Equities and Futures are the riskiest, but could have a large reward.


• Stocks and Efficient markets– Shares of common stock are called Equities– Represent ownership of corporations– Share Values

• Can purchase shares via a stockbroker – Buys or sells equities for clients

• Internet account can allow investor, you, to buy, sell, and monitor• Value is determined by profitability of the company• Goes up and down daily


• Stocks and Efficient markets– Reading a listing – Page 306

• DIV – Annual dividend paid in four equal installments• Yld% - Dividend divided by the closing price• PE – Price-Earnings ratio – Stocks closing price divided by annual

earnings of each share of common stock outstanding.• NET CHG – Where the stock closes today versus the day prior


• Stocks and Efficient markets– Using your phone….look up the share price of the following common

stocks:• Apple – • Google - • Microsoft – • Alibaba – • GE – • Heinz – • Ebay – • Facebook – - Then, using your technology, determine which stock would you determine to be the most profitable in your opinion


• Stocks Market Efficiency– Nothing is guaranteed in the market – Rise and fall– Efficient Market Hypothesis (EMH)

• Stocks are usually priced correctly and bargains are hard to find due to the competitive nature of investors.

• They, investors, constantly analyze the market for any fluctuations

– Portfolio Diversification• Being diverse, allows you to make up for losses by gaining in other

stocks at the same time• Don’t put all of your money into one stock!!!!!


• Mutual Funds– A company that sells stock in itself to individual investors– Then invests money it receives into other company’s stock and

sometimes bonds– Mutual fund stockholders receive dividends from their investments– Net Asset Value NAV – Market value of a mutual fund share

• Allows for diversification – invested in many companies

• 401K– A tax deferred investment and savings plan that acts as a personal

pension fund for employees– Contribute via payroll deductions– Lowers your taxable income – do not pay taxes on it until you withdraw


• 401K– Simple, safe way for employees to save– Employer usually matches your contribution based on a certain %


• Stock Markets and Performance– Most stocks are traded in a stock exchange (securities)– Members pay a fee to join, then can trade openly– NYSE – New York Stock Exchange – Oldest, largest, exchange in U.S– Wall Street – lists stock from around 2,700 companies

– AMEX – American Stock Exchange• New York City• Deals with smaller companies• Regional exchanges as well – Chicago, Philadelphia, etc.


– OTC – Over the Counter Markets• Electronic marketplace for securities not traded in an exchange• Most stocks in world traded this way• NASDAQ – National Association of Security Dealers Automated

Quotation• World’s largest automated electronic stock market• Connected to 80 countries

chapter eleven. objectiveto learn how the components of a financial system work together to transfer...

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