Businesses can borrow savings to: Businesses can borrow savings to: produce new goods and services...
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Transcript of Businesses can borrow savings to: Businesses can borrow savings to: produce new goods and services...
Financial Markets•Businesses can borrow savings to: •produce new goods and services •build new plants and equipment•create more jobs
Financial Markets•Financial Asset:•Legal claim on the property and income of the borrower.
•e.g. certificate of deposit – a piece of paper that says, “ABC Bank has my $1000 and promises to repay me on this date.”•I (lender) have provided ABC Bank with funds that they can loan.•My CD is a claim on the property/income of the bank for that $1000.
Financial Markets•Lenders (businesses/individuals):•can provide funds directly to the borrower (govt./business)
•Stocks, bonds – financial assets in the hands of the lenders.
Financial Markets•Financial intermediaries (“lying between”)
•Institutions that collect and channel funds from savers to borrowers.•Borrowers use the funds to:
•Invest in capital equipment•Build plant•Hire and train workforce
Financial Markets•Benefits of capital formation:•Lenders:
•Don’t have to find borrowers•Liquidity•Less risk
•Credit underwriting•Pooled portfolio
•“Guaranteed” rate of return (FDIC)
Financial Markets•Benefits of capital formation:•Borrowers:
•Don’t have to find lenders•Economies of scale
•Reduced time and expense•Ready capital
Financial Markets•Non-bank financial intermediaries•Pooled loan capital
•Life Insurance companies (e.g. MetLife)
•Collect premiums•Long-term finance
•Pension Funds (e.g. MD State Retirement and Pension System)– set aside assets which must be invested.
Financial Markets•Non-financial intermediaries (contd.)•Finance company (e.g. Ford Motor Credit)
•Nontraditional loans•Installment contracts
Financial Markets•Investment Considerations:•Consistency:
•“Can’t beat the market.”•11% historical average•Magic of compounding (1¢ or $5 million)
Financial Markets•Investment Considerations:
•Risk:•“The degree to which the outcome is uncertain, but a probable outcome can be estimated.
Financial Markets•Investment Considerations:•Objective:
•Rainy Day Fund•House Down payment•College Tuition•Retirement
Financial Markets•Debt Instruments
Junk bonds
Speculative stock
Common stock
Preferred stock
Investment-grade bonds
Prime commercial paper
U.S. Treasury bills
Financial Assets•Bonds:•Long-term financing instruments that pay principle and interest.
•Coupon rate•Maturity•Par (face) value
Financial Assets•Bond prices change when:•Market interest rates change:
•Ex: You hold a 10-yr. bond paying 7.5%, but market rates have declined to 5.5%;•Investors will pay a premium to own the higher yielding bond.
•Company’s ability to repay changes
Financial Assets•Bonds are rated by:•Standard and Poor’s (S&P)•Moody’s
•Determine the basic financial health of the issuer.•Ratings range from AAA (highest quality) to D (junk).•Investment grade bonds are rated BBB and above.
Financial Assets•Bond yield (rate of return) – seller wants to profit from market price:•Coupon rate ÷ market price
•Ex: $60 ÷ 950 = 6.32%$60 ÷ 850 = 7.01%$60 ÷ 1100 = 5.45%
Financial Assets•Bond Types:•CDs – issued by banking entities
•$500- 1000•Varying maturities, “penalty for early withdrawal”•FDIC insured•Taxable income
Financial Assets•Corporate bonds:
•$1000 – 10,000•Long-term investment•Easily liquidated in the market•Taxable income
Financial Assets•Municipal bonds (“munis”):
•Low-risk “borrower”•Government repays easily since it can tax•Tax-exempt interest
•Easier and cheaper for the issuer to borrow
Financial Assets•U.S. Savings Bonds:
•$50 - $10,000•50% discount from face value
•Accrued interest collected upon redemption
•Easy to obtain•“No” risk
Financial Assets•Treasuries:
•T-bills:•1, 3, 6 month maturities•Discounted like savings bond
•T-notes – 2-10 year maturities•T-bonds – 10-30 year maturities
Financial Assets•IRAs – long-term, tax sheltered
•Various investment amounts•Reduced taxable income•Interest earned tax deferred
Equities and Options
•Value of a share of stock depends on:•Outstanding number of shares•Company profitability•Market expectations
Equities and Options
•The market is infinitely efficient:•Efficient Market Hypothesis (EMH) – there are no bargain-priced stocks.•Portfolio diversification – “win some, lose some”:
•401 (k), 403 (b) –tax-deferred income•Lowers taxable personal income taxes•Usually employer-matched
•Mutual funds•Share of stock in a portfolio of stocks•Managed by experts
Equities and Options
•Trading – 3 markets:•NYSE – largest and most profitable corps.•AMEX – smaller corps. offering more speculative stocks•NASDAQ (OTC) – all stocks not traded on the other two organized exchanges.
Equities and Options
•Measurement:•DJIA (“the Dow”) – 30 major corps.•S&P 500 – 500 representative stocks•NASDAQ – tracks all the stocks traded on this exchange (about 3300).
Equities and Options
•Futures:•different from “spot” trades•An agreement to buy or sell at a future date for a specific price
•Ex: On 1/1/10, buy a 7/1/10 gold contract for $600/oz.•I expect gold to rise to $800/oz.•On 7/1/10, I buy $600 worth of gold from contract buyer and sell for $800.•Advantage: I keep $600 for six months.
Equities and Options
•Options – suppose you are not sure about the movement of commodity prices:•Call option – the right to buy at a future price•Put option – the right to sell at a future price
•Ex: I expect gold to rise to $800/oz. If it doesn’t, I tear up the contract.
•Used by industries that want to lock in commodity price (e.g. oil, lumber).