OCR Document

CHAPTER 13

FINANCIAL INSTITUTIONS, MARKETS AND EQUITIES

SAVINGS AND THE FINANCIAL SYSTEM

A GENERAL INFORMATION

1. SAVING - def - the absence of consumption

2. SAVINGS - def - dollars that become available for borrowing and investment

3. Savings make economic growth possible

4. A FINANCIAL SYSTEM transfers savings into investment

5. Financial Assets - def - claims on income or property ofthe borrower

a. Ex - C.D., mortgage bond, treasury bills

b. When funds are lent, a financial asset is created

B. Financial Intermediaries

1. Institutions that bring together surplus funds and financial assets

2. Best examples are banks and thrifts

C. Non-Bank Financial Intermediaries

1. FINANCE COMPANIES

a. Institutions that specialize in buying installment contracts from merchants or

offering bill consolidation loans

b. Ex- HFC, Girard, Beneficial, MONY

2. LIFE INSURANCE COMPANIES

a. These institutions invest surplus premiums after claims are paid through loans

or investments

3. MUTUAL FUNDS

a. People buy shares in a mutual fund which in turn invests the money in stocks and

bonds in corporations

b. The mutual fund allows the small investor the opportunity to diversify a portfolio

because of economies of scale

4. PENSION FUNDS

a. A fund is set up to collect income and disperse income especially to retirees

b. The fund generates income by investing these contributions in financial assets

5. REIT'S - Real Estate Investment Trusts

a. They make loans to construction companies that build homes, office buildings and

malls

b. They borrow money from banks and repay these loans from the rents and mortgages

collected ,from the units built

II. INVESTING IN FINANCIAL ASSETS

A INVESTMENT CONSIDERATIONS

1. Risk - def - an outcome that cannot be predicted but where probabilities can be estimated a. Junk Bonds are the riskiest but bring the highest returns

b. U. S. Treasury bills are the safest

c. An individual who is investing should take a risk no greater that he/she is comfortable with

2. Goals

a. The Accumulation of Wealth

A Typically for retirement

B. Assets that appreciate are typically invested in such things as stock and land

b. To Accumulate Reserves

A Maybe for a rainy day or for an expensive purchase

1. Ex - college, wedding unemployment

B. Assets that are sought are those that could be liquified easily

c. Income - annuities and Utilities

d. Tax Avoidance

A People in high income tax brackets could buy "munie's" or invest in an 401 k

B. SECRETS TO SUCCESSFUL INVESTING

1. Invest regularly - be consistent

a. Use a payroll deduction - DOLLAR COST AVERAGING

2. Invest in what you are familiar with - avoid complexity

3. Diversify

a. Especially if you have a large portfolio

2. Credit worthiness is important when buying bonds because they are not insured

3. Moody s and Standard and POORS are 2 companies that publish bond ratings

a. Factors That Influence Bond Rating

A. Financial health of the issuer

B. Ability to make future coupon payments

C. Past credit history

1. AAA is the highest

2. D is the lowest (default)

a. Check chart 13-4 p 328

3. Anything below BB for Standard and POORS and below Ba for Moody’s is

considered as high risk or junk bonds

D. FINANCIAL ASSETS AND THEIR CHARACTERISTICS

1. A financial asset represents a loan to a corporation in the form of a bond

2. TYPES

a. CERTIFICATES OF DEPOSIT - a time deposit

A. Vary in size and maturity

1. The longer the maturity, the higher the interest rate

2. JUMBO CD - $100,000

B. Covered by FDIC

C. Substantial interest penalty for early withdrawal

b. CORPORATE BONDS

A. Long term investments which can be liquidated easily

c. MUNICIPAL BONDS - mum's

A. Issued by state and local governments to finance highways, bridges, sewage

treatment plants etc..

B. They are attractive because they are relatively safe and they are tax exempt

the federal govt. doesn't tax the interest earned

1. Some states also exempt the interest from taxes

C. Good investment for wealthy people who want to continue to generate income

and shelter some of the interest earned

d. GOVERNMENT SAVINGS BONDS

A. Purchased at a discount

B. They are non-transferable

e. INTERNATIONAL BONDS

A. Usually purchased by pension funds or life insurance companies

B. You actually purchase a debt of another country

1. The coupon is usually paid in the currency of the issuing country

which because of currency fluctuation could produce a yield greater

or less than expected

C. Bonds start at a selling price of $1 million

f. MONEY MARKET MUTUAL FUNDS

A Usually makes loans in the form of CD's to other borrowers

B. Riskier than a regular CD so they will pay a higher return

C. They are not covered by FDIC

D. They usually have check writing privileges

g. TREASURY NOTES AND BONDS

A Notes have maturities between 2 and 10 years

B. Bonds have a maturity 10 to 30 years

C. Safest form of financial asset so the return is the lowest

1. Backed by the full faith and credit of the U.S.

h. TREASURY BILLS - T BILLS – BOUGHT AND SOLD BY THE FED

A Maturity of 1 year or less

B. Sold at a discount

1. IRA's - Individual Retirement Accounts – TRADITIONAL AND ROTH

A. A tax sheltered time deposit

B. An individual can shelter up to $2000/year

C. Any interest generated is also exempt from federal taxes until such time when

income is drawn from the IRA

1. When income is drawn, the taxpayer is typically in a lower tax bracket

D. Intent is to encourage individuals to save to supplement their Social Security

E. 401 K's

1. An arrangement where an employer encourages an employee to saving for

retirement with a promise to match part of employee contributions

2. Similar to a stock sharing plan

F. Financial Assets are classified by

1. TIME

a. Gapita1.Matkets are markets where money is loaned for more than 1 year

b. Money Markets are markets where money is loaned for less.than.1 year

2. How Traded

a. Primary Markets - only the original issuer can redeem the financial asset

b. Secondary Market the - f1nancraI asset can be sold

A This provides more liquidity to the investor

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INVESTING IN EQUITIES, FUTURES AND OPTIONS

A Equities represent shares of ownership in a corporation

whereas

a financial asset represents a loan

B. Factors that affect the Market Value of Equities

1. The number of outstanding shares

a. The higher the number of shares, the lower the market value

2. Expectations

C. E.M.H. - Efficient Market Hypothesis

1. Stocks are priced right and bargains are hard to find

translation

it is hard to "beat the market"

a. This is the reason why speculation is usually disastrous

b. Portfolio Diversification is the best strategy

D. A stockbroker is an individual or company who has a seat on the exchange and can

buy and sell securities

E. Organized Exchanges - NYC is the financial hub of the world

1. NYSE - the oldest, largest and most prestigious- 14000 seats

a. 80% of all transactions occur here

b. Lists 2400 stocks of over 1900 companies which are considered as the largest and most

profitable

2. AMEX

a. Has 600 seats and over 1000 stocks are listed

b. Companies that are listed here are smaller and more speculative than on the NYSE

3. Regional Exchanges

a. Stocks are too small and too new to be listed on the major exchanges

4. International Exchanges

a. MIP - Tokyo, Frankfort, and Hong Kong

F. Stocks are also traded "over the counter"

1. This is the electronic marketplace

2. OTC trades are made by NASD and are quoted on, NASDAQ

3. These stocks do not pay dividends

a. They are typically new and growing companies

G. MEASURES OF STOCK PERFORMANCE

1. DJIA - Dow Jones Industrial Average

a. Tracks 30 representative stocks from the NYSE which are typically the 30 largest

companies listed

b. These companies come and go

N.B c. A "one" point move in the average represents a $.45 change in the total price of all 30

stocks

2. STANDARD AND POORS 500

a. Monitors companies listed on the NYSE, AMEX and OTC markets

b. This is more broad-based

H. TRADING IN SPOT, FUTURES AND OPTION MARKETS

1. Both equities and commodities are traded in these markets

2. The NY Mercantile Exchange, Chicago Board of Trade, Kansas City Board of Trade

3. Spot Markets are markets where trades occur in the present

4. Futures are markets where trades are negotiated for the sale or purchase of something

down the road (usually 6 months) at a price specified today

a. These tend to be speculative

b. An Options Market is a unique type of futures market where buyer and seller try to

hedge a market

A. A CALL OPTION gives someone the right to buy a stock or commodity in

the future

1. For example, H you buy an option for $70 and the stock is selling for $30

down the road, you tear up the option and buy the stock for $30 but if

the stock is selling for $100, you exercise your option, bu)'the stock and sell it for $100 and collect the profit

a. If you tear up the option, your only expense is what you paid for the option

b. There is "always the assumption that there will be a buyer for the stock

B. A PUT OPTION gives someone-the right to sell something In the future

1. For Example - If you agree to sell something for $50 in the future and the price falls to

$40 you would require the buyer to pay $50, pay off the option and pocket the profit, if

the price were $80, you would tear up the option and sell it for $80