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Saving and Investing
Investment – saving
today for future
benefits.
Interest – the cost to
borrow money.
Promotes economic
growth.
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The Financial System
A system that allows the transfer of
money between savers and borrowers.
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Financial Intermediaries
Institutions that help channel funds
from savers to borrowers.
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The Flow of Savings and Investments
Financial intermediaries accept funds from
savers and make loans to investors.
Financial Intermediaries
Savers make deposits to…
Financial Institutions that make loans to…
Commercial banks
Savings & loan associations
Savings banks
Mutual savings banks
Credit unions
Life insurance companies
Mutual funds
Pension funds
Finance companies
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Investors
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What is Credit?
• Credit is an arrangement through which you may receive
cash, goods, or services now and pay for them in the future.
• What is the cost of using someone else’s money called?
INTEREST
There are two types of credit:
Open-end credit - credit that can be increased by the debtor by
continuing to purchase goods or services on credit, up to a
certain limit.
Closed-end credit – credit for a certain amount of money that
cannot be increased – secured with collateral.
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How do I earn a good credit score (FICO)?
• By using credit in a responsible manner!
• By paying credit card bills on time.
• 5 main categories that determine your final FICO score:
– 35% - Payment history – How you have paid your bills in the past
– 30% - Amounts owed – Measures debt against credit
– 15% - Length of credit History – Don’t open account after
account. Keep a couple of credit cards for a long period of time.
– 10% - Type of credit used – Lenders like to see a good mix of
credit, used responsibly
– 10% - New credit inquiries – Too many inquiries will lower your
credit score!
Average American Credit Score = 651
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Credit Statistics
Total amount of U.S. credit card debt in 2010--$800
billion
Number of different credit cards in the average
family—8
Outstanding credit card debt of the average
household—$15,956
Percent interest paid on that outstanding debt—
12.78%
Average late fee on a credit card - $34.00
http://www.indexcreditcards.com/finance/creditcardstatistics/2011-report-on-credit-card-usagefacts-statistics.html
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Advantages of Credit Cards
Advantages:
• Able to buy needed items now
• Reduce a need to carry cash
• Creates a record of purchases
• More convenient than writing checks
• Consolidates bills into one payment
• Established credit history
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Disadvantages of Credit Cards
Disadvantages:
• Interest (higher cost of items)
• May require additional fees
• Financial difficulties may arise if one loses track of how
much has been spent each month
• Increased impulse buying
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FICO Score
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How do I earn a good credit score (FICO)?
• By using credit in a responsible manner!
• By paying credit card bills on time.
• 5 main categories that determine your final FICO score:
– 35% - Payment history – How you have paid your bills in the past
– 30% - Amounts owed – Measures debt against credit
– 15% - Length of credit History – Don’t open account after
account. Keep a couple of credit cards for a long period of time.
– 10% - Type of credit used – Lenders like to see a good mix of
credit, used responsibly
– 10% - New credit inquiries – Too many inquiries will lower your
credit score!
Average American Credit Score = 651
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FICO Example
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Credit Agencies
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Risk and Return
Return and Risk
• Higher potential return,
greater the risk involved.
Return and Liquidity
–More liquid, less return
Return - money
received from
investment
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Risk Reward Pyramid
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Where to Invest?
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Bonds
Basically loans, or IOUs.
3 basic components:
1. Coupon rate — interest rate the issuer will
pay.
2. Maturity — the time when payment is due.
3. Par value — amount paid to purchase the
bond and that will be repaid to the investor at
maturity.
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Bond Ratings
• Standard & Poor’s and Moody’s rate bonds.
Bond Ratings
Standard & Poor’s
Highest investment grade
High grade
Upper medium grade
Medium grade
Lower medium grade
Speculative
Vulnerable to default
Subordinated to other debt rated CCC
Subordinated to CC debt
Bond in default
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Moody’s
AAA
AA
A
BBB
BB
B
CCC
CC
C
D
Best quality
High quality
Upper medium grade
Medium grade
Possesses speculative elements
Generally not desirable
Poor, possibly in default
Highly speculative, often in default
Income bonds not paying income
Interest and principal payments in default
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Aaa
Aa
A
Baa
Ba
B
Caa
Ca
C
D
Types of Bonds
Savings Bonds
• Low-denomination ($50 to $10,000) bonds
• Issued by the U.S. gov’t
• Purchased below par value and interest is paid only when the bond
matures. Zero-Coupon Bond.
Treasury Bonds (long term), Notes (1-10 years), Bills (short term)
• Issued by the U.S. Treasury Dept.
Municipal Bonds
• Issued by state or local gov’t to finance highways, state buildings,
libraries, and schools.
Corporate Bonds
• A bond that a corporation issues to raise money to expand its business.
Junk Bonds
• Junk bonds are lower-rated, potentially higher-paying bonds.
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Advantages and Disadvantages
to Bond Issuers
• Advantages for issuer:
1. Coupon rate is locked.
2. Bonds are not ownership.
• Disadvantages to the issuer:
1. Must make payments, even in bad years.
2. Must maintain financial health.
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How Stocks Are Traded
• Stock is representative of ownership in a company –
also referred to as equity
• A stockbroker is a person who links buyers and sellers
of stock.
• Stockbrokers work for brokerage firms, or businesses
that specialize in trading stock.
• Some stock is bought and sold on stock exchanges, or
markets for buying and selling stock.
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Stock Exchanges
The New York Stock Exchange (NYSE)
•
Country’s largest stock exchange.
•
Only stocks for the largest and most established
companies are traded on the NYSE.
NASDAQ – National Association of Securities Dealers
Automated Quotations
•
Exchange that specializes in high-tech and energy
stock.
•
Traded strictly over computer network
The Over-the-counter (OTC) Market
•
Electronic marketplace for stock that is not listed
or traded on an organized exchange.
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Measuring Stock Performance
Stock Performance Indexes
• The Dow Jones Industrial Average
– The Dow is an index that tracks the
performance of 30 of the largest companies.
• The S & P 500
– An index that tracks the performance of 500
different stocks.
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“The Dow 30”
Dow Jones Industrial Companies
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Stock Performance from 1900 - 2009
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In the Short Term….
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Buying Stock
• Corporations can raise money by issuing stock, which
represents ownership in the corporation. A portion of
stock is called a share. Stocks are also called equities.
• Stockowners can earn a profit in two ways:
1. Dividends, which are portions of a corporation’s
profits paid to shareholders
2. A capital gain is earned when a stockholder sells
stock for more than he or she paid for it.
A stockholder that sells stock at a lower price than
the purchase price suffers a capital loss.
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Types of Stock
Dividend Differences
Decision-Making Differences
• Income stock pays dividends
at regular times during the
year.
• Investors who buy common
stock are voting owners of the
company.
• Growth stock pays few or no
dividends. Instead, the
issuing company reinvests
earnings into its business.
• Preferred stock owners are
nonvoting owners of the
company, but receive
dividends before the owners
of common stock.
Stocks may be classified either by whether or not
they pay dividends or whether or not the stockholder
has a say in the corporation’s affairs.
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Stock Splits and Stock Risks
Stock Splits
Risks of Buying Stock
• A stock split is the division of
a single share of stock into
more than one share.
• Purchasing stock is risky
because the firm selling the
stock may encounter
economic downturns that
force dividends down or
reduce the stock’s value. It is
considered a riskier
investment than bonds.
• Stock splits occur when the
price of a stock becomes so
high that it discourages
potential investors from
buying it.
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Mutual Funds
• A collection of stocks – ticker symbol ends in an X
• Funds in which investment professionals manage your money and
decide on the investments
• Advantages
– Simplicity / Professional Management / Diversification / Liquidity
/ Usually Low Risk
• Disadvantages
– Fees (and lots of them)
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Other Types of Financial Assets
Certificates of Deposit (CD’s)
Money Market Mutual Funds
• Available through banks
•
A mutual fund that invests in
short-term debt securities such
as US Treasury bills
and commercial paper.
•
Higher interest, not FDIC insured
• Various terms of maturity
• Must keep money in until
maturity (will pay penalty for
early withdrawal)
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Compounding Interest
• Compound interest is the concept of adding
accumulated interest back to the principal, so that
interest is earned on interest from that moment on.
• The secret to getting rich slowly, says David Bach, is
the miracle of compound interest. Even modest returns
can generate real wealth given enough time and
dedication.
•
Rule of 72 - The Rule of 72 is a math formula that tells you how
long it will take to double the value of the money you invest:
•
Find out your interest rate...
•
Second... do the math!
•
72 / interest rate = years
•
Example: $100.00 invested at 6% interest rate
•
72 / 6 = 12 years --> In 12 years $100 will double at 6%!
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The Great Crash
Causes of the Crash
Effects of the Great Crash
•
Many ordinary Americans were
struggling financially: many
purchased new consumer goods
by borrowing money.
•
•
Speculation, or the practice of
making high-risk investments
with borrowed money in hopes of
getting a big return, was
common.
The Crash contributed to a much
wider, long-term crisis — the
Great Depression during which
many people lost their jobs,
homes, and farms.
•
Americans also became wary of
buying stock. As recently as the
early 1980s, only about 25
percent of households in the
United States owned stock.
The collapse of the stock market in 1929
is called the Great Crash.
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