Download The Circular Flow of Finance Financial Intermediaries

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
Quote of the Day
• “Very often a change of self is needed more
than a change of scenery”
• A.C. Benson
Savings and the Financial System
• 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?
Savings and the Financial System
• 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
The Circular Flow of Finance
Financial system has three parts
1. Funds that a saver transfers to a borrower
2. Financial assets that certifies conditions of the loan
3. The organizations that bring the surplus funds and
financial assets together
The Circular Flow of Finance
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
The Circular Flow of Finance
• 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
The Circular Flow of Finance
• 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.
The Circular Flow of Finance
• 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
Nonbank Financial Intermediaries
• 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.
Nonbank Financial Intermediaries
• Life Insurance Companies
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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
Nonbank Financial Intermediaries
• 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
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$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
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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
Financial Assets and their
Characteristics
• 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
Financial Assets and their
Characteristics
• 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
Financial Assets and their
Characteristics
• 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
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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.
Investing in Equities and Options
• 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
Investing in Equities and Options
• 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
Investing in Equities and Options
• 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
Investing in Equities and Options
• 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!!!!!
Investing in Equities and Options
• 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
Investing in Equities and Options
• 401K
– Simple, safe way for employees to save
– Employer usually matches your contribution based on a certain %
Investing in Equities and Options
• Stock Markets and Performance
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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.
Investing in Equities and Options
– 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
Investing in Equities and Options
– How stock performance is measured
• Dow Jones Industrial Average (DJIA)
– Most popular
– 1884 – Dow Jones Corporation published average closing of 11
active stocks
– Basically tells us the % change of stocks that averaged $1.00 of
change – Only with the NYSE
• Standard and Poor’s 500 (S&P 500)
– Uses a representative change of 500 stocks as an indicator of
overall market performance.
– NYSE, AMEX, OTC markets
Investing in Equities and Options
– Bull Vs. Bear Market
• Bull Market – Term used to describe a strong market with prices
moving up for a long period of time
• Bear Market – A mean or a nasty market….prices moving
downwardly