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Ch. 11: Financial Markets

Ch. 11: Financial Markets. What to do with money:. Make a list of as many places you can think of that you could invest money... . What to do with money:. Make a list of as many things you can think of to do with money… Spend it Savings account Certificate of Deposit Real Estate

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Ch. 11: Financial Markets

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  1. Ch. 11: Financial Markets

  2. What to do with money: • Make a list of as many places you can think of that you could invest money...

  3. What to do with money: • Make a list of as many things you can think of to do with money… • Spend it • Savings account • Certificate of Deposit • Real Estate • Stock Market • Savings Bond • Mutual Fund • Business Loan

  4. Section 1: Saving and Investing • Investors decide where to place their resources based on several factors.

  5. Investment • Investment is the directing of resources to create future benefits.

  6. Financial Systems • Any system that allows the transfer of money between savers and borrowers.

  7. Financial Intermediaries • Institutions that channel funds from savers to borrowers. • Banks • Finance companies • Stock brokerages

  8. Risk and Reward • Risk is the extent to which you could lose your investment. • Reward is the extent to which your investment could be profitable. • High risk = high (potential) reward • Low risk = low reward

  9. Diversification • Diversification is spreading out investments to reduce risk. • “Don’t put all your eggs in one basket”

  10. Diversification: Mutual Funds • Mutual Funds are diversified pools of many different stocks and bonds. • Buying 1 share of a mutual fund means you are buying 100s (maybe 1000s) of different stocks and bonds. • Reduces risk

  11. Portfolio • Portfolio is the compilation of an individual’s investments.

  12. Liquidity • Can an investment easily be turned into spendable cash? If so- it is a “liquid” investment. • Rank the liquidity of the following investments • Real Estate • Savings Account • Certificate of Deposit • Retirement Fund

  13. Return and Percentages • Return in the amount received from an investment. • Investors consider interest percentages to determine how profitable an investment is.

  14. Section 2: Bonds and Financial Assets • Bonds are loans to organizations (government or business)

  15. Bonds vs. Stocks • Buying stocks is buying a portion of a business • Buying bonds is loaning money to a business or government • As a bond holder, you are not an owner • Means less risk/reward than stocks

  16. Bond Components • Coupon Rate: the interest rate at which a bond is purchased (5%) • Maturity: the amount of time a bond must be held before payment can be received (10 years) • Par Value: amount the investor pays initially ($1,000)

  17. Problem: Compound Interest • Assume the following bond example: • $1000 par value • 10% coupon rate • 10 year maturity • How much will the bond holder get back at the end of the 10 years?

  18. Problem: Compound Interest • Assume the following bond example: • $1000 par value • 10% coupon rate • 10 year maturity • How much will the bond holder get back at the end of the 10 years? • Answer: 2,593.74 - Why?

  19. Understanding Compound Interest • If you clap now • Clap again in 1 second • Clap again in 2 seconds • Clap again in 4 seconds, in 8 seconds, 16 seconds… • How many times will you clap in a year?

  20. Understanding Compound Interest • Compound interest applies the new interest to the old principal, making growth exponential… • 25 by 25 scenario… • If you invest $25,000 by the age of 25… • With 10% interest, how much will it be at a retirement age of 67 (42 years?)

  21. Rule of 72 • 72/Interest Rate = Years for Money to Double • 72/10 = 7.2 • 0 years = 25,000 • 7 years = 50,000 • 14 years = 100,000 • 21 years = 200,000 • 28 years = 400,000 • 35 years = 800,000 • 42 years = 1,600,000

  22. 500 Million Dollar Bet • 2 Professors, experts in aging, made a bet. One believed someone currently alive will live to 150, the other disagreed. • They bet 500 Million Dollars. • How? • http://discovermagazine.com/2003/nov/cover

  23. Types of Bonds • US Savings Bonds: loans to the US government • Municipal Bonds: loans to state and local governments. • Corporate Bonds: loans to corporations (usually higher denominations $5,000-10,000) • Junk Bonds: low-rated corporate bonds that are high yielding, but likely to fail

  24. Risk vs. Reward High Risk/High Return Low Risk/Low Return

  25. Risk vs. Reward US Savings Bonds Junk Bonds CDs High Risk Stocks/ Individual Stocks Low Risk Stocks/ Mutual Funds Real Estate Savings Accounts High Risk/High Return Low Risk/Low Return

  26. Section 3: The Stock Market • Stocks are ways to assume ownership of a corporation.

  27. Stocks & Shares • Publicly traded corporations issue shares of stock, ownership, in their business. • Shares are portions of stock (ownership)

  28. Dividends & Capital Gains • Dividends are payments to shareholders. Usually quarterly (4x a year). • Capital gain is when shareholders sell their stock for more than they bought it for.

  29. Types of Stock • Income stock: stock that pays dividends throughout the year. • Growth stock: the stock does not pay dividends, but reinvests earnings and stock value grows.

  30. Stock Splits • A stock split is when companies split shares into more than one share. • 10 shares @ $10/share = 20 shares @ $5/share • OR 5 shares @ $20 • To understand how a corporation is valued- you need to look at the quantity of shares, not just the price.

  31. Trading Stocks • Stocks are purchased through stockbrokers who work for brokerage firms. • Brokerage firms charge commission. • Online brokerages have become common, as they are automated and charge less commission.

  32. Stock Exchanges • Brokers trade through stock exchanges. • New York Stock Exchange (NYSE) and Nasdaq.

  33. Day Trading and Financial Engineering • The stock market has become a playground that can resemble gambling more than investing. • Through options, futures, short-sales, and complex indexes- you can bet on anything. • Businesses failing, the weather, entire countries. • Day traders hold shares for just one day.

  34. Bull and Bear Markets • Bull Markets are markets that are on the rise; investors are buying. • Bear Markets are markets that are falling; investors are selling.

  35. Dow Jones / S&P 500 • The Dow Jones takes 30 diverse corporations that represent the entire stock market, and average them. • The S&P 500 takes 500 corporations • Both are designed to reflect overall trends of the market.

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