Money and Investment

1. Money and Investment Economics Mr. Bordelon

2. Money Money. Anything that serves as a medium of exchange, unit of account, and a store of value. Currency. Coins and paper bills used as money.

3. Money as a Medium of Exchange • Medium of exchange. Anything that is used to determine value during the exchange of goods and services. • Barter. Direct exchange of one set of goods or services for another. • Think of it as the method of payment. • How are we paying?

4. Money as a Unit of Account • Unit of account. A means for comparing the value of goods and services. • Numerical. In this case, we’re talking about the actual price in number. • Currency. This allows us to compare prices of g/s between different countries. • Think of it as the amount we are paying. • How much is it? • Are we paying in U.S. Dollars or Chinese Yuan, and how much in that currency?

5. Money as a Store of Value • Store of value. Something that keeps its value if it is stored rather than used. • Think of it as the value of the money. • How much is my money actually worth? • What can it buy, and in what amount?

6. Characteristics of Money Durability. Objects used as money must withstand the wear and tear from being used again and again. Portability. People need to be able to take money with them. Divisibility. Money must be easily divided into smaller denominations. Uniformity. Any two units of money must be the same in terms of what they can buy—accuracy. Acceptability. Everyone must be able to exchange the objects that server as money for g/s. Limited supply. To be useful, money must have a limited supply. Otherwise, it becomes worthless.

7. Types of Money

8. Questions • Two units of the same type of money must be the same in terms of what they will buy, that is, they must be • divisible. • portable. • acceptable. • uniform. • What is the source of fiat money’s value? • it represents the value of another item • government decree • presidential pardon • it is equal to the value of the stock market

9. Questions • Two units of the same type of money must be the same in terms of what they will buy, that is, they must be • divisible. • portable. • acceptable. • uniform. • What is the source of fiat money’s value? • it represents the value of another item • government decree • presidential pardon • it is equal to the value of the stock market

10. Measuring the Money Supply in the U.S. M1. Represents money people can gain access to easily and immediately. These assets have liquidity, the ability to be used as or directly converted into cash. Cash, demand deposits (checking accounts), traveler’s checks. • M2. All the assets in M1 plus illiquid assets, assets that can’t be converted easily into cash (near money). • Savings accounts, money market mutual funds, time deposits. • Money market mutual funds. Fund that pools money from small savers to purchase short-term government and corporate securities (stocks and bonds).

11. Measuring the Money Supply in the U.S. Money Supply in the United States, July 17, 2003

12. Measuring the Money Supply • Why measure it? • The Federal Reserve is active in the economy, stimulating it primarily by changing interest rates. • By changing interest rates, they can either expand or shrink the money supply. • The Federal Reserve does this as a tool to fight inflation.

13. Functions of Financial Institutions • Storing money • Saving money • Savings and checking accounts (most common). Used to make withdrawals often. Small of interest at an annual rate. • Money market accounts. Pay a higher rate of interest. Limited number of checks. Interest rates change based on the market it is tied to. • Certificates of deposit (CDs). Guaranteed rate of interest over a certain period of time. Funds can not be removed until the end of that time period without substantial penalty.

14. Functions of Financial Institutions Loans. Banks can help new businesses to get started and help established businesses grow. Interest is charged on the loan. Mortages. A mortgage is aloan that is used to buy real estate. Credit cards. Cards entitling their holder to buyg/s based on card holder’s promise to pay.Short-term loan with high interest.

15. Simple and Compound Interest • Interest. Price paid for the use of borrowed money. • Principal. Amount of money borrowed. • Simple interest: I = prt • p: principal • r: rate • t: time • Calculate the simple interest on a loan of $5,000 at 10% for 6 years.

16. Simple and Compound Interest • Simple interest: I = prt • p: principal • r: rate • t: time • Calculate the simple interest on a loan of $5,000 at 10% for 6 years. • I = ($5,000)(0.10)(6) • I = $3,000 • This means on a loan of $5,000, you’d have to pay $3,000 interest, for a total of $8,000 over 6 years.

17. Simple and Compound Interest • Compound interest. Paid on original principal and on accumulated past interest. • A = p(1 + r)n • A: amount of money accumulated after n years, including interest • p: principal • r: annual rate of interest • n: number of years amount is deposited or borrowed for

18. Simple and Compound Interest • A = p(1 + r)n • A: amount of money accumulated after n years, including interest • p: principal • r: annual rate of interest • n: number of years amount is deposited or borrowed for • Calculate compound interest for a 401(k) for $100,000 at 3% over 30 years.

19. Simple and Compound Interest A = p(1 + r)n Calculate compound interest for a 401(k) for $100,000 at 3% over 30 years. A = ($100,000)(1 + 0.03)30 A = ($100,000)(2.43) A = $243,000 This means that after 30 years, your initial investment of $100,000 would jump to $243,000.

20. Simple and Compound Interest A = p(1 + r)n Calculate compound interest for a student loan for $50,000 at 3.4% over 30 years.

21. Simple and Compound Interest A = p(1 + r)n Calculate compound interest for a student loan for $50,000 at 3.4% over 30 years. A = ($50,000)(1 + 0.034)30 A = ($50,000)(2.73) A = $136,500 This means that a student loan of $50,000 will end up as $136,500 at the end of 30 years.

22. Types of Financial Institutions • Commercial Banks • Commercial banks offer checking services, accept deposits, and make loans. • Savings and Loan Associations • Savings and Loan Associations were originally chartered to lend money for home-building in the mid-1800s. • Savings Banks • Savings banks traditionally served people who made smaller deposits and transactions than commercial banks wished to handle. • Credit Unions • Credit unions are cooperative lending associations for particular groups, usually employees of a specific firm or government agency. • Finance Companies • Finance companies make installment loans to consumers.

23. Questions 1. The money supply of the United States is made up of which of the following? (a) M1 (b) M1 and parts of M2 (c) all the money available in the economy (d) all the money available in the economy plus money that the country could borrow 2. Why are funds in checking accounts called demand deposits? (a) they are available whenever the depositor demands them by writing a check (b) they are not liquid (c) they are usually in great demand (d) they are held without interest by the bank

24. Questions 1. The money supply of the United States is made up of which of the following? (a) M1 (b) M1 and parts of M2 (c) all the money available in the economy (d) all the money available in the economy plus money that the country could borrow 2. Why are funds in checking accounts called demand deposits? (a) they are available whenever the depositor demands them by writing a check (b) they are not liquid (c) they are usually in great demand (d) they are held without interest by the bank

25. Saving and Investing Investment. Act of redirecting resources from being consumed today so that they may create benefits in the future; use of assets to earn income or profit. In short, investment is the use of assets to earn income or profit. When people save or invest their money, their funds become available for businesses to use to expand and grow. In this way, investment promotes economic growth.

26. Financial Intermediaries • Financial intermediaries. Institutions that help channel funds from savers to borrowers. • Banks, Savings and Loan Associations, and Credit Unions. Take in deposits from savers and then lend some of these funds to various businesses • Finance Companies. Make loans to consumers and small businesses, but charge borrowers higher fees and interest rates to cover possible losses • Mutual Funds. Pool the savings of many individuals and invest this money in a variety of stocks and bonds • Life Insurance Companies. Provide financial protection to the family, or other beneficiaries, of the insured • Pension Funds. Are set up by employers to collect deposits and distribute payments to retirees

27. Services Provided by Financial Intermediaries • Sharing risk through diversification • Diversification. Spreading out of investments to reduce risk. Financial intermediaries help individual savers diversify their investments. • Providing information. Reduce costs in time and money that lenders and borrowers would pay if they had to search out investment information on their own. • Providing liquidity. Allow savers to easily convert their assets into cash.

28. Risk and Return Return. Money an investor receives above and beyond the sum of money initially invested. • Return and Liquidity • Savings accounts have greater liquidity, but in general have a lower rate of return. • Certificates of deposit (CDs) usually have a greater return but liquidity is reduced. • Return and Risk • Investing in a friend’s internet company could double your money, but there is the risk of the company failing. • The higher potential return on investment, the greater the risk involved.

29. Questions • Investment is • providing money for your family. • the act of redirecting resources from being consumed today so that they may create benefits in the future. • an institution that helps channel funds from savers to borrowers. • a collection of financial intermediaries. • The money an investor receives above and beyond the money initially invested is called • investment • savings • return • prospectus

30. Questions • Investment is • providing money for your family. • the act of redirecting resources from being consumed today so that they may create benefits in the future. • an institution that helps channel funds from savers to borrowers. • a collection of financial intermediaries. • The money an investor receives above and beyond the money initially invested is called • investment • savings • return • prospectus

31. Bonds • Bonds are loans that represent debt that the government or a corporation must repay to an investor. Three components: • Coupon rate. Interest rate paid to bondholder. • Maturity. Time when payment to bondholder is due. • Bond yield. Annual rate of return on bond if bond held to maturity. • Par value. Amount investor pays to purchase bond that will be repaid to investor at maturity. • Bonds can be held to maturity, traded or sold. Price of a bond can change also.

32. Advantages and Disadvantages of Bonds Advantages Disadvantages Once bond is sold, coupon rate for bond will not go up or down. Unlike stock, bonds are not shares of ownership in a company. Company must make fixed interest payments, even in bad years when it does not make money. If bond issuer does poorly, the bonds can be downgraded. Makes it harder to sell bonds.

33. Types of Bonds Savings bonds. Low amount bonds issued by U.S. govt. Interest paid only when bond matures. Treasury bonds, bills, and notes. Issued by U.S. Dept. of Treasury. Municipal bonds. Issued by state or local govts to finance things like highways, libraries, and schools. Corporate bonds. Bond that corporation issues to raise money to expand its business. Junk bonds. Lower rating, but potentially higher-paying bonds.

34. Other Financial Assets Certificates of Deposit (CDs) Money Market Mutual Funds Available through banks, which use funds for a fixed amount of time. Low risk. Investors receive higher amount of interest on these funds than from savings or CD. Not FDIC insured. High risk.

35. Questions • A bond is a • loan that represents debt that the government or corporation must repay to an investor. • portion of ownership in a corporation. • system that allows the transfer of funds between savers and borrowers. • collection of financial assets. • How does risk involved in a money market mutual fund compare with the risk of a CD? • The risk of the money market mutual fund is less than the CD. • The risk of the money market mutual fund is greater than the CD. • The risk of the money market mutual fund is much greater than the CD. • The risk of both is about the same.

36. Questions • A bond is a • loan that represents debt that the government or corporation must repay to an investor. • portion of ownership in a corporation. • system that allows the transfer of funds between savers and borrowers. • collection of financial assets. • How does risk involved in a money market mutual fund compare with the risk of a CD? • The risk of the money market mutual fund is less than the CD. • The risk of the money market mutual fund is greater than the CD. • The risk of the money market mutual fund is much less than the CD. • The risk of both is about the same.

37. 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, are paid out to stockholders of many corporations. The higher the corporate profit, the higher the dividend. 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.

38. Types of Stock Dividend Differences Decision-Making Differences Income stock. Pays dividends at regular times during the year. Growth stock. Pays few or no dividends; earnings reinvested into business. Common stock. Voting owners of the company. Preferred stock. Non-voting owners, receive dividends before common stock owners.

39. Stock Risks Risky because 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.

40. Stock Exchanges New York Stock Exchange (NYSE). Largest stock exchange in the U.S. Largest and most established companies. NASDAQ. Primarily high-tech and energy stock.

41. Stock Averages Dow Jones Industrial Average (DJIA). Shows how certain stocks have traded over the day. Reliable and established companies. S&P 500. Shows price changes of 500 different stocks.

42. Random Bull market. Steady rise in stock market over a period of time. Bear market. Steady decline in stock market over a period of time.