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Financial Markets

Chapter 30. Financial Markets. To Start A Business. Entrepreneurs without personal wealth must get start-up funds to start a business. Borrow the money Go to the bank, sell bonds Get others to invest in the venture Sell stock, venture capital. Chapter 30. 2. Financial Intermediaries.

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Financial Markets

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  1. Chapter 30 Financial Markets

  2. To Start A Business • Entrepreneurs without personal wealth must get start-up funds to start a business. • Borrow the money • Go to the bank, sell bonds • Get others to invest in the venture • Sell stock, venture capital Chapter 30 2

  3. Financial Intermediaries • Institutions that makes savings available to dis-savers. • Gets money from those who have it to those who need it. • Banks • Stock Markets • Bond Markets Chapter 30 3

  4. Financial Intermediaries • The goal is to make it easier to get money for projects • They reduce information costs • You only need to share details & information with one institution, instead of many individuals Chapter 30 4

  5. Supply Of Loanable Funds • Comes from savings • “Investing” in stocks by individuals is just a form of saving. • We generally buy from other individuals, not from the company. • We are not buying tools & equipment, the company is. Chapter 30 5

  6. Determinants of Supply of Loanable Funds • Time Preferences • Interest Rates • Risk • Present Value of Future Funds • Uncertainty / Expectations Chapter 30 6

  7. 1. Time Preferences • Saving now means planned spending in the future • People who do not think of the future save little Chapter 30 7

  8. 2. Interest Rates • The higher the rate (of return) the more attractive saving is. • Saving first becomes attractive when the rate of return becomes greater than the expected inflation rate • Maintain or increase purchasing power of your money Chapter 30 8

  9. 3. Risk • The greater the risk of saving, the higher the rate of return should be. • Risk Premium • The difference in rates of return on risky and safe investments. Chapter 30 9

  10. Risk Management • To minimize risk to your savings, diversify • This means having savings in more than one form. • Some in the bank (safe, low return) • Some in Mutual Funds (not as safe, higher return) • Some individual stocks (somewhat risky, higher return) • Lottery/gambling (very risky, big payoff) • Lend to your brother… Chapter 30 10

  11. 4. Present Value of Future Profits • Money in the future is not as useful to you as money today. • You must discount the value of expected future earnings into “today’s” money to evaluate an investment. Chapter 30 11

  12. Present Value of Future Profits • The Present Value of Money declines as: • Interest Rates go up • Length of time before payments increases. Chapter 30 12

  13. 5. Uncertainty • The possibility of non-payment. • You can evaluate the value of a project using “Expected Value” • Possible incomes are weighted by their probability of occuring. Chapter 30 13

  14. Expected Value Example ProfitProbability • Pessimistic: $2,000 25% • Likely $5,000 50% • Optimistic $7,500 25% • EV = (2000x.25)+(5000x.5)+(7500x.25) • EV = $5,125 Chapter 30 14

  15. The Demand for Loanable Funds • The demand for loanable funds depends on: • Expected rate of return • The cost of funds • This is similar to those for the supply of loanable funds • Individuals save money to make money • Businesses borrow money to make money Chapter 30 15

  16. Stock Market • To raise money, an owner can sell part-ownership of their company. • Corporate Stock • A share of stock is a certificate worth a percentage of ownership in a corporation. • In principle, the shareholders collectively run the company Chapter 30 16

  17. Shareholder Value • Stocks give value to the shareholders by: • Dividends • Capital gains Chapter 30 17

  18. Dividends • As an owner of a company, shareholders are entitled to a share of the profits – Dividends. • A dividend is the amount of corporate profits paid out for each share of stock. • Each share of stock you own will earn a dividend. Chapter 30 18

  19. Dividends • Companies that do not make profit do not pay dividends. • There are exceptions • Dividends are not guaranteed as income Chapter 30 19

  20. Capital Gains • If the value of the stock increases after you buy it, you can sell it for more than you paid for it – Capital Gain • If the value of the stock decreases, when you sell the stock you take a Capital Loss. • Capital Gains are not guaranteed as income. Chapter 30 20

  21. Value of a Stock Share • The value (or price) of a share comes from the value of the company. If the company becomes more valuable, the share price goes up. • A company is worth more than the price of the tools & buildings it owns. Chapter 30 21

  22. Value of a Stock Share • The value of a company is the Present Value of the expected future stream of income for the company. • Divide that by the number of shares to get the share price. Chapter 30 22

  23. Value of a Stock Share • To “discount” the future income into “today’s” money, You must determine the Discount Rate • Discount Rate is based on: • Interest rate to borrow • Rate of return possible form other available investments • The riskiness & uncertainty of the company, industry, & economy Chapter 30 23

  24. Value of a Stock Share • Anything that can change the future sales of a company will change the value of the company, and the share price. Chapter 30 24

  25. Stock Quote Finance.yahoo.com Chapter 30 25

  26. Bond Market • A bond is another way to get savings into the hands of dis-savers. • When a company sells a bond, they are not selling a piece of the ownership to the company. • A Bond is a promise to pay a certain amount to the bondholder at a certain future date. Chapter 30 26

  27. Bonds • A Bond is a simple & fast way for a company to borrow money. • If you buy a bond from a company, you are lending them money. • You can then re-sell this “I.O.U.” to other people, as needed. Chapter 30 27

  28. Bonds • Bonds are loans, so their risk is smaller. • If the company declared bankruptcy, the bondholder would still be able to collect some money as a creditor. Bondholders would collect all their money before shareholders collect any. • Where bonds are less risky, their return is lower. Chapter 30 28

  29. Bonds • Bonds are generally issued in $1,000 amounts. • The company will pay $1,000 to the bondholder at some point in the future. • The bond will be worth less than $1,000 up until the day it “matures” (the day to cash it in for the face value) Chapter 30 29

  30. Bond Valuation • The value of a bond is based on: • Time left until maturity • The outlook of the company, industry, and economy • The value of any “coupons” the bond pays • Coupons are moneys paid to the bondholder before the bond matures. • The rate of return for other available investments. Chapter 30 30

  31. Bond Quote Finance.yahoo.com Chapter 30 31

  32. Rate of Return for Bonds • The return on a bond changes daily as the price changes. • In general, look at the difference between the price & the maturity value as a percent, and then annualize it over the time left until maturity. • As prices increase, the yield decreases. Chapter 30 32

  33. Venture Capitalists • Financiers with a lot of money to invest into new companies & ideas. • They specialize in lending money to (or buying ownership in) new companies with potential. • They may be more willing to take a risk than a bank. Chapter 30 33

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