Financial markets bring together savers and investors through financial intermediaries like banks. Investing carries risk but also potential returns that can fuel economic growth. Common financial assets include bonds, stocks, and mutual funds. Bonds are loans that pay interest, while stocks are shares of company ownership. Investors consider risk versus return when choosing assets. Well-established stock markets let people trade assets, but crashes like in 1929 can have severe economic impacts.

1. Financial Markets
Chapter 11

2. SAVING AND INVESTING
Section 1

3. Saving and Investing
• Savings you deposit in a bank will grow with
hardly any risk at all.
• Investing, while more risky, may yield a
larger return for your initial investment. It
may also prove to be financially devastating if
it is ill-timed or mismanaged.

4. Investing and Free Enterprise
• Investing is essential to the free enterprise
system.
– It promotes economic growth and contributes to
a nation’s wealth.
– People deposit money into a savings account and
the bank lends this money to businesses.
– Businesses can then increase production, which
leads to expansion and growth.

5. The Financial System
• Financial systems are established in an
economy so investments can take place.
• When people save money they are really
loaning it to other people.
– Savers receive a document, such as a passbook
or a bond certificate, that confirms their purchase
or deposit.
– These documents represent the claims, or
financial assets, of the borrower.

6. Savers and Investors
• Financial systems bring together savers and
investors, or borrowers, which fuels
investment and economic growth.
– Savers include:
• Households
• Individuals
• Businesses
– Investors include:
• Businesses
• Government

7. Financial Intermediaries
• Financial intermediaries, including banks and
other financial institutions, accept funds from
savers to make loans to investors.

8. Sharing Risk
• Dealing with financial intermediaries offers three
advantages:
– Sharing risk
– Providing information
– Providing liquidity
• Sharing risk
– Diversification allows you to spread out your investments
so that you don’t put all of your money into one single
investment.
– Sharing risk helps ward against losing everything on a bad
investment.

9. Types of Risk
• Investors must weigh the risks of investment
against the potential rate of return on their
investment.

10. Providing Information and Liquidity
• By providing vital data, either in a portfolio or
a prospectus, financial intermediaries reduce
the costs in time and money that lenders and
borrowers would pay if they had to get the
information on their own.
• Financial intermediaries also help people get
access to their money when they need it,
depending on how liquid the investment is.

11. Return and Risk
• Some investments, like CDs, are very safe
because they are insured by the government.
• Investing in a new business is far riskier, but
if the business is
a success, the
return could be
very big.

12. Return and Risk, cont.
• In general, the higher the potential return,
the riskier the investment.
• Whenever people evaluate their potential
investments, they must balance the risks
involved with the rewards they expect
to gain.

13. BONDS AND OTHER FINANCIAL ASSETS
Section 2

14. Bonds as Financial Assets
• Bonds are loans that represent debt that the seller
must repay to the investor.
• Bonds have three basic components:
– Coupon rate - the
interest rate that a
bond issuer
will pay to a bondholder
– Maturity - the time at
which payment to a
bondholder is due
– Par value - the amount
to be paid to the
bondholder at maturity

15. Discounts from Par
• Investors can not only
earn money from the
interest on their bonds
but they can also earn
money by buying bonds
at a discount, called a
discount from par.

16. Bond Ratings
• In order to decide which bonds to buy,
investors can check bond quality through
independent firms, such as Standard & Poor’s
and Moody’s, which publish bond issuers’
credit ratings.
– These firms rate bonds on the issuer’s financial
strength, its ability to make future interest
payments, and its ability to repay the principal
when the bond matures.
– A high grade, such as AAA, means that the bond
is safe to invest in.

17. Advantages & Disadvantages
• Advantages
– Once a bond is sold, the
coupon rate remains
the same.
– The company does not
have to share profits
with bondholders if it is
doing well
• Disadvantages
– The company must make
fixed interest payments
and cannot change its
interest payments.
– A firm’s bonds may be
given a low bond rating
and be harder to sell
when the firm is not
doing well.

18. Types of Bonds
• Savings Bonds
– Low-denomination bonds
issued by the
U.S. government, who
pays interest on the bonds.
• Treasury Bonds, Bills, and
Notes
– The U.S. Treasury
Department issue Treasury
bonds, bills, and notes,
which are among the safest
investments in terms of
default risk.
Which of these three types of
government securities is the most
liquid?

19. Municipal Bonds
• State and local
governments issue
municipal bonds to
finance such projects as
highways, libraries, parks,
and schools.
• These are attractive to
long-term investments
and are relatively safe.

20. Corporate and Junk Bonds
• Corporate bonds are issued by corporation to help raise
money to expand business.
– These bonds have a
moderate risk level
because investors
must depend on the
corporation’s success.
• Junk bonds are bonds
with a high risk and a
potentially high return.
– Investors in junk bonds
face a strong possibility
that some of the issuing
firms will default on their
debt.

21. Other Types of Financial Assets
• Certificates of Deposit
– CDs are available through banks, which lend out
funds deposited in CDs for a fixed amount of
time.
• Money Market Mutual Funds
– Investors receive higher interest on a money
market mutual fund than they would on a savings
account. These funds, however, are not covered
by FDIC insurance.

22. Financial Asset Markets
• Bonds, CDs, and money market mutual funds are
traded on financial asset markets.
• One way to classify financial asset markets is
according to the length of time for which the funds
are lent.
– Capital Markets
• In these markets, money is lent for periods longer than a
year, like in a CD.
– Money Markets
• In these markets, money is lent for periods of a year or less
and include Treasury bills and money market mutual funds.

23. Financial Asset Markets, cont.
• Markets may also be classified according to whether
or not assets can be resold to other buyers.
– Primary Markets
• In a primary market, financial assets can be redeemed only
by the original holder. Examples include savings bonds and
small CDs.
– Secondary Markets
• In a secondary market, financial assets can be resold, which
provides liquidity to investors.

24. THE STOCK MARKET
Section 3

25. How Does the Stock Market Work?
• Stock, or shares in a company, are bought
and sold on the stock market.
• Stock brokers help individuals and businesses
invest their money in the stock market.
• Investors can keep track of the stock market
by checking their local paper. When the
market is doing well, people see a large
return on the initial investment. When it is not
doing well, people may lose a great deal of
money.

26. Benefits of Buying Stock
• In addition to selling bonds, corporations can raise
money by selling stock
shares in that corporation.
• The benefits of buying
stock include:
– Dividends—part of the
firm’s profits
– Capital gains—selling
the stock for more than
you paid for it

27. Types of Stock
• Stock may be classified by whether or not it pays
dividends.
– Income stock—provides investors with income by paying
dividends
– Growth stock—pays few or no dividends and earnings
are reinvested in the company

28. Types of Stock, cont.
• Stock is also classified by whether or not the
holder has a voice in the company:
– Common stock: These holders are voting
members of the company.
– Preferred stock: These holders are nonvoting
members of the company.
• Common stock owners may initiate a stock
split when the price of a stock becomes to
high.

29. Risks of Buying Stock
• Buying stock is risky
because the dividends are
determined by how well a
company is doing.
• Because of the laws
governing bankruptcy,
stocks are riskier than
bonds since bondholders
are paid before
stockholders when a
company goes bankrupt.

30. How Stocks are Traded
• If you want to buy stock, you would first contact a
stockbroker to advise you on which stocks
to buy.
• You buy stocks on a secondary market known as a
stock exchange.
– The New York Stock Exchange is the country’s largest and
most powerful exchange, handling stock and bond
transactions for the top companies in the United States
and the world.
– The Nasdaq is the second largest securities market and
the largest electronic market.

31. Futures and Options
• Futures are contracts to buy or sell
commodities at a particular date in the future
at a specified price today.
• Similarly, options are contracts that give
investors the choice to buy or sell stock and
other financial assets.
• Most people who buy stock hold their
investment for a significant period of time.
– Day traders, on the other hand, trade stocks
daily, which is very risky.

32. Measuring Stock Performance
• When the stock market rises steadily over a
period of time it is known as a bull market.
• When the stock market falls or stagnates for
a significant period it is a bear market.
• The Dow Jones Industrial Average measures
stock performance. It represents the average
value of a particular set of stocks, and it is
reported as a certain number of points.

33. The Great Crash
• In the 1920s, the stock market was soaring.
– Speculation and buying on margin, however, led to a crash in
the market that crippled
the U.S. economy.
• The Dow began steadily
dropping in September, 1929.
People began to sell their
shares and companies
couldn’t keep up with it. On
October 29, 1929, a record
16.4 million shares were
sold and the market crashed

34. The Aftermath
• The Crash led to the Great Depression.
– Many people lost everything—their homes, their jobs, and
their farms.
• After the Depression, many people saw stocks as
risky investments and avoided them.
• By the 1980s, with the development of mutual
funds, Americans became more comfortable with
stock ownership once again.
– The stock market crashed again in 1987 but was able to
recover much faster than in did in 1929.

35. Scandals & the Stock Market Today
• By the 1990s, when people began once again to buy
more stock, investors started to worry that many
companies could not make enough money to justify
their high stock prices.
• The Enron scandal and others caused many
investors to question how much they knew about
the companies they invested in.
• In 2008, the stock market began falling, causing a
major economic crisis in the United States once
again.