CHAPTER 13
FINANCIAL
INSTITUTIONS, MARKETS AND EQUITIES
SAVINGS AND THE FINANCIAL
SYSTEM
·
GENERAL
INFORMATION
o
SAVING – DEF
– THE ABSENCE OF CONSUMPTION
o
SAVINGS –
DEF – DOLLARS THAT BECOME AVAILABLE FOR BORROWING AND INVESTMENT
o
SAVINGS MAKE
ECONOMIC GROWTH POSSIBLE
o
A FINANCIAL SYSTEM TRANSFERS SAVINGS INTO
INVESTMENT
o
FINANCIAL ASSETS – DEF – CLAIMS ON INCOME OR PROPERTY OF THE BORROWER
o
EX – CD,
MORTGAGE, BONDS, TREASURY BILLS
o
WHEN FUNDS ARE
LENT, A FINANCIAL ASSET IS CREATED
·
FINANCIAL INTERMEDIARIES
o
INSTITUTIONS THAT
BRING TOGETHER SURPLUS FUNDS AND FINANCIAL ASSETS
o
THE BEST EXAMPLES
ARE BANKS AND THRIFTS (S & L’S)
·
NON-BANK FINANCIAL INTERMEDIARIES
o
FINANCE COMPANIES
§
INSTITUTIONS THAT
SPECIALIZE IN BUYING INSTALLMENT CONTRACTS FROM MERCHANTS OR BY OFFERING BILL
CONSOLIDATION LOANS
§
EX – HFC, GIRARD, BENEFICIAL, MONY
o
LIFE INSURANCE COMPANIES
§
THESE
INSTITUTIONS INVEST SURPLUS PREMIUMS AFTER CLAIMS ARE SATISFIED
o
MUTUAL FUNDS
§
PEOPLE BUY SHARES
IN A MUTUAL FUND WHICH IN TURN INVESTS THE MONEY IN CORPORATE STOCKS AND BONDS
§
THE MUTUAL FUND
ALLOWS THE SMALL INVESTOR THE
o
PENSION FUNDS
§
A FUND IS SET UP
TO COLLECT INCOME AND DISPERSE INCOME ESPECIALLY TO RETIREES
§
THE FUND
GENERATES INCOME BY INVESTING SURPLUS CONTRIBUTIONS IN FINANCIAL ASSETS
o
REITS – REAL ESTATE INVESTMENT TRUSTS
§
THEY MAKE LOANS
TO CONSTRUCTION COMPANIES THAT
§
THEY BORROW MONEY
FROM BANKS AND REPAY THESE LOANS FROM THE RENTS AND MORTGAGES RECEIVED FROM
THE CONSTRUCTED UNITS
INVESTING IN FINANCIAL ASSETS
·
INVESTMENT
CONSIDERATIONS
o
RISK
§
DEF – AN OUTCOME
THAT CANNOT BE PREDICTED BUT WHERE PROBABILITIES CAN BE ESTIMATED
·
A JUNK BOND IS THE RISKIEST BUT GENERATES THE
HIGHEST RETURNS
·
§
AN INDIVIDUAL WHO
IS INVESTING SHOULD TAKE A RISK NO GREATER THAT WHAT THEY ARE COMFORTABLE WITH
(RISK TOLERANCE)
o
GOALS
§
THE ACCUMULATION OF WEALTH
·
TYPICALLY FOR
RETIREMENT
·
ASSETS THAT
APPRECIATE ARE TYPICALLY INVESTED IN SUCH THINGS AS STOCK AND LAND
o
USUALLY A LONG TIME HORIZON
§
TO ACCUMULATE RESERVES
·
MAY BE FOR A
RAINY DAY OR FOR AN EXPENSIVE PURCHASE
o
COLLEGE, WEDDING,
UNEMPLOYMENT, AUTO, HOME
o
ASSETS THAT ARE
SOUGHT ARE THOSE THAT AN EASILY BE LIQUEFIED
§
SHORT TIME
HORIZON
§
INCOME
·
ANNUITIES AND
UTILITIES
o
LITTLE OR NO RISK
§
TAX AVOIDANCE
·
PEOPLE IN HIGH
INCOME BRACKETS COULD BUY “MUNIE’S” OR INVEST IN
IRA’S OR A 401 K
·
·
SECRETS TO SUCCESSFUL INVESTING
o
INVEST REGULARLY
- BE CONSISTENT
§
USE A PAYROLL
DEDUCTION – TAKE ADVANTAGE OF “DOLLAR
COST AVERAGING”
o
INVEST IN WHAT YOU ARE
FAMILIAR WITH – AVOID
COMPLEXITY
o
DIVERSIFY
§
DON’T PUT ALL
YOUR EGGS INTO 1 BASKET
§
ESPECIALLY IF YOU
HAVE A LARGE PORTFOLIO
·
BONDS
o
DEF – A LONG TERM
OBLIGATION TO PAY A STATED RATE OF INTEREST FOR A SPECIFIED NUMBER OF YEARS
o
BOND TERMINOLOGY
§
COUPON – THE
INTEREST RATE
§
MATURITY –
THE LIFE OF THE BOND
§
PAR VALUE –
THE COST OF THE BOND (PRINCIPAL)
·
TECHNICALLY BOND
PRICES ARE NEGOTIABLE – THE PRICE IS DETERMINED BY SUPPLY AND DEMAND
§
YIELD – THE
ANNUAL DIVIDEND DIVIDED BY THE PURCHASE PRICE
o
CREDIT WORTHINESS
IS IMPORTANT WHEN BUYING BONDS BECAUSE THEY ARE NOT INSURED
o
MOODY’S AND STANDARD AND POORS
ARE 2 COMPANIES THAT PUBLISH BOND RATINGS
§
FACTORS THAT
INFLUENCE BOND RATING
·
FINANCIAL HEALTH
OF THE ISSUER
·
ABILITY TO MAKE
FUTURE COUPON PAYMENTS
·
PAST CREDIT
HISTORY
o
AAA IS THE
HIGHEST
o
D IS THE LOWEST
(DEFAULT)
§
CHECK THE CHART
ON PAGE 328
o
ANYTHING BELOW BB
FOR STANDARD AND POORS AND BELOW BB FOR MOODY’S IS
CONSIDERED AS HIGH RISK OR A JUNK BOND
·
FINANCIAL ASSETS
AND THEIR CHARACTERISTICS
o
A FINANCIAL ASSET
REPRESENTS A LOAN TO A CORPORATION
IN THE FORM OF A BOND
o
TYPES
§
CERTIFICATE OF DEPOSIT – A TIME DEPOSIT
·
THEY VARY
ACCORDING TO SIZE AND MATURITY
o
THE LONGER THE
MATURITY, THE HIGHER THE INTEREST RATE
o
JUMBO CD -
$100,000
·
INSURED BY FDIC
·
SUBSTANTIAL
INTEREST FOR EARLY WITHDRAWAL
§
CORPORATE BONDS
·
LONG TERM
INVESTMENTS WHICH CAN BE LIQUIDATED EASILY
o
REPRESENT A LOAN
TO A CORPORATION
o
CREDITORS OF A
CORPORATION
§
MUNICIPAL BONDS
– MUNIE’S
·
ISSUED BY STATE
AND LOCAL GOVERNMENTS TO FINANCE HIGHWAYS, BRIDGES, SEWAGE TREATMENT PLANTS ,
SCHOOLS ETC
·
THEY ARE
ATTRACTIVE BECAUSE THEY ARE SAFE AND THEY ARE TAX EXEMPT
o
THE FEDERAL
GOVERNMENT DOESN’T TAX THIS INTEREST
o
SOME STATES ALSO
EXEMPT THIS INTEREST
·
THIS IS A GOOD
INVESTMENT FOR WEALTHY PEOPLE WHO ARE IN HIGHER TAX BRACKETS
§
GOVERNMENT SAVINGS BONDS
·
PURCHASED AT A
DISCOUNT
o
YOU PAY $18.76
FOR A $25.00 BOND
·
THEY ARE NON
TRANSFERABLE
§
INTERNATIONAL BONDS
·
USUALLY PURCHASED
BY PENSION FUNDS OR INSURANCE COMPANIES
·
YOU ACTUALLY
PURCHASE THE DEBT OF A FOREIGN COUNTRY
o
THE COUPON
(INTEREST) IS PAID IN THE CURRENCY OF THE ISSUING COUNTRY
§
THIS INTEREST
COULD BE GREATER OR LESS THAN EXPECTED
§
THESE BONDS
USUALLY HAVE A STARTING PRICE AROUND $1,000,000
§
MONEY MARKET MUTUAL FUNDS
·
USUALLY MAKE
LOANS IN THE FORM OF CD’S TO OTHER BORROWERS
·
RISKIER THAN A
REGULAR CD BECAUSE THEY ARE NOT INSURED BY FDIC AND AS A RESULT THEY WILL PAY A
HIGHER RETURN
·
THEY USUALLY
PROVIDE CHECK WRITING PRIVILEGES
§
TREASURY NOTES AND BONDS
·
NOTES HAVE
MATURITY OF 2 TO 10 YEARS
·
BONDS HAVE A
MATURITY OF 10 TO 30 YEARS
·
SAFEST FORM OF
FINANCIAL ASSET SO THE RETURN IS THE LOWEST
o
BACKED BY THE
FULL FAITH AND CREDIT
OF THE
§
TREASURY BILLS – T BILLS
·
BOUGHT AND SOLD
BY THE FED
·
MATURITY OF 1
YEAR OR LESS
·
USUALLY SOLD AT A
DISCOUNT
§
IRA’S –
INDIVIDUAL RETIREMENT ACCOUNTS
·
INTENDED TO
SUPPLEMENT SOCIAL SECURITY
·
WITHDRAWALS ARE
TYPICALLY DEFERRED UNTIL AGE 59 1/2
o
EARLY WITHDRAWALS
ARE SUBJECT TO A SUBSTANTIAL INTEREST PENALTY
§
EXCEPTIONS
·
COLLEGE EDUCATION
·
MEDICAL
EMERGENCIES
·
TRADITIONAL IRA’S ARE A TAX EXEMPT DEPOSIT
o
MONIES ARE
TAXABLE WHEN THEY ARE WITHDRAWS
·
ROTH IRA’S
ARE PURCHASED WITH AFTER TAX DOLLARS
o
MONEY, WHEN THEY
ARE WITHDRAWN, ARE TAX EXEMPT
§
401 K
·
AN ARRANGEMENT
WHERE AN EMPLOYER ENCOURAGES AN EMPLOYEE TO SAVE FOR RETIREMENT WITH A PROMISE
TO MATCH A PART OF THE CONTRIBUTION
·
SIMILAR TO A
STOCK SHARING PLAN
o
FINANCIAL ASSETS ARE CLASSIFIED BY
§
TIME
·
CAPITAL MARKETS
ARE MARKETS WHERE MONEY IS LENT FOR MORE THAN 1 YEAR
·
MONEY MARKETS ARE
MARKETS WHERE MONEY IS LENT FOR LESS THAN 1 YEAR
§
HOW TRADED
·
PRIMARY MARKETS
– ONLY THE ORIGINAL ISSUER CAN REDEEM THE FINANCIAL ASSET
·
SECONDARY MARKETS
– THE ASSET CAN BE BOUGHT AND SOLD
o
THIS PROVIDES
MORE LIQUIDITY TO THE INVESTOR
INVESTING IN EQUITIES,
FUTURES AND OPTIONS
·
EQUITIES REPRESENT SHARES OF OWNERSHIP IN A CORPORATION
·
FINANCIAL ASSETS REPRESENT A LOAN
·
FACTORS THAT
AFFECT THE MARKET VALUE OF EQUITIES
o
THE NUMBER OF
OUTSTANDING SHARES
§
THE HIGHER THE
NUMBER OF SHARES OUTSTANDING, THE LOWER THE MARKET VALUE
o
EXPECTATIONS
·
EMH – EFFICIENT
MARKET HYPOTHESIS
o
STOCKS ARE PRICED
JUST RIGHT AND BARGAINS ARE HARD TO FIND
§
TRANSLATION – IT
IS HARD TO BEAT THE MARKET
§
THIS IS THE
REASON WHY SPECULATION IS USUALLY DISASTROUS
§
PORTFOLIO
DIVERSIFICATION IS THE BEST STRATEGY
·
A STOCKBROKER IS AN INDIVIDUAL OR A
COMPANY WHO HAS A SEAT ON THE EXCHANGE AN IS ABLE TO BUY AND SELL SECURITIES
·
ORGANIZED
EXCHANGES
o
NYSE- THE
OLDEST, LARGEST AND MOST PRODIGIOUS – 14,000 SEATS
§
80% OF ALL
FINANCIAL TRANSACTIONS OCCUR HERE
§
LISTS 2,400
STOCKS OF OVER 1,900 COMPANIES WHICH ARE CONSIDERED AS THE LARGEST AND MOST
PROFITABLE
o
AMEX
§
HAAS OVER 600 SEATS AND LISTS OVER 1000 STOCKS
§
MORE SPECULATIVE
THAN THE NYSE
o
REGIONAL EXCHANGES
§
STOCKS LISTED HER
ARE TYPICALLY TOO NEW OR TOO SMALL TO BE LISTED ON THE MAJOR EXCHANGES
o
INTERNATIONAL EXCHANGES
§
MIP,
·
STOCKS ARE ALSO
TRADED OVER THE COUNTER
o
THIS IS THE
ELECTRONIC MARKETPLACE
o
OTC TRADES
ARE MADE BY NASD AND ARE QUOTED ON NASDAQ
§
THESE STOCKS
TYPICALLY DO NOT PAY DIVIDENDS
·
AT ONE TIME, THEY
WERE TYPICALLY NEW AND GROWING COMPANIES
·
MEASURES OF STOCK
PERFORMANCE
o
DJIA – DOW JONES INDUSTRIAL AVERAGE
§
TRACKS 30
REPRESENTATIVE STOCKS FROM THE NYSE WHICH ARE TYPICALLY THE 30 LARGEST
COMPANIES LISTED
§
THESE COMPANIES
COME AND GO
§
A 1 POINT MOVE IN
THE AVERAGE REPRESENTS A 45 CENT CHANGE IN THE TOTAL PRICE OF ALL 30 STOCKS
o
S & P 500
§
MONITORS
COMPANIES LISTED ON THE NYSE, AMEX AND OTC MARKETS
§
THIS IS MORE
BROAD BASED
o
WILSHIRE 1000
AND RUSSELL 2000
§
THESE ARE EVEN MORE BROAD BASED
TRADING IN SPOT, FUTURES AND
OPTION MARKETS
·
BOTH EQUITIES AND
COMMODITIES ARE TRADED IN THESE MARKETS
·
THE NY MERCANTILE
EXCHANGE,
·
SPOT MARKETS
ARE MARKETS WHERE TRADES ARE MADE IN THE PRESENT
·
FUTURES ARE
MARKETS WHERE TRADES ARE NEGOTIATED FOR THE
o
THESE TEND TO BE
SPECULATIVE
o
AN OPTIONS MARKET
IS A UNIQUE TYPE OF FUTURES MARKET WHERE BUYER AND SELLER TRY TO HEDGE THE
MARKET
§
A CALL OPTION GIVES SOMEONE THE RIGHT TO BUY A STOCK OR COMMODITY IN THE
FUTURE
·
FOR EXAMPLE – IF
YOU BUY AN OPTION FOR $70 AND THE STOCK
IS SELLING FOR $50 DOWN THE ROAD YOU TEAR UP THE OPTION AND BUY THE STOCK FOR
$50 BUT IF THE STOCK IS SELLING FOR $80, YOU EXERCISE YOUR OPTION BUY THE STOCK FOR
$70 AND SELL IT FOR $80 AND COLLECT THE PROFIT
o
IF YOU TEAR UP
THE OPTION, YOUR ONLY EXPENSE IS THE COST OF THE OPTION
o
THERE IS ALWAYS
AN ASSUMPTION THAT THERE WILL BE A BUYER
FOR THE STOCK
§
A PUT OPTION GIVES SOMEONE THE RIGHT TO
SELL SOMETHING IN THE FUTURE
·
FOR EXAMPLE – IF
YOU AGREE TO SELL SOMETHING IN THE FUTURE FOR $50 AND THE PRICE FALLS TO $40
YOU WOULD REQUIRE THE BUYER TO PAY THE $59, PAY THE OPTION AND POCKET THE
PROFIT; IF THE PRICE WERE $80 YOU WOULD TEAR UP THE OPTION AND SELL IT FOR $80