CHAPTER 11 ECONOMICS SAVING AND INVESTING. I. WHAT IS “INVESTMENT” THE ACT OF REDIRECTING RESOURCES FROM BEING USED TODAY SO THEY CAN CREATE BENEFITS.

CHAPTER 11 ECONOMICS

SAVING AND INVESTING

I. WHAT IS “INVESTMENT”

• THE ACT OF REDIRECTING RESOURCES FROM BEING USED TODAY SO THEY CAN CREATE BENEFITS IN THE FUTURE.

a. Promotes economic growth

II. THE FINANCIAL SYSTEM

• I. ALLOWS FOR THE TRANSFER OF MONEY FROM SAVERS TO BORROWERS.

– Savings is a method to make money available for borrowers,

– Savers obtain a document that confirms the amount they have saved.

– i. Passbooks / savings account books

– ii. Stock or bond records– iii. Portfolio reports

• c. These documents are called ASSETS

Financial Intermediaries

• People / institutions that channel money from the saver to the borrower.

• Savers and borrowers are linked together by– FINANCIAL INTERMEDIARIES!

• THERE ARE SEVERAL TYPES OF “FINANCIAL INTERMEDIARIES”

1. Banks, S & L’s, Credit Unions

• Receive deposits from savers and lend a per cent to borrowers (individuals or business)

• Borrowers pay back loans at higher rates of interest.

• Savers paid interests on their deposits.

2. Finance Companies

• Rates close to 22-24%• Lend money to consumers or small

businesses. A higher degree of risk so their interest rates and fees are very high

3. Mutual Funds

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Mutual Funds

•Pool the savings / deposits of the investors and invests them in a variety of stocks and bonds. Key goal is diversification.

4. Hedge Funds

• A private investment organization that invests in high risk ventures to make profit for their clients. Not regulated by the SEC.

• A hedge fund is a lightly regulated investment fund that is typically open to a limited range of investors who pay a performance fee to the fund's investment manager.

5. Life Insurance Companies

• Provides financial protection for the family if the insured dies suddenly. 2 types of insurance:

• 1. Universal—premiums applied toward insurance and a variable investment strategy. Policy can be surrendered for cash value when the policy matures.

• 2. Term Life—premiums paid insure a life only, no investment. Premiums are lower and based on a number of mortality factors.

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6. Pension funds

• collect funds which then are invested and allowed to grow.

•The funds are dispersed thru payments for injury, retirement, or death.

WHAT STRATEGIES DO YOU EMPLOY IN DETERMINING WHAT OR

HOW TO INVEST ?• Diversification—Spreading out your investments in

order to reduce risk and possible loss.• Find information—Intermediaries will provide the

client with information about their investments:– i. Prospectus—A report that gives information

about the investment and how it has performed recently.– ii. Portfolios—A collection of all the assets the

client owns or controls.• Insure Liquidity—an investment should have the

ability to be quickly converted to cash.• Examine the Risk / Return Ratio—The higher the

risk, the higher the rate of return. As an investor, you have to decide if the risk is worth the return.

III. TYPES OF RISK

• Credit Risk—Borrowers may be late with payments or may not make make payments.

• Liquidity Risk—May not be able to convert your investment into cash.

• Inflation rate risk—Inflation erodes the value of your investment

• Time risk—You may miss better investment opportunities because your funds are already invested somewhere else.

CHAPTER 11—SAVING AND INVESTING

SECT. 2—BONDS AND OTHER ASSETS

• I. BONDS AS FINANCIAL ASSETS

–a.1942 –U.S. starts a War Bond drive–b.Bonds act like loans.–c.Bonds pay a fixed rate of interest at

regular intervals–d.Bonds rank low on the risk / return

ratio.

I. THE COMPONENTS OF A BOND

• a. Par Value—The amount the investor pays to purchase the bond. Also called face value or the principal.

• b. Coupon Rate—The amount of interest the bond issuer pays the bondholder.

• c. Maturity—The time at which payment to a bondholder is due. Lengths vary according to the bond.

• d. Yield—The annual rate of return on an interest paying bond if the bond were held to maturity.

I. BUYING BONDS ON DISCOUNT

• Buy bonds at below full par value.

• Example -Purchase a $100 bond for $80– Bondholder may need cash.

• Then redeem the bond at full value!– Profit of $20

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RATING THE BONDS—CHECK THE QUALITY OF THE INVESTMENT

• a. Standard & Poor’s and Moody’s are companies that rate bonds

• b.Ranks go from AAA (Highest) to D (Usually in default)

• c.Higher rating has a lower risk and return, lower rating has a higher rate and return.

ADVANTAGES AND DISADVANTAGES OF THE BOND

ISSUER

• ADVANTAGES• i. Interest rate will not vary—Know that you have

fixed payments

• ii. Selling bonds does not give up ownership of your company.

• DISADVANTAGES• i. Must make fixed payments even when the company

is not doing well.

• ii. If your bond rating goes down it will be harder to sell them in the future.

TYPES OF BONDS

• U.S. SAVINGS BOND• i. Denominations of $50 to $10000 issued by

U.S. Govt. The par value is only one half of the face value ($50 bond costs $25)

• ii. Funds used to finance public projects

• iii. Next to No risk of default

• iv. Interest payments are paid when the full maturity date is reached.

• v. Specific tax advantage

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The Treasury Bond

• Denominations / minimum purchase of $1000 issued by U.S. Government

• Safe investment since backed by U.S. Government

• Maturity date ranges from 10-30 years—considered a long term investment.

• Specific tax advantage

The Treasury Note

• Denominations / minimum purchase of $1000 issued by U.S. Govt

• Safe investment since backed by U.S. Gov’t.

• Maturity date ranges from 2-10 years—mid term investment

• Specific tax advantage

The Treasury Bill

• Denominations / minimum purchase of $1000 issued by U.S. Govt

• Safe investment since backed by U.S. Gov’t.

• Maturity date ranges from 3-12 months, the most liquid of these types of investments.(Short term investment)

• Specific tax advantage

The Municipal Bond (the Muni’s)

• Issued by state and local governments to finance public works

• Considered reasonably safe investment• Denominations usually begin at $100**• Maturity can range from a few months to

as high as 20-30 yrs.• Exempt from income taxes

• *** Most government Bonds are NOT Inflation indexed Bonds

• This means their interest rate does not change with inflation.

Corporate Bonds

• Used by corporations to raise capital.• Denominations range from $1000 and up(set by

corporation)• Maturity date is also set by corporation• Bond sales are monitored by :

– a) Standard and Poor’s– b) Moody’s– c) Securities and Exchange

Comm.

Junk Bonds—High Yield &High Risk Securities

• The return may be 12% or higher• The rating is lower for the chance of default is greater

• Term ranges from less than 1 year to 5 years in rare occasions

• Denominations set by each company, usually start at $50-100.

JUNK BONDS

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International Bonds

• Issued by foreign countries at units that begin at $1million

• Interest payments made in foreign countries/ currency

• Subject to being affected by international politics.

VII. OTHER TYPES OF INVESTMENTS

• The Pros and Cons of Alternative Investment• +They can diversify your overall portfolio• + provide some tax advantages• + provide strong cash flow and/or appreciation.• - your liquidity is very limited until the program

goes full cycle and returns your principal along with whatever gain or loss it generated.

• - As with all investments, the return of your principal is not guaranteed.  

Certificates of Deposit (C.D.’s)

• Time sensitive accts. where investors can invest for as little as $100 at a higher rate than regular savings acct.

• Investors can vary the term of the CD

• Penalty paid on early withdrawals

MONEY MARKET MUTUAL FUNDS

• SHORT TERM FINANCIAL ASSETS ARE PURCHASED (LIQUIDITY)

• RATE OF RETURN IS HIGHER THAN A REGULAR SAVINGS ACCOUNT AND MOST C.D.’S

• HIGHER RISK FOR HIGHER RETURN

The IRA (Individual Retirement Account)

• 1)Basic IRA

• 2) Educational IRA

• 3) Roth IRA

• 4) 401 plan

INDIVIDUAL RETIREMENT ACCOUNT

• http://www.youtube.com/watch?v=2K0ubOpyZt8

• http://www.youtube.com/watch?v=movFGvSBkF8

FINANCIAL ASSET MARKETS

• BASED UPON THE LENGTH OF TIMES THAT FUNDS ARE LENT.

• A. Capital Markets—Where investments last more than 1 year

• B. Money Markets-Where investments reach maturity– (Money is lent) for less than 1 year.

FINANCIAL ASSET MARKETS

• ) BASED UPON HOW ASSETS ARE SOLD TO OTHER BUYERS

• Primary Markets—Financial assets that can be redeemed ONLY by the original owner

• Secondary markets—A market where the assets can be traded

SECTION 3—THE STOCK MARKET

• 1. BUYING / INVESTING IN STOCK

• 1) PURCHASING STOCK IN THE MARKET

• a) Each stock represents a share of ownership

• b) Also called Equities–based on ownership.

2) BENEFITS OF STOCK PURCHASES—PROFITS

• A) Dividends—share of a profit made by a corporation.

• B) Capital Gains-selling stock at more that you paid for it.

• C) Net Worth--increase the overall financial standing of your portfolio

TYPES OF STOCK

• 1) COMMON STOCK• a) A share of ownership• b) One corporate vote per share

• 2) PREFERRED STOCK• a) Nonvoting share of stock• b) Receive dividends before common stockholders• 3) INCOME STOCK• a) Pays dividends when a profit is shown—at regular intervals•• 4) GROWTH STOCK• a) Pays no dividends—profit is reinvested into the company• b) Stock value rises over time.

• 5) WHEN A STOCK SPLITS• a) Purchase price so high that investors are discouraged• b) Price lowered so that more investors can afford stock.• c) Each previously owned share now splits into two.• d) More investing will drive stock prices back up.

SELLING STOCK

• 1) STOCKBROKERS—LINK COMPANIES TO INVESTORS

• a) Work for Brokerage firms

• b) Sell products as OTC –Over the Counter stock

• c) Also buy / sell on the major markets like the

New York Stock Exchange (NYSE) or electronically (NASDAQ.)

SELLING STOCK

• DAY TRADERS• a) Buy and sell stock by the hour or less• b) Quick profit on price changes• c) High risk trading!• http://www.youtube.com/watch?v=7JtCF2i2r2M• http://www.youtube.com/watch?v=ALn0GBkM_5c

&feature=related

FUTURES AND OPTIONS• a) Futures—contracts to buy or sell stocks at a set future

date.• 1) Listed on the New York Mercantile Exchange and

the Chicago Board of Trade.

• b) Options—contracts to buy or sell stocks at a future date based on a set price, but with the option to buy or sell at a better price and bypass the contract.

• 1) Put Option—The option to sell stocks at a specified time in the future.

• 2) Call Option-- The option to buy stocks at a specified time in the future.

Call Options

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Put Options

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THE BULL AND BEAR MARKETS

• 1) THE BULL MARKET• ** Refers to any Market that shows

a prolonged rise in prices or sales.

• 2) THE BEAR MARKET• ** Refers to the market that shows

a decrease in prices and sales.• ** May lead to a recession or

depression!

THE GREAT CRASH OF 1929 & BEYOND

• 1) CAUSES OF THE GREAT CRASH• a) Inequal distribution of wealth • b) Overproduction caused demand to drop and

unemployment to rise• c) Credit buying of consumer goods• d) Buying stocks on Margin—SPECULATING• 2) MARGIN CALLS--Demands to repay “borrowed

money used to purchase stocks.– Margins not met--money not repaid!

EFFECTS OF THE CRASH

• a) High Unemployment-25%• b) Homes and Lands lost• c) Hoovervilles erected• d) New Deal programs established

• http://www.youtube.com/watch?v=-b1dTvNaL0Q•

THE STOCK MARKET IN MODERN TIMES.

• a) 1930’s thru the 1980’s people lost confidence in market.

• b) Market now highly regulated by the Government

• c) Oct, 1987—Black Monday. Market crashes, loses 23% of value but rebounds with government help.

STOCK MARKET FLUCTUATIONS AFFECTED

BY• 1) Technology stocks—Dot.com

stocks• 2) Sept. 11 terrorist attacks• 3) Enron Bankruptcy• 4) Corporate buyouts—collapse of

the housing market