2. 11-1: Savings and the Financial System
•Savings – the dollars that become available when people abstain
from consumption
•Types of savings
•Savings account
•Bond
•Certificate of Deposit
Overview of the Financial System
•Nonbank Financial Intermediaries
•Finance companies
•Life insurance companies
•Pension funds
3. • Basic Investment Considerations
– Consistency
• Amount invested is not as important as investing on a
regular basis.
• Power of Compounding Interest
– Simplicity
• Stick with what you know.
– Risk-Return Relationship
• The higher the risk, the higher the return.
– Investment Objectives
• Why are you investing? Will you need the money
short-term or long-term? How much risk are you
willing to accept?
4. 11-2: Financial Assets and Their Markets
• Bonds
– Formal long-term contract that requires repayment of borrowed
money and interest on the borrowed funds at regular intervals over
time
– Issued by governments (local, state and national) and businesses.
– Good for people who need an income stream
– 3 main components:
• Coupon Rate – stated interest on the debt
• Maturity – life of the bond
• Par Value – principal or total amount initially borrowed
• Example: 6%, 20 year, $1000 par value bond that pays interest annually
5. – Bond Prices and Bond Yields
• Investors consider changes in future interest rates, the risk that the
company will default, and other factors.
• Supply and demand will then establish the final price of the bond.
• Current yield = annual interest divided by the purchase price.
• Issuers fix the return on the bond when it is first issued, however when
the bond is resold, the yield will be based on the price paid.
– Bond Ratings
• Standard and Poor’s and Moody’s publish bond ratings.
• Bonds with high ratings sell at higher prices than bonds with lower
ratings.
• Bonds with high ratings offer lower yields.
6. – Please read pages 299 – 303 and then answer the following
questions.
• 1. Why would you choose a certificate of deposit over a corporate
bond?
• 2. What do corporate bonds, municipal bonds, and government
savings bonds have in common? How are they different?
• 3. Why would anyone be willing to invest in “junk” bonds?
• 4. Look at the chart at the top of page 302. If you were investing
your money for retirement, would you invest in a money market or a
capital market? In which market would you invest to save for a
vacation? Explain your answer using specific examples of financial
assets.
• How much money will you have at retirement?
7. 11-3: Investing in Equities and Options
• Equities
– Shares of common stocks that represent ownership of
corporations
– Value depends on several factors
• Number of outstanding shares
• Company’s profitability
• Expectations
• Value fluctuates daily
• Efficient Market Hypothesis
– Stocks are prices correctly and bargains are hard to find
because stocks are followed so closely by so many investors.
– Implies that it doesn’t matter which stocks you purchase.
– Portfolio diversification (holding a large number of different
stocks) is a popular strategy.
8. – Mutual Funds
• Company that sells stock in itself to individual investors, then invests
the money in stocks and bonds issued by other companies.
• Allows for diversification for a small amount of money.
– 401 (k) Plan
• Tax-deferred investment and savings plan that acts as a personal
pension fund for employees.
• Employees authorize regular payroll deductions pretax.
• Companies often match a portion of your contribution.
• Consistent, relatively safe and portable.
• Vanguard Group
