Econ: Ch 10 and 11 Study Guide

Financial Asset Markets

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. - 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.

Review the causes of the Great Crash of 1929. What lessons can investors learn from the Crash?

Causes: Overvalued stocks, federal policies, bad banking structure, regulations. -Investors should have a stock investment plan which should have rules for money management and risk management. Do not use excessive leverage to invest in shares.

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.

Types of Financial Institutions

Commercial Banks - Offer checking accounts, accept deposits, and make loans • Savings and Loan Associations - Allow people to save up and borrow enough for their own homes • Savings Banks - Owned by depositors who make smaller deposits than a commercial bank would handle • Credit Unions - Cooperative lending associations established for particular groups • Finance Companies - Make installment loans to consumers

Three basic components of bonds

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

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.

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. -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. 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.

What would happen if the dollar lost its store of value? What could you substitute as a medium of exchange?

One would have to trade items that were considered valuable if the dollar had no value. Services might be exchanged as well. Such as milk for veggies.

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 - Common stock: These holders are voting members of the company. - Preferred stock: These holders are nonvoting members of the company.

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.

Some economists have predicted a "cashless society" in which all banking will be done electronically. Do you think this will be true of the US economy? Support your conclusion w/ examples.

Yes, I think it will happen in the US. What is likely is that new forms of payment will continue to make inroads. Already, smart and debit cards are eating into the territory of cash, credit cards, and checks. "Home banking" services now enable customers to pay bills and purchase goods electronically, developing their own forms of electronic money.

national bank

a bank chartered, or licensed, by the national government

fractional reserve banking

a banking system that keeps only a fraction of funds on hand and lends out the remainder

municipal bond

a bond issued by a state or local government or municipality to finance such improvements as highways, state buildings, libraries, parks, and schools

corporate bond

a bond that a corporation issues to raise money to expand its business

brokerage firm

a business that specializes in trading stocks

credit card

a card entitling its holder to buy goods and services based on the holder's promise to pay for these goods and services

debit card

a card used to withdraw money

portfolio

a collection of financial assets

money market mutual fund

a fund that pools money from small savers to purchase short-term government and corporate securities

junk bond

a lower-rated, potentially higher-paying bond

stock exchange

a market for buying and selling stock

unit of account

a means for comparing the values of goods and services

gold standard

a monetary system in which paper money and coins are equal to the value of a certain amount of gold

stockbroker

a person who links buyers and sellers of stock

mortgage

a specific type of loan that is used to buy real estate

bear market

a steady drop in the stock market over a period of time

bull market

a steady rise in the stock market over a period of time

money supply

all the money available in the US economy

OTC market

an electronic marketplace for stocks and bonds

Securities and Exchange Commission

an independent agency of the government that regulates financial markets and investment companies

bank

an institution for receiving, keeping, and lending money

prospectus

an investment report to potential investors

medium of exchange

anything that is used to determine value during the exchange of goods and services

money

anything that serves as a medium of exchange, a unit of account, and a store of value

member bank

bank that belongs to the Federal Reserve System

central bank

bank that can lend to other banks in times of need

What is fractional reserve banking?

banking system that keeps only a fraction of funds on hand and lends out the remainder

financial asset

claim on the property or income of a borrower

equities

claims of ownership in a corporation

currency

coins and paper bills used as money

options

contracts that give investors the choice to buy or sell stock and other financial assets

futures

contracts to buy or sell at a specific date in the future at a price specified today

default

failure to pay back a loan

mutual fund

fund that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets

return

the money an investor receives above and beyond the sum of money initially invested

demand deposit

the money in checking accounts

Federal Reserve System

the nation's central banking system

Federal Reserve note

the national currency we use today in the United States

call option

the option to buy shares of stock at a specified time in the future

put option

the option to sell shares of stock at a specified time in the future

speculation

the practice of making high-risk investments with borrowed money in hopes of getting a big return

interest

the price paid for the use of borrowed money

Great Depression

the severe economic decline that began in 1929 and lasted for more than a decade

financial sytem

the system that allows the transfer of money between savers and borrowers

maturity

the time at which payment to a bondholder is due

bank run

widespread panic in which great numbers of people try to redeem their paper money

Benefits of buying stock

• 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

Banking Services

-loans: help businesses grow -store money: keep money in a safe and convenient place -mortgages: help you buy real estate -save: use savings accounts, money checking accounts, money market accounts -credit cards: entitle holders to buy goods and services based on the cardholder's promise to pay for them later

Three Uses of Money

-medium of exchange -unit of account -store of value

Durability

-money must be able to withstand the physical wear and tear that comes with being used over and over again

Divisibility

-money must be easily divided into smaller denominations

limited supply

-money would lose its value if there was an unlimited supply of it -therefore, the Federal Reserve regulates the amount of money in circulation in the US

uniformity

-people must be able to count and measure money accurately

Explain how a $1 bill has all six characteristics of money

-portable: it can last a year in circulation -portable: you can carry it anywhere with you -divisible: you can break it up with pennies, nickels, dimes, and quarters -uniform: it always buys a dollar value worth of goods -limited in supply: there is not an infinite number of bills lying around

Why do people invest?

-promotes economic wealth and contributes to a nation's wealth -save for retirement -grow your money -earn higher returns -build on pre-tax dollars -qualify for Employer-Matching programs -start and expand a business -reduce taxable income -support others

Why are bonds bought and sold?

Bonds are sold by governments and or corporations to finance projects. - Bonds offer a higher return than savings accounts, although they are generally riskier than savings accounts.

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.

Investment options

-savings bonds (low denomination bonds bought below par value and returned at maturity for full value) -mutual funds (pool the funds of many investors) -income stock (pays regular dividends) -growth stocks (pays few/no dividends and instead the issuing company reinvests its earnings in its business so the business and its stock increase in value over time)

Investments from safest to riskiest

1) cash and checking accounts 2)savings accounts 3) certificates of deposit 4) government bonds 5) corporate bonds 6) mutual funds 7) stocks 8) real estate 9) collectibles 10) commodities

What should your portfolio look like when you are just a few years away from retirement?

-inflation risk -focus on what you can control -plan for a long life -maintain your balance -use cash appropriately -don't reach for yield

representative money

objects that have value because the holder can exchange them for something else of value

commodity money

objects that have value in themselves and that are also used as money

greenback

paper currency issued during the Civil War

creditor

person or institution to whom money is owed

share

portion of stock

store of value

something that keeps its value if it is stored rather than used

diversification

spreading out investments to reduce risk

Key difference between stocks and bonds

stocks make no promises about dividends or returns

liquidity

the ability to be used as, or directly converted to, cash

investment

the act of redirecting resources from being consumed today so that they may create benefits in the future; the use of assets to earn income or profit

principal

the amount of money borrowed

par value

the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity

yield

the annual rate of return on a bond if the bond were held to maturity

Great Crash

the collapse of the stock market in 1929

capital gain

the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the seller

capital loss

the difference between a lower selling price and a higher purchase price resulting in a financial loss to the seller

barter

the direct exchange of one set of goods or services for another

stock split

the division of a single share of stock into more than one share

Federal Deposit Insurance Corporation (FDIC)

the government agency that insures customer deposits if a bank fails

Electronic Banking

- ATMs allow customers to deposit money, withdraw cash, and obtain information. - Debit cards can be used at an ATM or in a store to purchase goods. These cards require a PIN for security reasons. - Home banking—More and more people use the Internet to check balances, transfer money, automatically deposit paychecks, and pay bills.

What banking services do financial institutions provide?

- Financial institutions: • Provide electronic services • Issue credit cards • Make loans to businesses • Provide mortgages to prospective home buyers • Manage ATM machines

Investing is essential to the free enterprise system because

- 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.

Savers and Investors

- Savers include: • Households • Individuals • Businesses - Investors include: • Businesses • Governmen

coupon rate

the interest rate that a bond issuer will pay to a bondholder

Why is investing not the same as gambling?

-Gambling is to play games of chance for money; bet -Investing is expending money with the expectation of achieving a profit or material result by putting it into financial schemes, shares, or property, or by using it to develop a commercial venture

Describe three ways that stocks are traded.

-It can be traded through the New York Stock Exchange, where stocks for country's largest and most established companies are rapidly traded by investors and their stockbrokers. -There is also the OTC market, where stocks are traded electronically. Investors can buy directly from a dealer or from a banker who will search the market for the best price. -Daytrading is a newer type of stock trading where traders try to predict minute-by-minute price changes based on computer programs that tell the trader when to buy and sell. These traders might make dozens of trades a day in hopes of making a profit, but daytrading is very risky and traders can lose a great deal of money.

Name two measures that have been taken to stabilize American banking since the Great Depression

-Restrictions that have been put on the interest rates banks could pay depositors -Rates that banks could charge consumers for loans

Types of bonds

-US Gov bonds: US treasury bills, US treasury notes, US treasury bonds -Corporate bonds

Types of Investments

-bonds -stocks -dividends -mutual funds -real estate -certificate of deposit -portfolio

3 things to look for when buying bonds

-coupon rate -maturity -par value

Six characteristics of money

-durability -portability -divisibility -uniformity -limited supply -acceptability

acceptability

-everyone in an economy must be able to take the objects that serve as money and exchange them for goods and services

Two views of banking

-federalists wanted a centralized banking system and Alexander Hamilton, as Secretary of the Treasury, proposed a national bank in 1789 -Antifederalists, like Thomas Jefferson, opposed this plan. They favored a decentralized banking system in which states established and regulated banks within their borders.

Describe the 3 functions of money

-form of communicator b/w producer and consumer about the value of a good or service -allows buyers and sellers to compare goods with other goods being bought or sold -allows you to hold onto a value for a time being without having to spend it on a good or service

Advantages and Disadvantages of Bonds

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.

Using evidence from the chapter, support the following statement: Savings and investments play an essential role in the free enterprise system.

All businesses require capital to start up. As long as the business can make enough to pay all it's costs and wages at the same time pay back the investment plus interest at the same time, you have a win-win situation.

Nasdaq

American market for OTC securities

ACHs and Stored-Value Cards

Automated Clearing Houses (ACHs) allow consumers to pay bills without writing checks. • Stored-value cards carry money on them and can be used by college kids on campus or by people using a phone card with stored minutes.

Compare different means by which savings can be invested and the risks each strategy poses to the consumer.

Interest rate risk is the possibility that fixed-rate debt instrument will decline in value as a result of a rise in interest rates. Whenever investors buy securities that offer a fixed rate of return, they are exposing themselves to interest rate risk. Credit risk- a particular bond issuer will not be able to make expected interest rate payments or principal repayment.

What is electronic banking?

It is the use of ATMS and debit cards, the ability to check account balances, transfer money, pay bills, and deposit paychecks on the computer, the use of Automatic Clearing Houses, and the use of stored value cards.

How does diversification strengthen an investor's portfolio?

It reduces the changes of losing your entire investment. When you spread out investments, you are reducing your risk because it is estimated that more than half of all new businesses fail. So, when you diversify your investments you reduce the risk that you will lose all of your funds if a single investment fails.

Loans

Loans help consumers: - Buy homes - Pay for college - Start and grow businesses

M1

M1 represents money that people can gain access to easily. This includes: - Currency held by the public - Deposits in checking accounts - Traveler's checks

M2

M2 consists of all the assets in M1 plus several additional assets. These funds cannot be used as cash directly, but can be converted to cash fairly easily.

Analyze the economic impact of investing in the stock and bond market.

Movements in the stock market can have a profound economic impact on the economy and people. A collapse in share prices has the potential to cause widespread economic disruption. A fall in the stock market makes other investments more attractive. People may move out of shares and into gas bonds or gold. These investments offer a better return in times of uncertainty.

What do financial intermediates do?

They help channel funds from savers to borrowers and share the risks, provide info, and provide liquidity to investors.

How do ratings influence which bonds investors buy? How are bond ratings established?

They tell investors how risky their investment is going to be, so people are more inclined to buy bonds with good ratings. As a result, the higher the bond rating the lower the interest rate the company has to pay to get people to buy its bonds. If a bond has a not so great rating, the issuer may give a higher interest rate to the investor to make up for the bond's riskiness. Also, the higher the bond rating, the higher the price at which the bonds will sell. Bond ratings are established by 2 firms, Standard & Poor's and Moody's, which analyze bond.

The Dow

index that shows how certain stocks have traded

S & P 500

index that shows the price changes of 500 different stocks

financial intermediary

institution that helps channel funds from savers to borrowers

savings bond

low-denomination bond issued by the US government

secondary market

market for reselling financial assets

primary market

market for selling financial assets that can only be redeemed by the original holder

capital market

market in which money is lent for periods longer than a year

money market

market in which money is lent for periods of less than a year

portability

money must be easily carried by people. paper money and coins work because they are small and light

fiat money

money that has value because the government has ordered that it is an acceptable means to pay debts