Financial Markets: Allocating Financial Resources

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2 Financial Markets: Allocating Financial Resources Explain the role of financial markets in the U.S. economy and identify the key players in these markets Identify the key laws that govern the way financial markets operate and explain the impact of each law Describe and compare the major types of securities that are traded in securities markets 2

3 Financial Markets: Allocating Financial Resources Explain how securities are issued in the primary market and traded on secondary markets Compare several strategies that investors use to invest in securities Interpret the information provided in the stock quotes available on financial websites 3

4 Financial Markets and the U.S. Economy Financial markets: Transfer funds from savers to borrowers Depository institutions: Obtain funds by accepting checking and savings deposit and lending those funds Commercial banks Credit unions Savings and loan associations 4

5 Financial Markets and the U.S. Economy Nondepository financial institutions Institutional investors: Amass financial capital and acquire a portfolio of different assets Securities brokers: Agents for investors who want to trade in financial securities Securities dealers: Buy and sell stocks and bonds for their own account Investment banks: Help firms issue new securities to raise financial capital 5

6 Financial Markets: Key Laws and Impacts Federal Reserve Act of 1913 Created Federal Reserve System to serve as the central bank in the United States Primary responsibility of overseeing the nation s banking system Banking Act of 1933 Or the Glass-Steagall Act established the Federal Deposit Insurance Corporation Insured depositors against financial losses when a bank failed Banned commercial banks from competing with nondepository institutions 6

7 Financial Markets: Key Laws and Impacts Securities Act of 1933 Dealt mainly with the process of issuing new securities Required firms issuing new stock in a public offering to file a registration statement with the SEC Securities Exchange Act of 1934 Regulated the trading of previously issued securities Securities and Exchange Commission: Oversee the securities industry 7

8 Deregulation During the 1980s and 1990s Financial Services Modernization Act of 1999 Reversed the Glass-Steagall Act s prohibition of banks selling insurance or acting as investment banks Known as the Gramm-Bliley-Leach Act 8

9 Re-regulation in the Aftermath of Financial Turmoil Sarbanes-Oxley Act in 2002 Ensured that external auditors offered fair opinions while examining a company s financial statements SEC s authority was increased to regulate financial markets Dodd-Frank Act of 2010 Expanded the Fed s regulatory authority over nondepository financial institutions Established the Financial Stability Oversight Council to identify emerging risks 9

10 What is the fundamental role of a hedge fund, and how do the activities of the individuals featured in the video contribute to fulfilling that role? Why should wealthy investors be concerned about putting their money into a hedge fund? istockphoto.com / DNY59 10

11 Securities Markets: An Overview Common stock: Basic form of ownership in a corporation Voting rights Right to dividends Capital gains: Received when the price of the stock goes over the amount paid for it Preemptive right Right to a residual claim on assets 11

12 Securities Markets: An Overview Preferred stocks - Holders get preferential treatment Claim on assets Payment of dividends Can be cumulative Company s stronger earnings do not ensure greater gains for the holder 12

13 Securities Markets: An Overview Bonds - Formal IOU issued by a corporation or government entity Maturity date: Date a bond comes due Par value: Amount at maturity Coupon rate: Annual interest payment as a percentage of the bond s par value Current yield: Bond s interest payment as a percentage of the bond s current market price rather than its par value 13

14 Securities Markets: An Overview Convertible securities - Shares of preferred stock that investors exchange for a number of shares of the issuing corporation s common stock Conversion ratio - Number of common stock shares exchanged for each security Financial diversification: Holding many different securities in different sectors 14

15 Mutual Funds Closed-end fund Issues a fixed number of shares and invests the money received from selling them in a portfolio of assets Open-end mutual fund Issues additional shares when demand increases or redeems old shares when investors cash in Based on net asset value per share 15

16 Exchange Traded Funds Allows investors to buy ownership in a market basket of many different securities Market basket - Reflects the composition of a broad-based stock index 16

17 Primary Securities Market Corporations raise additional financial capital by selling newly issued securities Public offering: Securities sold to the investing public Initial public offering: First time a corporation sells its stock in a public offering Underwrite: Investment bank purchases all the shares at a specified price guaranteeing the firm new funds 17

18 Primary Securities Market Registration statement: Firm s statement with the SEC on its financial statements Private placement: Securities sold to one or more accredited investors Accredited investors: Individuals or other organizations that meet specific financial requirements set by the SEC Under terms negotiated between the issuing firm and the private investors 18

19 Secondary Securities Markets Stock exchange Organized venue to trade listed stocks and securities Market makers: Securities dealers who continuously buy and sell specific NASDAQ-listed stocks with an ask-price and bid-price Over-the-counter market Where securities that are not listed on exchanges are traded Electronic Communications Networks Entirely automated and computerized trading systems that allow traders to bypass the market makers used in the NASDAQ and OTC markets 19

20 Choosing a Broker Full service broker Perform market research, investment advice, and tax planning Discount brokers Provide basic services needed to trade in securities Offer fewer additional services 20

21 Buying Securities Market orders: Instruct brokers to buy or sell a security at the current market price Limit orders: Limits the prices at which orders are executed Buy limit order - Buying at a specified value Sell limit order - Selling at a specified value 21

22 How to Invest In Securities? Investing for income Focus on buying bonds and preferred stocks Market timing Use of analytical techniques to predict fall/rise in prices of specific stocks Value investing Find stocks that are undervalued in the market, to generate a capital gain Investing for growth Look for companies that have the potential to grow leading to a steady rise in price Buying and holding Purchasing diversified securities and holding them for a long period of time 22

23 Market Trends and Performance Tracking Stock index: Tracks prices of a large group of stocks that meet defined criteria Dow Jones Industrial Average (DJIA): Adjusted average price of 30 stocks picked by the editors of The Wall Street Journal Standard & Poor s 500: With 500 stocks it is a much broader index than the DJIA 23

24 Market Trends and Performance Tracking To check out a specific stock, type its stock symbol into a Get Quote box Last trade - Price of firm s common stock for the most recent trade Change - Last trade of the firm s stock Bid and ask - Highest/lowest price currently offered to buy/sell the firm s stock Day s range - Highest stock price during the day Market Cap - Total market value of all shares 24

25 Market Trends and Performance Tracking 52-week range - Highest price for the stocks over the previous 52 weeks Volume - Shares of the stock that have been traded in the current trading session Price-to-earnings ratio - Divide the stock s price per share by its earnings per share Earnings per share - Divide net income by the number of shares outstanding Div and yield - Sum of dividends paid by the firm in the previous 12 months 25

26 Explain the role of financial markets in the U.S. economy and identify the key players in these markets Identify the key laws that govern the way financial markets operate and explain the impact of each law Describe and compare the major types of securities that are traded in securities markets 26

27 Explain how securities are issued in the primary market and traded on secondary markets Compare several strategies that investors use to invest in securities Interpret the information provided in the stock quotes available on financial websites 27