Financial Markets Economics Fall, 2013
What Can You Do With Your Money? Spend it or save it Savings: income not used for consumption Marginal propensity to consume: the change in personal spending that results from an increase in income Savers and borrowers come together in the financial markets
Investment Objectives How long are you investing for? When do you need your money? How much money do you have available? Will you need your investment money as you go along? Do you need your investment to pay you? Are you a risk-taker?
Investment Basics: Risk and Return How much is an investment supposed to return? Are risk and return related? Can you measure risk? How do you measure risk? Standard deviation: a measure of the dispersion from the mean used to measure risk, in terms of price fluctuations of an asset Correlation: a measure of how two securities move in relation to one another Values are from -1 to 1. Values close to -1 indicate an inverse correlation, values close to 1 indicate a positive correlation Beta: a measure of the systematic risk of an investment, compared to the market Generally: how the return is related to the market's return The higher the value, the more the investment moves compared to the market Beta of 1 indicates the security moves the same amount as the benchmark
Let s Invest: Stocks Stock: a share of ownership in a corporation Common stock: holders have voting rights, share of profits Preferred stock: pays dividends, generally no voting rights also, higher on capital ladder
All About A Stock: Details Open: price at the open of trading Vol/Avg: Number of shares traded today/ average number of shares traded each day Market Cap: size of the company; number of shares times price P/E: price / earnings per share EPS: earnings per share Div. Yield: dividend yield; value of dividend divided by price of share Inst. own: percent owned by institutions
Trading Stock Most stocks are sold to investors through a stock exchange Exchanges are secondary markets Organized stock exchanges securities must be listed NYSE: >8,000 issues; exchanges have listing requirements auction market: buyers and sellers are matched through bidding to determine prices; prices vary continuously Stocks trade under ticker symbols ticker symbol: arrangement of letters that represents a particular stock, used to place orders for the stock Examples: Ford (F), Boeing (BA), Apple (AAPL) Examples: NYSE, NASDAQ, Tokyo Stock Exchange, BM&F Bovespa Over-the-counter (OTC) exchanges: trading of securities not listed on exchanges
Measuring Performance: Market Indices/Indexes How do we measure stock performance? How do we measure performance of all stocks? answer: market indexes stock index: a measure of the change in price for a specific set of stocks so, can you have an index of any stocks? well, yes... price-weighted index: arithmetic average of current security prices sum of stock prices divided by number of stocks in index Dow Jones Industrial Average: price-weighted index of 30 blue chip stocks market-value (capitalization) weighted index: total value of all stocks in index current market cap divided by base year market cap market cap is price times number of shares outstanding S&P500: cap-weighted index of 500 stocks, balanced by sector
The Dow Jones Industrial Average
Let s Compare: Stock vs. Index Stocks can be compared to indices to determine relative performance Outperforms the index if the stock s returns are better than the index returns Underperforms the index if the stock s returns are worse than the index Which index do you choose to measure performance? NASDAQ? Russell 2000? FTSE 100?
Bulls and Bears, Continued Bull market: a steady rise in stock prices Generally, a 20% rise over at least two months Bear market: a steady decline in stock prices Generally, a 20% decline over at least two months
Bonds and Other Financial Instruments Equity vs. debt securities security: a contract that can be assigned a value, and traded negotiable financial instrument -- its ownership can be legally transferred to another party equity security: a security that represents an ownership stake debt security: a security that represents debt, or a promise to repay a balance borrowed include corporate bonds (corporates), government bonds (treasuries)
How Do Bonds Work? A bond is a security where the issuer (borrower) promises to pay the holder the money borrowed, plus interest Principal: the amount borrowed not always the same as the coupon: bonds may trade at a premium or discount bond price and yield move inversely Par value: the amount that must be paid at maturity Coupon: the interest rate the holder receives may be paid annually, semiannually, or not at all Yield: the annual rate of return at par: yield = coupon above par: yield < coupon below par: yield > coupon Maturity: the date the bond is due to be repaid Usually 1-30 years
Are These Things Safe? Do They Carry Risks? Some don t... Treasuries, debt securities issued by the US government, are considered risk-free Backed by the full faith and credit of the US government Treasury bills: >1 year maturity, Treasury notes: 1-10 years, Treasury bonds: 20-30 years States and municipalities also issue debt: municipal bonds, or munis The main risk is default risk: the likelihood that the issuer will be unable to pay at maturity Rating agencies: Fitch, Moody s, Standard & Poor s