Financial Markets

Financial Markets

Financial markets, are spaces in which funds are transferred from people who have an excess of available funds to people who have a shortage. Financial markets, such as bond and stock markets, are crucial to promoting greater economic efficiency by channeling funds from people who do not have a productive use for them to those who do.

Well-functioning financial markets are a key factor in producing high economic growth.

Activities in financial markets also have direct effects on personal wealth, the behavior of businesses and consumers, and the cyclical performance of the economy.

Debt Markets and Interest Rates

A security is a financial instrument. It is a claim on the issuer's future income or assets. An asset is any financial claim or piece or property that is subject to ownership.

A bond is a debt security that promises to make payments Bonds are both short- and long-term debt instruments. Debt markets are also referred to as the bond market, and they enable corporations and governments to borrow in order to finance their activities.

Debt Markets

The bond market is also where interest rates are determined. An interest rate is the cost of borrowing or the price paid for the rental of funds (usually expressed as a percentage of the rental of $100 per year). Many types of interest rates are found in the economy: mortgages, car loan, and interest rates on many types of bonds.

Interest rates

On a personal level, high interest rates could deter you from buying a house or a car because the cost of financing it would be high.

Conversely, high interest rates could encourage you to save because you can earn more interest income by putting aside some of your earnings as savings. On a more general level, interest rates have an impact on the overall health of the economy because they affect not only consumer's willingness to spend or save but also businesses' investment decisions.

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The Stock Market

A common stock represents a share of ownership in a corporation, It is a security that is a claim on the earnings and assets of the corporation. Issuing stock and selling it to the public is a way for corporations to raise funds to finance their activities. The stock market, in which claims on the earnings of corporations (shares of stock) are traded, is the most widely followed financial market in almost every country that has one.

A big swing in the prices of shares in the stock market is always a major story on the news. People speculate on where the market is heading. The stock market is a place where people can get rich or poor, quickly -stock prices are extremely volatile-.

The stock market is also an important factor in business investment decisions because the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending.

A higher price for a firm's shares means that it can raise a larger amount of funds, which can be used to buy production facilities and equipment.

The Financial System

The financial system is complex, including many types of private-sector financial institutions, including banks, insurance companies, mutual funds, finance companies, and investment banks- all of which are heavily regulated by governments. If you wanted to make a loan to Apple or Amazon, for example, you wouldn't go directly to the company and offer a loan. Instead, you would lend to such companies indirectly through financial intermediaries, institutions such as commercial banks, savings and loan associations, credit unions, insurance companies, mutual funds, pension funds, and finance companies that borrow funds from people who have saved and in turn make loans to others.

Financial crises

Major disruptions in financial markets are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. A stock market crash occurs when stock prices drop suddenly by a large amount over a single or several days. A stock market collapse typically occurs when the economy is overheated, inflation is rising, market specutlation is rampant, and there is significant uncertainty about the path of an economy.

Central Banks and Monetary Policy

The most important financial institution is the central bank; it is a government agency responsible for the conduct of monetary policy (The Federal Reserve, Banxico, Bank of Japan, European Central Bank, Bank of England, etc.). Monetary Policy involves the management of interest rates and the quantity of money, also referred as money supply -anything accepted in payment for goods and services or in the repayment of debt-. Monetary policy affects interest rates, inflation and business cycles, which have an impact on financial markets.

Investment Insights

A valuable lesson form Warren Buffett is to wait on the side lines for a solid, profitable company to experience certain financial problems or have need for cash. It is at this moment an investor can then pounce on the opportunity to purchase stocks, generally at heavily discounted prices.

This is a window of opportunity to purchase stock and invest in an otherwise stable and reliable company at great prices. In time, when the situation normalizes again, and the stock price goes up, you will find yourself getting back what you put in, and earning more.

Bonds

Have you ever borrowed money? Just like people need money, so do companies and governments. A company needs funds to expand into new markets while governments need money for everything from infrastructure to social programs. Large oranizations typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds or other debt instruments to a public market.

Bonds

Thousands of investors lend a portion of the capital needed. A bond is nothing more than a loan of which you are the lender. The organization that sells a bond is known as the issuer. You can think of it as an IOU given by a borrower (the issuer) to a lender (the investor). The issuer of a bond must pay the investor something extra for the privilege of using his money. This 'extra' comes in the form of interest payments, which are made at a predetermined rate and schedule. The interest rate is often referred to as the coupon.

Bonds

The date on which the issuer has to repay the amount borrowed, known as face value, is called the maturity date. Bonds are known as fixed-income securities because you know the exact amount of cash you'll get back, provided you hold the security until maturity. Example: You purchase a bond with a face value of $1000, a coupon of 8%, and a maturity of ten years. This means you'll receive a total of $80 ($1000 x 8%) of interest per year for the next 10 years. Actually, because most bonds pay interest semi-annually, you'll receive two payments of $40 a year for ten years. When the bond matures after a decade you'll get your $1000 back.

Types of Bonds

Government bonds Bills- Debt securities maturing in less than one year. Notes.- Debt securities maturing in one to ten years. Bonds.- Debt securities maturing in more than ten years. They are all known as Treasuries (Treasury Bonds, Treasury notes, and Treasury bills).

Corporate Bonds

A company can issue bonds just like it can issue stock. Corporate bonds are characterized by higher yields because there is a higher risk a company defaulting rather than a government. The company's credit quality is very important: the higher the quality, the lower the interest rate the investor receives.

Elements to know in a Bond table

Issuer is the company, government agency or country that is issuing the bond. Coupon. Refers to the fixed interest rate that the issuer pays to the lender.

Maturity Date. It is the date on which the borrower will pay the investors their principal back. The yield indicates annual return until the bond matures.

Bid Price, is the price someone is willing to pay for the bond. It is quoted in relation to 100, regardless of the par value. A bond with a bid price of 93 means it is trading at 93% of its par value.

Yield

Yield is a figure that shows the return you get on a bond. Yield =coupon amount/price

If you buy a bond a its $1000 par value with a 10% coupon, the yield is 10% ($100/$1000). But if the price goes down to $800, then the yield goes up to 12.5%. You are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). If the bond goes up in price to $1200 the yield shrinks to 8.33% ($100/$1200).

The Link Between Price and Yield

When price goes up, yield goes down and vice versa. Technically you'd say the bond's prices and its yield are inversely related. Everything depends on your perspective: if you are bond buyer you want high yield. A buyer wants to pay $800 for the $1000 bond, which gives the bond a yield of 12.5%. On the other hand, if you already own a bond, you've locked in your interest rate, so you hope the price of the bond goes up. This way you can cash out by selling your bond in the future.

The Price

Appart from the face value, coupon, maturity and yield, the factor that influences a bond more than any other is the prevailing interest rates in the economy. When interest rates rise, the prices of bonds fall, thereby raising the yield of the older bonds and bringing them into line with the newer bonds issued with a higher coupon. When interest rates fall, the prices of bonds in the markets rise, thereby lowering the yield of the older bonds and bringing them into line with the newer bonds being issued with a lower coupon.

Debt versus Equity

Bonds are bebt whereas stocks are equity. Both are securities. By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government). In the case of bankruptcy a bondholder will get paid before a shareholder does. The bondholder is entitled to the principal plus interest. The shareholder benefits from profits if a company does well.

Capital Market

A market where debts or securities are traded. Instruments generally have longer term -stocks, bonds, funds-. The Stock Market is a Capital Market. What is a stock? A certificate representing a unit of ownership in a company. Stocks are also known as equities; it is a security representing partial ownership of a publicly traded company. When you buy stocks in a company, it means you own a part of that company. A share is the unit of stock; the more shares you buy, the more stock you have in a company.

Types of stock

There are two main types of stocks. Common or ordinary stocks give shareholders the right to vote on company matters and participate in the growing earnings of the company.

Preferred stocks come with a higher fixed dividend payout, and with no voting rights.

What is a stock market?

The stock market is a trading network that connects investors looking to buy and sell stocks and their derivatives. Private companies list shares of stock on an exchange through a process called an Initial Public Offering.

Investors purchase those shares, which allows the company to raise money from the public to grow its business. Once the company is listed on a stock exchange it is now a public company and investors can buy and sell the company's shares on an exchange which tracks the stock price.

The stock market

The supply and demand helps determine the price for each security at which investors and traders are willing to buy or sell.

What is a stock exchange? Stock exchanges are where stocks and other types of investments are bought and sold. Examples include the New York Stock Exchange, NASDAQ, Toronto Stock Exchange, London Stock Exchange, the Shanghai Stock Exchange and the Tokyo Stock Exchange.

Primary vs Secondary Market

Primary Market The Market for newly issued shares. Shares are sold directly from issuers to investors.

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Secondary Market A market where an investor buys a share from another rather than the issuer, after the issuance of the shares in the primary market.

Buying quality

In many ways, quality is relative to price, of course. When a product is cheaper than most competitors, you may find that there is less if offers, or the quality is not as good. But there are also opportunities to buy top quality items at much lower prices. Warren Buffett emphasizes quality and the importance of investing only in an opportunity that will enhance your portfolio and raise your standard, rather than settling for something less just because it is priced better.

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