Stock: a “share” is ownership in a corporation o Anyone can buy or sell o Owners receive profits as “dividends” o Hopefully selling price > purchase price o Stock sold by corporations to buy K (IPO = initial public offering) o Very difficult to predict stock price`s Bonds: a security sold by large business or government (issuer) that offers fixed future payments to buyers o the borrower (bond issuer) promises a fixed nominal payment to the investor (lender or bond buyer) at a set date
o Most bonds: > 1 year maturity with twice annual payments (coupons) and face value o Ex: Treasury Bill (T-Bill) Investors bid and pay now to receive a set amount in 1 year from the U.S. Treasury. The set amount is the “face value” Interest rate = (face value - P T-Bill ) / P T-Bill No coupons o Existing bonds are bought and sold in very active markets - prices change by the second o Borrowers (bond issuers) want low rates and lenders (bond buyers) want high rates o “Iron Law of Bonds:” their price rises → their interest rate falls (and vice versa) o Market prices of issued bonds vary as interest rates go up and down o Why do firms and governments issue bonds? Firms: raise $ to buy capital (stocks too) Governments: cover deficits Stocks or bonds? In general, stocks offer higher average returns than bonds, but with more risk 2. Be able to explain why college students should know about financing retirement and how it is done. (notes) Young workers rarely get traditional “defined benefit pension plans” o Defined benefit pension plan is one in which you still receive pay after retirement o These are fading out Social security will be there for you but the benefits aren’t enough to support an opulent lifestyle Most employers offer defined contribution plans o This is one in which you choose how much you want to put in and your employer will match it. Nothing is guaranteed - if you put nothing in, you will receive nothing o Many tax benefits - taxes will not reduce your amount In order to be comfortable after retirement, you must save and save often Best choice - easiest “life cycle fund” - selects age appropriate investments o Invest more in stocks younger and bonds as you get older 3. Be able to explain how and why the Fed can alter interest rates and the money supply. (Ch. 14.3, 14.4, and notes)
Fed buys and sells bonds with the public in “open market operations.” o When the fed buys bonds (from treasury) , bond prices rise and interest rates fall o Fed buys bonds → higher bond prices → lower interest rates For banks: customer deposits are liabilities and loans to customers are assets Another key bank asset: their deposit at the Fed “reserves” o By law banks are required to keep a fraction of their customers deposits on account at the Fed o This is in case many customers want their money back at once - banks can get money from the Fed o RR = (reserve / customer deposits) o Customer deposits = (1 / RR) x reserves Reserve ratio = RR 4. Be able to describe future problems with fiscal policy. (Ch. 16.1, 16.6,
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- Fall '10