Doing Chapter 5 in Finance today, and then starting on Chapter 2 after the break. Got the quiz and homework back from last week. I did just fine on both of them. Didn’t lose any points.
Next week will be our first test.
Back to Financial Institutions.
In many cases, direct transfer of funds from savers to borrowers is impractical. This is the primary reason for financial intermediaries to exist.
Types of Financial Institutions:
- Investment Banks are companies which help other companies raise money by issuing securities for the first time. Experts on the legal and practical issues associated with offering stock or bonds.
- Commercial banks, savings (thrift) institutions, and credit unions are all considered depository institutions. Depository institutions function by taking deposits from savers, which they pay for with interest or services, and then lend to individuals or firms. Commercial banks focus on commercial lending, and are for-profit institutions. Savings institutions come in various types, can be for-profit or not-for-profit, and focus more on personal and home loans. Credit unions are not-for-profit organizations, and tend to be themselves smaller organizations and to do smaller-scale lending, such as home and personal loans. Credit unions must, by law, have restricted membership.
- Pension Funds are funds set up by companies to pay out to retired employees. Normally payment is made under either a payout formula according to factors such as length of employment and ending salary, or are individually controlled by the employees. Holdings are invested by the fund managers. Depending on the size and holdings of the fund, pension funds can be very influential.
- Life insurance companies get capital by selling life insurance, and invest that money.
- Mutual funds are managed collective investments. Many investors pool their resources, and the fund managers invest those resources according to the nature of the fund. For individuals, this is likely to be the most prevalent investment source.
- Hedge Funds are investment funds for millionaires. Very high fees associated with them; often $1 million is the ground floor for entry into the fund. They tend to be black boxes; you give them money to invest, and they invest it and pay back to you. Less regulated than mutual funds.
There are two forms of stock markets. Physical location exchanges and electronic dealer-based markets. The differences between them are narrowing. Physical location exchanges are auction markets conducted at particular locations, such as the New York Stock Exchange. Electronic dealer-based markets are over-the-counter exchanges, meaning brokers are not strictly needed and no exclusive trading location exists. There are various computer platforms for conducting trades.
Efficient Market Hypothesis — Theory of market behavior. Accepts that the market is efficient in pricing securities, and therefore makes several assumptions about market conditions and behavior.
- Securities are in equilibrium and are fairly priced
- Investors can only beat the market through good luck or superior information
- Efficiency is described in three levels. These largely reflect the effect that you believe information has on the market. Evidence suggests that the market is highly efficient in the weak form, reasonably efficient in the semistrong form, and not efficient in the strong form.
- Weak-form efficiency – Suggests you cannot determine any new information by studying old price data. All the older price data has already been incorporated into the current stock price. A stock’s price falling recently does not tell you what is likely to happen next. Evidence exists to support weak-form efficiency, but technical analysis is still used.
- Semistrong-form efficiency – All publicly available information is reflected in the stock price, so it does not make sense to overanalyze annual reports looking for undervalued stocks. Accepted as largely true, but superior analysts can still actually find and use new information.
- Strong-form efficiency – All information, even inside information, is embedded in stock prices. Not actually true; insiders have a proven history of benefiting via trade on insider information. This is generally illegal.
- Behavioral Finance incorporates elements of cognitive psychology to better understand how individuals and markets respond to different situations.
Chapter 2 — Time Value of Money
- Future Value
- Present Value
- Annuities
- Rates of Return
- Amortization
The first step in time value analysis is setting up a time line. The time line is set up to show the payment intervals or periods, and allows one to see the value of the money after different amounts of time.
Test next week. Homework for chapters 4 and 5 due. One sheet of notes, front and back, is acceptable. Need a blue scantron. 35 multiple choice questions, each worth 4 points. Mix of math and knowledge questions.