Economics Principles & Practices

Chapter 12: Financial Markets

Chapter Overviews

Chapter 12 deals with financial investments, markets, and equities in the context of the financial system that makes economic growth possible.

Section 1 describes the role of saving in a financial system—a process that makes dollars available for others to invest. Financial assets—such as mortgages, demand deposit accounts, Treasury bills, bonds, certificates of deposit (CDs), savings accounts, and mutual fund shares-are generated in the process and are issued by individuals, businesses, and governments. The circular flow of borrowed funds and their financial assets is similar to the circular flow diagram illustrated in Chapter 1.

Section 2 explains how to invest in financial assets. Successful investors require larger returns to compensate for greater risk, analyze their goals, invest consistently, and avoid complex investments if they do not thoroughly understand them. 401(k) plans are becoming increasingly popular for retirement because of their convenience and high yields. Bonds are popular financial assets, along with CDs, money market mutual funds, and Individual Retirement Accounts (IRAs). Financial assets can be found in money markets where funds are borrowed or lent for periods of one year or less. Financial assets are also found in capital markets where funds are borrowed or lent for more than one year.

Section 3 deals with stocks, which represent ownership of a corporation. Many stocks are traded on organized exchanges like the New York Stock Exchange, the American Stock Exchange, and the many regional exchanges around the country, although the great majority are traded on a computerized marketplace of organized dealers called the Over-the-Counter market. Investors follow the Dow-Jones Industrial Average (DJIA) or the Standard & Poor's 500 (S&P 500) to track the performance of stocks. Bull markets are strong markets with prices going up; bear markets are bad markets with prices going down. Investors who are not afraid of risk can also invest in futures and options if these suit their investment needs.