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Financial Markets

Starting a business without personal wealth requires innovative financing strategies. Entrepreneurs can secure start-up funds through various means including bank loans, selling bonds, attracting investors, and issuing stock to venture capitalists. Financial intermediaries like banks and stock markets facilitate the flow of funds from savers to those in need. Understanding concepts such as the supply of loanable funds, interest rates, risk management, and present value is crucial for making informed financial decisions. This guide explores these concepts to help aspiring entrepreneurs succeed.

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Financial Markets

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  1. Chapter 30 Financial Markets

  2. To Start A Business • Entrepreneurs without personal wealth must get start-up funds to start a business. • Borrow the money • Go to the bank, sell bonds • Get others to invest in the venture • Sell stock, venture capital Chapter 30 2

  3. Financial Intermediaries • Institutions that makes savings available to dis-savers. • Gets money from those who have it to those who need it. • Banks • Stock Markets • Bond Markets Chapter 30 3

  4. Financial Intermediaries • The goal is to make it easier to get money for projects • They reduce information costs • You only need to share details & information with one institution, instead of many individuals Chapter 30 4

  5. Supply Of Loanable Funds • Comes from savings • “Investing” in stocks by individuals is just a form of saving. • We generally buy from other individuals, not from the company. • We are not buying tools & equipment, the company is. Chapter 30 5

  6. Determinants of Supply of Loanable Funds • Time Preferences • Interest Rates • Risk • Present Value of Future Funds • Uncertainty / Expectations Chapter 30 6

  7. 1. Time Preferences • Saving now means planned spending in the future • People who do not think of the future save little Chapter 30 7

  8. 2. Interest Rates • The higher the rate (of return) the more attractive saving is. • Saving first becomes attractive when the rate of return becomes greater than the expected inflation rate • Maintain or increase purchasing power of your money Chapter 30 8

  9. 3. Risk • The greater the risk of saving, the higher the rate of return should be. • Risk Premium • The difference in rates of return on risky and safe investments. Chapter 30 9

  10. Risk Management • To minimize risk to your savings, diversify • This means having savings in more than one form. • Some in the bank (safe, low return) • Some in Mutual Funds (not as safe, higher return) • Some individual stocks (somewhat risky, higher return) • Lottery/gambling (very risky, big payoff) • Lend to your brother… Chapter 30 10

  11. 4. Present Value of Future Profits • Money in the future is not as useful to you as money today. • You must discount the value of expected future earnings into “today’s” money to evaluate an investment. Chapter 30 11

  12. Present Value of Future Profits • The Present Value of Money declines as: • Interest Rates go up • Length of time before payments increases. Chapter 30 12

  13. 5. Uncertainty • The possibility of non-payment. • You can evaluate the value of a project using “Expected Value” • Possible incomes are weighted by their probability of occuring. Chapter 30 13

  14. Expected Value Example ProfitProbability • Pessimistic: $2,000 25% • Likely $5,000 50% • Optimistic $7,500 25% • EV = (2000x.25)+(5000x.5)+(7500x.25) • EV = $5,125 Chapter 30 14

  15. The Demand for Loanable Funds • The demand for loanable funds depends on: • Expected rate of return • The cost of funds • This is similar to those for the supply of loanable funds • Individuals save money to make money • Businesses borrow money to make money Chapter 30 15

  16. Stock Market • To raise money, an owner can sell part-ownership of their company. • Corporate Stock • A share of stock is a certificate worth a percentage of ownership in a corporation. • In principle, the shareholders collectively run the company Chapter 30 16

  17. Shareholder Value • Stocks give value to the shareholders by: • Dividends • Capital gains Chapter 30 17

  18. Dividends • As an owner of a company, shareholders are entitled to a share of the profits – Dividends. • A dividend is the amount of corporate profits paid out for each share of stock. • Each share of stock you own will earn a dividend. Chapter 30 18

  19. Dividends • Companies that do not make profit do not pay dividends. • There are exceptions • Dividends are not guaranteed as income Chapter 30 19

  20. Capital Gains • If the value of the stock increases after you buy it, you can sell it for more than you paid for it – Capital Gain • If the value of the stock decreases, when you sell the stock you take a Capital Loss. • Capital Gains are not guaranteed as income. Chapter 30 20

  21. Value of a Stock Share • The value (or price) of a share comes from the value of the company. If the company becomes more valuable, the share price goes up. • A company is worth more than the price of the tools & buildings it owns. Chapter 30 21

  22. Value of a Stock Share • The value of a company is the Present Value of the expected future stream of income for the company. • Divide that by the number of shares to get the share price. Chapter 30 22

  23. Value of a Stock Share • To “discount” the future income into “today’s” money, You must determine the Discount Rate • Discount Rate is based on: • Interest rate to borrow • Rate of return possible form other available investments • The riskiness & uncertainty of the company, industry, & economy Chapter 30 23

  24. Value of a Stock Share • Anything that can change the future sales of a company will change the value of the company, and the share price. Chapter 30 24

  25. Stock Quote Finance.yahoo.com Chapter 30 25

  26. Bond Market • A bond is another way to get savings into the hands of dis-savers. • When a company sells a bond, they are not selling a piece of the ownership to the company. • A Bond is a promise to pay a certain amount to the bondholder at a certain future date. Chapter 30 26

  27. Bonds • A Bond is a simple & fast way for a company to borrow money. • If you buy a bond from a company, you are lending them money. • You can then re-sell this “I.O.U.” to other people, as needed. Chapter 30 27

  28. Bonds • Bonds are loans, so their risk is smaller. • If the company declared bankruptcy, the bondholder would still be able to collect some money as a creditor. Bondholders would collect all their money before shareholders collect any. • Where bonds are less risky, their return is lower. Chapter 30 28

  29. Bonds • Bonds are generally issued in $1,000 amounts. • The company will pay $1,000 to the bondholder at some point in the future. • The bond will be worth less than $1,000 up until the day it “matures” (the day to cash it in for the face value) Chapter 30 29

  30. Bond Valuation • The value of a bond is based on: • Time left until maturity • The outlook of the company, industry, and economy • The value of any “coupons” the bond pays • Coupons are moneys paid to the bondholder before the bond matures. • The rate of return for other available investments. Chapter 30 30

  31. Bond Quote Finance.yahoo.com Chapter 30 31

  32. Rate of Return for Bonds • The return on a bond changes daily as the price changes. • In general, look at the difference between the price & the maturity value as a percent, and then annualize it over the time left until maturity. • As prices increase, the yield decreases. Chapter 30 32

  33. Venture Capitalists • Financiers with a lot of money to invest into new companies & ideas. • They specialize in lending money to (or buying ownership in) new companies with potential. • They may be more willing to take a risk than a bank. Chapter 30 33

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