ECONOMICS TOPIC 6 LESSON 5

ECONOMICS TOPIC 6 LESSON 5

Investing

ESSENTIAL QUESTION

How can you make your money work for you?

OBJECTIVES

• •Describe how investing contributes to the free enterprise system.

• •Explain how investing brings together savers and borrowers in the free enterprise system.

• •Explain how different types of financial institutions serve as intermediaries between savers and borrowers.

• •Analyze liquidity, return, and risk within the free enterprise system.

Investment and Free Enterprise

There are both benefits and risks to savings and investment. The savings you put in the bank will grow with almost no risk to the principle.

However, as this section points out, a properly timed investment can bring a much greater reward than the same money put away in savings.

investment is the act of redirecting resources from being consumed today so that they may create benefits in the future.

Multiple Choice

Check Understanding One benefit of our free enterprise system is that it

• allows the government to decide what goods and services will be produced.

• provides people with opportunities to invest their savings for their most productive use.

• restricts individual wealth.

• benefits businesses and not individuals.

The Financial System

 A financial system is the network of structures and mechanisms that allows the transfer of money between savers and borrowers.

Financial Assets

When people save, they are, in essence, lending funds to others. Whether they put cash in a savings account, purchase a certificate of deposit, or buy a government or corporate bond, savers obtain a document that confirms their purchase or deposit.

Such documents represent claims on the property or income of the borrower. These claims are called financial assets, or securities.

Open Ended

Analyze Graphs How would you describe the trend in the percentage that Americans saved between 1975 and 2005?

Savers and Borrowers

On one side are savers—households, individuals, and businesses that lend out their savings in return for financial assets, such as the promise of regular interest payments.

On the other side are investors—governments and businesses—who invest the money they borrow to build roads, factories, and homes.

Open Ended

Analyze Information Why do investors typically borrow money from financial institutions rather than directly from savers?

Multiple Choice

Identify Main Ideas Interest helps allocate savings to its most productive use by

• limiting risk.

• directing households to save or invest.

• transferring money from borrowers to savers.

• providing money for business improvements.

Financial Intermediaries

 financial intermediaries are institutions that help channel funds from savers to borrowers.

Banks, savings and loan associations (S&Ls), credit unions, and finance companies

Banks, S&Ls, and credit unions take in deposits from savers and then lend out some of these funds to businesses and individuals. Finance companies make loans to consumers and small businesses.

Mutual funds

mutual fund pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets.

Hedge funds

A hedge fund is a private investment organization that employs risky strategies that often make huge profits for investors.

Life insurance companies

The main function of life insurance is to provide financial protection for the family or other people named as beneficiaries of the insured.

Pension funds 

A pension is income that some retirees receive after working a certain number of years or reaching a certain age.

Open Ended

Analyze Graphs About how many times more assets are held by pension funds than by life insurance companies?

Sharing Risk

As a saver, you may not want to invest your entire life savings in a single company or enterprise.

Since it is estimated that more than half of all new businesses fail, you would be wise not to risk all of your money in one investment. Instead, you would want to spread the money around to various businesses. This would reduce your chances of losing your entire investment.

Open Ended

Investing money almost always comes with some type of risk. Analyze Charts How are a liquidity risk and a time risk similar? How are they different?

DIVERSIFICATION

This strategy of spreading out investments to reduce risk is called diversification.

financial intermediaries can diversify your investments and thus reduce the risk that you will lose all of your funds if a single investment fails.

Providing Information

Financial intermediaries are also good sources of information. Your local bank collects information about borrowers by monitoring their income and spending.

 portfolios,  or collections of financial assets.

 all intermediaries provide information to potential investors in an investment report called a prospectus

Providing Liquidity

Financial intermediaries also provide investors with liquidity. Liquidity is the ability to convert an asset into cash. 

Multiple Choice

Define A mutual fund

• pools the savings of many individuals and invests it in a variety of financial assets.

• collects premiums from the people who buy insurance and lends out a portion to investors.

• uses risky strategies that often make huge profits for wealthy investors.

• invests employee retirement money in stocks, bonds, and other financial assets.

Liquidity, Return, and Risk

 Savings accounts are good ways to save when you need to be able to get to your cash for immediate use. Return is the money an investor receives above and beyond the sum of money that has been invested.

Liquidity, Return, and Risk

 Whenever individuals evaluate an investment, they must balance the risks involved with the rewards they expect to gain from the investment. In general, the higher the potential return on an investment, the riskier the investment.

Multiple Choice

Define What is credit risk?

• the risk that you may not be able to convert the investment back into cash quickly enough to meet your needs

• the risk that inflation rates will erode the value of your assets

• the risk that you may have to pass up better opportunities for investment

• the risk that borrowers may not pay back the money they have borrowed or may be late on payments

Open Ended

hOW CAN YOU MAKE YOUR MONEY WORK FOR YOU?