Financial Markets.docx

**Lesson Proper for Week 1** Completion requirements **Lesson 1.1 Definition of Financial Markets\           Financial markets**, from the name itself, are a type of marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. Of...

**Lesson Proper for Week 1** Completion requirements **Lesson 1.1 Definition of Financial Markets\           Financial markets**, from the name itself, are a type of marketplace that provides an avenue for the sale and purchase of assets such as bonds, stocks, foreign exchange, and derivatives. Often, they are called by different names, including "Wall Street" and "capital market," but all of them still mean one and the same thing. Simply both, businesses and investors can go to financial markets to raise money to increase growth their business and to make more money, respectively.\ **          **To state it more clearly, let us imagine a bank where an individual maintains a savings account. The bank can use their money and the money of other depositors to loan to other individuals and organizations and charge an interest fee. The depositors themselves also earn and see their money grow through the interest that is paid to it. Therefore, the bank serves as a financial market that benefits both the depositors and the debtors. **Lesson 1.2 Types of Financial Markets\           **There are so many financial markets, and every country is home to at least one, although they vary in size. Some are small while some others are internationally known, such as the New York Stock Exchange (NYSE) that trades trillions of dollars on a daily basis. Here are some **types of financial markets**: 1\. **Stock market** -The stock market trades [shares of ownership] of public companies. Each share comes with a price, and investors make money with the stocks when they perform well in the market. It is easy to buy stocks. The real challenge is in choosing the right stocks that will earn money for the investor. There are various indices that investors can use to monitor how the stock market is doing, such as the Dow Jones Industrial Average (DJIA) and the S&P 500. When stocks are bought at a cheaper price and are sold at a higher price, the investor earns from the sale. 2\. **Bond market** -The bond [market offers opportunities] for companies and the government to secure money to finance a project or investment. In a bond market, investors buy bonds from a company, and the company returns the amount of the bonds within an agreed period, plus interest. 3\. **Commodities market** -The commodities market is where traders and investors [buy and sell] natural resources or commodities such as corn, oil, meat, and gold. A specific market is created for such resources because their price is unpredictable. There are a commodities futures market wherein the price of items that are to be delivered at a given future time is already identified and sealed today. 4\. **Derivatives market** -Such a market involves derivatives or contracts whose [value is based on the market value of the asset being traded.] The futures mentioned above in the commodities market is an example of a derivative. **Lesson 1.3 Why study financial markets?\           **Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage. Financial markets such as bond and stock markets are crucial to promoting greater economic efficiency by channeling funds from people who do not have a productive use for them to those who do. Indeed, well-functioning financial markets are a key factor in producing high economic growth, and poorly performing financial markets are one reason that many countries in the world remain desperately poor. Activities in financial markets also have direct effects on personal wealth, the behavior of businesses and consumers, and the cyclical performance of the economy **The Bond Market and Interest Rates\           **-A security (also called a financial instrument) is a claim on the issuer's future income or assets (any financial claim or piece of property that is subject to ownership). A bond is a debt security that promises to make payments periodically for a specified period of rate on three-month Treasury bills, for example, fluctuates more than the other interest rates and is lower, on average. **The Stock Market\           **-A common stock (typically just called a stock) represents a share of ownership in a corporation. It is a security that is a claim on the earnings and assets of the corporation. Issuing stock and selling it to the public is a way for corporations to raise funds to finance their activities. The stock market, in which claims on the earnings of corporations (shares of stock) are traded, is the most widely followed financial market in almost every country that has one; that's why it is often called simply "the market." A big swing in the prices of shares in the stock market is always a major story on the evening news. People often speculate on where the market is heading and get very excited when they can brag about their latest "big killing," but they become depressed when they suffer a big loss.\ **          **Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that facilitate the accumulation of capital and the production of goods and services. The combination of well-developed financial markets and institutions, as well as a diverse array of financial products and instruments, suits the needs of borrowers and lenders and therefore the overall economy. **Lesson 1.4 What happens without well-developed financial markets?\           **In many developing nations, limited financial markets, instruments, and financial institutions, as well as poorly defined legal systems, may make it more costly to raise capital and may lower the return on savings or investments. Limited information or lack of financial transparency mean that information is not as readily available to market participants and risks may be higher than in economies with more fully-developed financial systems. In addition, it is more difficult to hold a diversified portfolio in small markets with only a limited selection of financial assets or savings and investment products. In such thin financial markets with little trading activity and few alternatives, it may be more difficult and costly to find the right product, maturity, or risk profile to satisfy the needs of borrowers and lenders. **Lesson 1.5 Functions of the Markets\ **The role of financial markets in the success and strength of an economy cannot be underestimated. Here are four important functions of financial markets:\ 1. **Puts savings into more productive use**\ **          **-As mentioned in the example above, a savings account that has money in it should not just let that money sit in the vault. Thus, financial markets like banks open it up to individuals and companies that need a home loan, student loan, or business loan.\ 2. **Determines the price of securities\           **-Investors aim to make profits from their securities. However, unlike goods and services whose price is determined by the law of supply and demand, prices of securities are determined by financial markets.\ 3**. Makes financial assets liquid**\ **          **-Buyers and sellers can decide to trade their securities anytime. They can use financial markets to sell their securities or make investments as they desire.\ 4. **Lowers the cost of transactions**\ **          **-In financial markets, various types of information regarding securities can be acquired without the need to spend. **Lesson 1.6 Importance's of Financial Markets\ **There are many things that financial markets make possible, including the following: Financial markets provide a place where participants like investors and debtors, regardless of their size, will receive fair and proper treatment. They provide individuals, companies, and government organizations with access to capital. Financial markets help lower the unemployment rate because of the many job opportunities it offers **Lesson 2.1 Why study financial institutions?\           **The term financial institution is a broad phrase referring to organizations which act as agents, brokers, and intermediaries in financial transactions. Agents and brokers contract on behalf of others; intermediaries sell for their own account. Financial intermediaries purchase securities for their own account and sell their own liabilities and common stock.\ **          **Banks and other financial institutions are what make financial markets work. Without them, financial markets would not be able to move funds from people who save to people who have productive investment opportunities. Thus they play a crucial role in the economy **Structure of the Financial System\           **The financial system is complex, comprising many different types of private sector financial institutions, including banks, insurance companies, mutual funds, finance companies, and investment banks, all of which are heavily regulated by the government.\ **          **Financial Crises At times -the financial system seizes up and produces financial crises, major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms. Financial crises have been a feature of capitalist economist for hundreds of years and are typically followed by the worst business cycle downturns.\ **          **Banks and Other Financial Institutions -Banks are financial institutions that accept deposits and make loans. Included under the term banks are firms such as commercial banks, savings and loan associations, mutual savings banks, and credit unions. Banks are the financial intermediaries that the average person interacts with most frequently. A person who needs a loan to buy a house or a car usually obtains it from a local bank.\ **          **Financial Innovation -In the good old days, when you took cash out of the bank or wanted to check your account balance, you got to say hello to a friendly human teller. Nowadays you are more likely to interact with an automatic teller machine (ATM) when withdrawing cash and you can get your account balance from your home computer. Particular emphasis on how the dramatic improvements in information technology have led to new means of delivering financial services electronically, in what has become known as e-finance. **Lesson 2.2 Functions of Financial Intermediaries\           **Financial markets facilitate the movement of funds from those who save money to those who invest money in capital assets. Savings are distributed among investments and expenditures through securities traded in the financial markets. Financial institutions facilitate and improve the distribution of funds, money, and capital in several respects: 1\. Payments mechanism 2\. Security trading 3\. Transmutation 4\. Risk diversification 5\. Portfolio management **          **All of these functions are important to an efficient financial system, and managers are improving execution capability through improved electronic communication, computer processing, and institutional design. Note that these functions are characteristic of agents. Financial intermediaries are special types of agents that collect information about economic entities, evaluate financial information, and package financial claims. **          **The financial intermediary, by purchasing primary securities and issuing secondary securities adds choices to borrowers and lenders. Issues of financial intermediaries are termed secondary securities. The process of changing the terms of money bought and sold by financial intermediaries is termed transmutation. **          **Financial institutions also act as portfolio managers and advisers over most of the primary securities owned by investors. The private financial sector manages most of the home mortgages, commercial mortgages, consumer loans, state and local government securities, and business loans. In addition, nearly one-fourth of outstanding common stocks are managed by investment companies, and a large portion of the remaining shares of stock are invested with the advice of trust institutions. The most important reasons for obtaining institutional management are: - -convenience, - -protection against fraud, - -quality of investment selection - -a low transaction cost. **          **Financial institutions provide a convenient place where savers can safely invest excess money and consumers can easily borrow funds. Investments are protected against unscrupulous borrowers by the institution's qualified loan officers and a bevy of collectors and attorneys. Well-trained investment analysts and loan officers seek good investment opportunities and screen prospective securities so as to obtain the best yield available for the risk level that suits the investor's preferences. **Lesson 3.1 Financial markets and institutions\           **Economic system relies heavily on financial resources and transactions, and economic efficiency rests in part on efficient financial markets. Financial markets consist of agents, brokers, institutions, and intermediaries transacting purchases and sales of securities. The many persons and institutions operating in the financial markets are linked by contracts, communications networks which form an externally visible financial structure, laws, and friendships. The financial market is divided between investors and financial institutions.\ **          **The term financial institution is a broad phrase referring to organizations which act as agents, brokers, and intermediaries in financial transactions. Agents and brokers contract on behalf of others; intermediaries sell for their own account. Financial intermediaries purchase securities for their own account and sell their own liabilities and common stock. For example, a stockbroker buys and sells stocks for us as our agent, but a savings and loan borrows our money (savings account) and lends it to others (mortgage loan). The stockbroker is classified as an agent and broker, and savings and loan is called a financial intermediary. Brokers and savings and loans, like all financial institutions, buy and sell securities, but they are classified separately, because the primary activity of brokers is buying and selling rather than buying and holding an investment portfolio. Financial institutions are classified according to their primary activity, although they frequently engage in overlapping activities. **Lesson 3.2 Why are financial markets and institutions important?\           **Financial markets play a critical role in the accumulation of capital and the production of goods and services. The price of credit and returns on investment provide signals to producers and consumers financial market participants. Those signals help direct funds (from savers, mainly households and businesses) to the consumers, businesses, governments, and investors that would like to borrow money by connecting those who value the funds most highly (i.e., are willing to pay a higher price, or interest rate), to willing lenders. In a similar way, the existence of robust financial markets and institutions also facilitates the international flow of funds between countries.\ **          **In addition, efficient financial markets and institutions tend to lower search and transactions costs in the economy. By providing a large array of financial products, with varying risk and pricing structures as well as maturity, a well-developed financial system offers products to participants that provide borrowers and lenders with a close match for their needs. Individuals, businesses, and governments in need of funds can easily discover which financial institutions or which financial markets may provide funding and what the cost will be for the borrower. This allows investors to compare the cost of financing to their expected return on investment, thus making the investment choice that best suits their needs. In this way, financial markets direct the allocation of credit throughout the economy---and facilitate the production of goods and services. **Lesson 3.3 Time Preference\           **Time preference refers to the value of money spent now relative to money available for spending in the future. Businesses are frequently making decisions among short-term and long-term uses of funds, and business executives must judge between outlays which provide a return in a year term and those which pay off many years from now. They must decide upon commitments requiring funds now and those requiring funds later, by allocating not only funds that they expect to receive currently, but also those that they expect to receive in the future.\ **          **The money and capital markets price funds so that businesses and governments can make rational economic allocations of capital. The price of capital is set in a competitive marketplace by supply and demand forces. The market price of capital is compared by businesses to the expected returns in proposed capital expenditures. Businesses allocate their capital to real investments whose return is at above the cost of capital. Long-term investments are compared to short-term investments using the financial-market-determined cost of capital. Consequently, the allocation of capital between short-and long-term investments depends on the free play of supply and demand in an open market.\ **          **Like businesspersons, consumers may decide upon a time pattern for expenditures that does not necessarily coincide with their current or expected income flows. Financial markets allow us to implement time adjustments in the payments for goods. Without them, there would be no opportunity to earn interest on savings, and expenditures would be limited to current receipts and cash. Savings allows many consumers to postpone consumption and to receive returns from investments. **Lesson 3.4 Risk Distribution\           **The financial markets distribute economic risks. Employment and investment risks are separated by the creation and distribution of financial securities. On a larger scale, the money and capital markets transfer the massive risks from people actually performing the work (employment risks) to savers who accept the risk of an uncertain return. The chance of failure for a 100 million € mobile phones manufacturer may be divided among thousands of investors living and working all over the world. If the mobile phones business fails, each investor loses only part of his or her wealth and may continue to receive income from other investments and employment. **Lesson 3.5 Diversification of risk\           **In addition to permitting individuals to separate employment and investment risks, the financial markets allow individuals to diversify among investments. Diversification means combining securities with different attributes into a portfolio. Ordinarily, a diversified portfolio of financial claims is less risky than a portfolio consisting of one or at most a handful of similar securities. Total risk is reduced because losses in some investments are offset by gains in others. The benefits of diversification are possible due to the existence of large, diversified financial markets where investors may buy and sell securities with minimum transactions cost, regulatory interference, and so forth. Lesson 1.1 The Definition of Money ================================== ***Money*** is any object that is generally accepted as payment for goods and services and repayment of debts in a given socioeconomic context or country. Money comes in three forms: commodity money, fiat money, and fiduciary money. ***Fiat* money** is money whose value is not derived from any intrinsic value or guarantee that it can be converted into a valuable commodity (such as gold). Instead, it has value only by government order (fiat). Usually, the government declares the fiat currency to be legal tender, making it unlawful to not accept the fiat currency as a means of repayment for all debts. Paper money is an example of fiat money. Fiduciary money includes demand deposits (such as checking accounts) of banks. Fiduciary money is accepted on the basis of the trust its issuer (the bank) commands. Most modern monetary systems are based on fiat money. However, for most of history, almost all money was commodity money, such as gold and silver coins. Lesson 1.2 The Functions of Money ================================= The monetary economy is a significant improvement over the barter system, in which goods were exchanged directly for other goods. *Barter* is a system of exchange in which goods or services are directly exchanged for other goods or services without using a medium of exchange, such as money. The reciprocal exchange is immediate and not delayed in time. It is usually bilateral, though it can be multilateral, and usually exists parallel to monetary systems in most developed countries, though to a very limited extent. The barter system has a number of limitations which make transactions very inefficient, including: -Double coincidence of wants: The needs of a seller of a commodity must match the needs of a buyer. If they do not, the transaction will not occur. -Absence of common measure of value: In a monetary economy, money plays the role of a measure of value of all goods, making it possible to measure the values of goods against each other. This is not possible in a barter economy. -Indivisibility of certain goods: If a person wants to buy a certain amount of another's goods, but only has payment of one indivisible good which is worth more than what the person wants to obtain, a barter transaction cannot occur. -Difficulty of deferred payments: It is impossible to make payments in installments and difficult to make payments at a later point in time. -Difficulty storing wealth: If society relies exclusively on perishable goods, storing wealth for the future may be impractical. Despite the long list of limitations, the barter system has some advantages. It can replace money as the method of exchange in times of monetary crisis, such as when the currency is either unstable (e.g. hyperinflation or deflationary spiral) or simply unavailable for conducting commerce. It can also be useful when there is little information about the credit worthiness of trade partners or when there is a lack of trust. The money system is a significant improvement over the barter system. It provides a way to quantify the value of goods and communicate it to others. 1. A medium of exchange: -An object that is generally accepted as a form of payment. 2. A unit of account: -A means of keeping track of how much something is worth. 3. A store of value: -It can be held and exchanged later for goods and services at an approximate value. 4. A standard of deferred payments -Money is also useful because of its ability to serve as a standard of deferred payment. It can facilitate exchange at a given point by providing a medium of exchange and unit of account. The use of money as a medium of exchange has removed the major difficulty of double coincidence of wants in the barter system. It separates the act of sale and purchase of goods and services and helps both parties in obtaining maximum satisfaction and profits independently. Lesson 1.3 5 Stages of Evolution of Money ========================================= Some of the major stages through which money has evolved are as follows: (i) Commodity Money (ii) Metallic Money (iii) Paper Money (iv) Credit Money (v) Plastic Money. Money has evolved through different stages according to the time, place and circumstances. i. **Commodity Money**: In the earliest period of human civilization, any commodity that was generally demanded and chosen by common consent was used as money. Goods like furs, skins, salt, rice, wheat, utensils, weapons etc. were commonly used as money. Such exchange of goods for goods was known as 'Barter Exchange'. ii. **Metallic Money:** With progress of human civilization, commodity money changed into metallic money. Metals like gold, silver, copper, etc. were used as they could be easily handled and their quantity can be easily ascertained. It was the main form of money throughout the major portion of recorded history. iii. **Paper Money**: It was found inconvenient as well as dangerous to carry gold and silver coins from place to place. So, invention of paper money marked a very important stage in the development of money. Paper money is regulated and controlled by Central bank of the country (RBI in India). At present, a very large part of money consists mainly of currency notes or paper money issued by the central bank. iv. **Credit Money**: Emergence of credit money took place almost side by side with that of paper money. People keep a part of their cash as deposits with banks, which they can withdraw at their convenience through cheques. The cheque (known as credit money or bank money), itself, is not money, but it performs the same functions as money. v. **Plastic Money**: The latest type of money is plastic money in the form of Credit cards and Debit cards. They aim at removing the need for carrying cash to make transactions. Lesson 1.4 Commodity versus fiat money ====================================== Money has taken a wide variety of forms in different cultures. Gold, silver, cowrie shells, cigarettes, and even cocoa beans have been used as money. Although these items are used as commodity money, they also have a value from use as something other than money. Gold, for example, has been used throughout the ages as money although today it is not used as money but rather is valued for its other attributes. Gold is a good conductor of electricity and is used in the electronics and aerospace industry. Gold is also used in the manufacturing of energy efficient reflective glass for skyscrapers and is used in the medical industry as well. Of course, gold also has value because of its beauty and malleability in the creation of jewelry. As commodity money, gold has historically served its purpose as a medium of exchange, a store of value, and as a unit of account. Commodity-backed currencies are dollar bills or other currencies with values backed up by gold or other commodity held at a bank. Lesson 2.1 **What Is an Interest Rate?** An ***interest rate*** is the percentage of principal charged by the lender for the use of its money. The principal is the amount of money loaned. An interest rate is either the cost of borrowing money or the reward for saving it. It is calculated as a percentage of the amount borrowed or saved. 1\. You borrow money from banks when you take out a home mortgage. Other loans can be used for buying a car, an appliance, or paying for education. Banks borrow money from you in the form of deposits, and interest is what they pay you for the use of the money deposited. 2 They use the money from deposits to fund loans. Banks charge borrowers a slightly higher interest rate than they pay depositors. The difference is their profit. Since banks compete with each other for both depositors and borrowers, interest rates remain within a narrow range of each other. Lesson 2.2 How Interest Rates Work ================================== The bank applies the interest rate to the total unpaid portion of your loan or credit card balance, and you must pay at least the interest in each compounding period. If not, your outstanding debt will increase even though you are making payments. Although interest rates are very competitive, they aren\'t the same. A bank will charge higher interest rates if it thinks there\'s a lower chance the debt will get repaid. For that reason, banks will tend to assign a higher interest rate to revolving loans such as credit cards, as these types of loans are more expensive to manage. Banks also charge higher rates to people they consider risky; The higher your credit score, the lower the interest rate you will have to pay. Lesson 2.3 Fixed Versus Variable Interest Rates =============================================== Banks charge fixed rates or variable rates**. Fixed rates** remain the same throughout the life of the loan. Initially, your payments consist mostly of interest payments. As time goes on, you pay a higher and higher percentage of the debt principal. Most conventional mortgages are fixed-rate loans. **Variable rates** change with the prime rate. When the rate rises, so will the payment on your loan. With these loans, you must pay attention to the prime rate, which. is based on the fed funds rate.7 With either type of loan, you can generally make an extra payment at any time toward the principal, helping you to pay the debt off sooner. Lesson 2.4 **How Are Interest Rates Determined?** Interest rates are determined by either Treasury note yields or the fed funds rate. The Federal Reserve sets the federal funds rate as the benchmark for short-term interest rates. The fed funds rate is what banks charge each other for overnight loans. The fed funds rate affects the nation\'s money supply and, thus, the economy\'s health. Treasury note yields are determined by the demand for U.S. Treasury, which are sold at auction. When demand is high, investors pay more for the bonds. As a result, their yields are lower. Low Treasury yields affect interest rates on long-term bonds, such as 15year and 30-year mortgages. Lesson 2.5 Impact of High Versus Low-Interest Rates =================================================== **High-interest** rates make loans more expensive. When interest rates are high, fewer people and businesses can afford to borrow. That lowers the amount of credit available to fund purchases, slowing consumer demand. At the same time, it encourages more people to save because they receive more on their savings rate. High-interest rates also reduce the capital available to expand businesses, strangling supply. This reduction in liquidity slows the economy. Low-interest rates have the opposite effect on the economy. Low mortgage rates have the same effect as lower housing prices, stimulating demand for real estate. Savings rates fall. When savers find they get less interest on their deposits, they might decide to spend more. They might also put their money into slightly riskier but more profitable investments, which drives up stock prices. Low-interest rates make business loans more affordable. That encourages business expansion and new jobs. If low-interest rates provide so many benefits, why wouldn\'t they be kept low all the time? For the most part, the U.S. government and the Federal Reserve prefer low-interest rates. But low-interest rates can cause inflation. If there is too much liquidity, then the demand outstrips supply and prices rise; That\'s just one of the causes of inflation. Lesson 2.6 Understanding APR ============================ The annual percentage rate (APR) is the total cost of the loan. It includes interest rates plus other costs. The biggest cost is usually one-time fees, called \"*points*.\" The bank calculates them as a percentage point of the total loan. The APR also includes other charges such as broker fees and closing costs. Both the interest rate and the APR describe loan costs. The interest rate will tell you what you pay each month. The APR tells you the total cost over the life of the loan. Use the APR to compare total loan costs. It\'s especially helpful when comparing a loan that only charges an interest rate to one that charges a lower interest rate plus points. The APR calculates the total cost of the loan over its lifespan. Keep in mind that few people will stay in their house with that loan so you also need to know the break-even point, which tells you at what point the costs of two different loans are the same. The easy way to determine the break-even point is to divide the cost of the points by the monthly amount saved in interest. Lesson 2.7 Factors Affecting Interest Rates =========================================== 1. **Forces of demand and supply** -Interest rates are influenced by the demand for, and supply of, credit in an economy. An increase in demand for credit eventually leads to a rise in interest rates, or the price of borrowing. Conversely, a rise in the supply of credit leads to a decline in interest rates. The credit supply increases when the total amount of money that's borrowed goes up. For example, when money is deposited in banks, it is in turn used by banks for investment activities or to lend it elsewhere. As banks lend more money, there is more credit available, and thus borrowing increases. When this occurs, the cost of borrowing decreases (due to normal supply and demand economics). 2. **Inflation** -The higher the inflation rate, the higher interest rates rise. That is because interest earned on money loaned must compensate for inflation. As compensation for a decline in the purchasing power of money that they will be repaid in the future, lenders charge higher interest rates. 3. **Government** -In some cases, the government's monetary policy influences the amount of interest rates. Also, when the government buys more securities, banks are injected with more money to be used for lending, and thus interest rates decrease. When the government sells these securities, money from the banks gets drained, giving banks less money for lending purposes and leading to a rise in interest rates. Lesson 3.1 Cost of Borrowing ============================ **The interest expense** -- also known as the cost of borrowing money -- can be classified into the following two types: 1. **Simple Interest** -This type of interest is calculated on the original or principal amount of loan. The formula for calculating simple interest is: SIMPLE INTEREST = Principal x Interest Rate x Term of the loan For example, if the simple interest rate is 5% on a loan of \$1,000 for a duration of 4 years, the total simple interest will come out to be: 5% x \$1,000 x 4 = \$200. 2. Compound Interest -Compound interest is calculated not just on the basis of the principal amount but also on the accumulated interest of previous periods. This is the reason why it is also called "interest on interest." The formula for compound interest is as follows: COMPOUND INTEREST = P (1 + i) n - P Where: P = Principal amount i = Annual interest rate n = Number of compounding periods for a year Unlike simple interest, the compound interest amount will not be the same for all years because it takes into consideration the accumulated interest of previous periods as well. Real and Nominal Interest Rates =============================== A **nominal interest rate** is one with no adjustments made for inflation. In other words, regardless of the rate of inflation in the economy, the interest received, for example, on a deposit, will be the same even after a number of years. The **real interest rate** takes the inflation rate into account. The repayment of principal plus the interest is measured on the basis of real terms compared against the buying power of the amount at the time it was borrowed, lent, invested, or deposited. It's important to factor in the effects of inflation on purchasing power because that's the only way to know if you're really earning a return from the interest being paid. For example, if you deposit money with a bank and earn a nominal 2% annual interest -- if the inflation rate is 4%, then in terms of purchasing power, the money you have on deposit is actually losing 2% of its value every year. The real rate of return on an interest-bearing account is the nominal interest rate MINUS the rate of inflation. The stated interest rate is just the "nominal" rate, meaning "in name only" -- i.e., not the REAL rate being earned. Lesson 1.1 **Payment system** A ***payment system*** is any system used to settle financial transactions through the transfer of monetary value. This includes the institutions, instruments, people, rules, procedures, standards, and technologies that make its exchange possible. A common type of payment system is called **an *operational network*** that links bank accounts and provides for monetary exchange using bank deposits. Some payment systems also include credit mechanisms, which are essentially a different aspect of payment. **Payment systems** are used in lieu of tendering cash in domestic and international transactions. This consists of a major service provided by banks and other financial institutions. ***Traditional payment systems*** include negotiable instruments such as drafts (e.g., cheques) and documentary credits such as letters of credit. With the advent of computers and electronic communications, many alternative electronic payment systems have emerged. The term ***electronic payment*** refers to a payment made from one bank account to another using electronic methods and forgoing the direct intervention of bank employees. Narrowly defined electronic payment refers to e-commerce---a payment for buying and selling goods or services offered through the Internet, or broadly to any type of electronic funds transfer. ***Modern payment systems*** use cash-substitutes as compared to traditional payment systems. This includes debit cards, credit cards, electronic funds transfers, direct credits, direct debits, internet banking and e-commerce payment systems. Payment systems may be physical or electronic and each has its own procedures and protocols. Standardization has allowed some of these systems and networks to grow to a global scale, but there are still many country-specific and product-specific systems. Examples of payment systems that have become globally available are credit card and automated teller machine networks. Other specific forms of payment systems are also used to settle financial transactions for products in the equity markets, bond markets, currency markets, futures markets, derivatives markets, options markets. Additionally, forms exist to transfer funds between financial institutions. Domestically this is accomplished by using Automated clearing house and real-time gross settlement (RTGS) systems. Internationally this is accomplished using the SWIFT network. Lesson 1.2 **Types of Payment Methods for E-Commerce** **Credit/Debit card payments:** -Payments via cards are one of the most widely used and popular methods not only in India but on the international level. As a global payment solution, by enabling payment acceptance via cards merchants can reach out to an international market. **Credit cards** are simple to use and secure. The customer just has to enter the card number, expiry date, and CVV, which has been introduced as a precautionary measure. The CVV helps detect fraud by comparing customer details and the CVV number. Coming to debit cards, they can be considered the next popular method for e-Commerce payments. **Debit cards** are usually preferred by customers who shop online within their financial limits. The main difference between credit and debit card is with a debit card one can only pay with the money that is already in the bank account, whereas in the case of a credit card, the spent amount is billed, and payments are made at the end of the billing period. **Prepaid card payments:** -As an alternative for credit/debit cards, prepaid cards are introduced. They usually come in different stored values and the customer has to choose from them. Prepaid cards have virtual currency stored in them. Though the adoption rate of prepaid cards is low, they are gradually becoming popular for certain niche categories. **Bank transfers:** -Though not popular nowadays but still bank transfer is considered as an essential payment method for e-Commerce. It is considered as 'if all else fails' kind of payment method. Some of the e-Commerce stores are also keen on using bank transfer payment options. Customers enrolled in internet banking can do bank transfers for their online purchases. Bank transfer is the most secure method as the transactions need to be approved and authenticated by the customers. It is a simple way of paying for online purchases and does not require the customer to have a card for payment purposes **E-Wallets:** -E-wallet is one of the upcoming trends which gives a new shopping experience altogether. The use of e-wallets is becoming popular at an alarming rate. E-Wallets require a sign up from merchants as well as customers. After creating an e-wallet account and linking it to the bank account they can withdraw or deposit funds. The whole procedure with an e-wallet is easy and fast. Considered as an advanced and instant digital payment method, e-wallets can be integrated with mobile wallets using advanced functionalities like NFC. Prepaid e-wallet accounts store customer information and multiple credit/ debit cards and bank accounts. It needs one-time registration and eliminates the need for re-entering information every time while making payments. **Cash:** -Let's face it, in India cash is the king. For e-Commerce, it comes in the form of the cash-on-delivery option. Cash is often used for physical goods and cash-on-delivery transactions. It does come with several risks, such as no guarantee of an actual sale during delivery, and theft. Though nowadays, cash on delivery does not necessarily mean customers pay with cash (they can use cards, mobile payments as payment terminals are often available with delivery agents), missing out on this is a strict NO. **Mobile payments:** -Payment acceptance was no exception for mobile penetration. This digital payment solution offers a quick solution for customers. To set up a mobile payment method, the customer just has to download software and link it to the credit card. As e-Commerce is becoming mobile mainstreamed, customers are finding it more convenient to use mobile payment options. A ***QR code*** (abbreviated from Quick Response code) is a type of matrix barcode (or two-dimensional barcode) first designed in 1994 for the automotive industry in Japan. A barcode is a machine-readable optical label that contains information about the item to which it is attached. In practice, QR codes often contain data for a locator, identifier, or tracker that points to a website or application. A QR code uses four standardized encoding modes (numeric, alphanumeric, byte/binary, and kanji) to store data efficiently; extensions may also be used. The Quick Response system became popular outside the automotive industry due to its fast readability and greater storage capacity compared to standard UPC barcodes. Applications include product tracking, item identification, time tracking, document management, and general marketing. A QR code consists of black squares arranged in a square grid on a white background, which can be read by an imaging device such as a camera, and processed using Reed--Solomon error correction until the image can be appropriately interpreted. The required data is then extracted from patterns that are present in both horizontal and vertical components of the image. Lesson 1.3 **What is an e-Commerce payment gateway?** An **e-Commerce payment gateway** is an essential tool for processing the online payment. They process payment information for different websites integrated with them. The payment gateway generates a link between the customer and the bank. **Use of e-Commerce payment gateway:** -The quick and hassle-free checkout: One of the issues for an e-commerce business is cart abandonment, which often happens at checkout. A complicated checkout process can be considered as the main reason behind it. According to a survey, more than 70% of customers abandon the cart without making the purchase. A good payment gateway makes the process simple to capture most of the sales. E-commerce payment gateway makes the checkout process easy for customers. An e-Commerce payment gateway must make the checkout experience convenient and provide necessary payment methods for customers to choose from.  Lesson 1.4 **Why Propose Multiple Online Payment Methods?** As discussed, the cart abandonment issue is one of the problems in the eCommerce business. And one of the reasons is the lack of a preferred payment method. Customers prefer a payment method that suits their needs. If that digital payment method is unavailable, they can and will abandon the cart and look for an alternative option. Enabling different payment methods makes a better customer experience and if one of the options failed customers would not feel stuck. It gives the customer the freedom to explore other options and get the best deal. Multiple payment methods provide a more seamless experience and increase online purchase orders. Lesson 1.5 **What are the 3 methods of payment?** The three most basic methods of payment are cash, credit, and payment-in-kind (or bartering). These three methods are used in basic transactions; for example, one may pay for a candy bar with cash, a credit card or, theoretically, even by trading another candy bar. Lesson 1.6 **Central Banking and the Payment System** Central banks play an important role at the center of modern payment systems because it is central banks' liquid liabilities---and more particularly reserves balances---that are the instrument in which the bulk of domestic payment obligations are legally finally settled. This pivotal role reflects, in part, the central bank's statutory legal tender monopoly in most countries. Nevertheless, this factor is sometimes disguised by the fact that, in today's world, settlement at the central bank is simply required by law in many countries. The term "***reserve**s*" is being used to identify those balances at the central bank that are available for banks to use as final settlement of payment obligations. This abstracts from cases where balances held under a legally imposed reserve requirement are not available for settlement purposes. Reserves are also commonly referred to as "settlement balances" or, more loosely, "clearing" or "correspondent balances" at the central bank. A central bank typically has certain obligations authorized by law: control of inflation and fostering the stability and soundness of the financial system. Not all central banks, however, are legally responsible for financial system stability. In containing inflation, central banks increasingly are moving away from direct measures and relying on indirect instruments such as open-market operations, Lombard facility, rediscount window, and, to a less extent, reserve requirements). Indirect instruments are more effective the more well-functioning are financial markets because it is through these markets that monetary policy signals get transmitted to achieve their intermediate and ultimate targets. Lesson 2.1 **What Is Electronic Money?** ***Electronic money*** refers to money that exists in banking computer systems that may be used to facilitate electronic transactions. Although its value is backed by fiat currency and may, therefore, be exchanged into a physical, tangible form, electronic money is primarily used for electronic transactions due to the sheer convenience of this methodology. Lesson 2.2 **How Electronic Money Works** **Electronic money** is used for transactions on a global basis. While it may be exchanged for fiat currency (which, incidentally, distinguishes it from crypto currencies), electronic money is most commonly utilized through electronic banking systems and monitored through electronic processing. Because a mere fraction of the currency is utilized in physical form, the vast percentage of it is housed in bank vaults and is backed by central banks. Lesson 2.3 **Electronic Money Special Considerations** **Currency in Circulation** -Electronic money can be held in various places. Most individuals and businesses store their money with banks that provide electronic records of the cash on deposit. However, prepaid cards and digital wallets like PayPal and Square likewise allow users to deposit fiat currency for electronic money. Such companies will make their profit by charging a percentage on any amount that is withdrawn from accounts or converted from electronic money back into fiat currency. **Electronic Payment Processing** -Many Americans process transactions electronically in a multitude of ways. This includes receiving paychecks through direct deposits, moving money from one account to another via electronic fund transfers, or spending money with credit cards and debit cards **While physical currency i**s still advantageous in certain situations, its role has gradually diminished over time. Many consumers and businesses believe electronic money is more secure and convenient because it cannot be misplaced, and it is widely accepted by merchants nationwide. The U.S. financial market has consequently established a robust infrastructure for transacting electronic money, which is primarily facilitated through payment processing networks, such as Visa and Mastercard. Banks and financial institutions partner with electronic money networking processors to issue their customers branded network cards that facilitate these electronic transactions from bank accounts to merchants. Electronic money is also easily transacted through ecommerce, letting consumers conveniently shop for goods and services online. Lesson 2.4 **Criticisms of Electronic Money** Although electronic money is quickly becoming the norm and is often hailed as the more secure and transparent alternative to physical currency, this does not mean that it comes without its own set of risks and vulnerabilities. For instance, fraud becomes an issue when money can be transferred from one party to another without the necessity for the physical verification of the original owner's true identity. Electronic transactions also lend themselves to being more discreet and, thus, easier to hide from the IRS, making electronic money a potential and unwilling accomplice to tax evasion. Lastly, the computer systems that are responsible for carrying out electronic transactions are not perfect, meaning that electronic money transactions can sometimes go awry simply due to system error. Lesson 2.5 **What is Bitcoin?** ***Bitcoin*** is a digital currency created in January 2009 following the housing market crash. It follows the ideas set out in a whitepaper by the mysterious and pseudonymous Satoshi Nakamoto. The identity of the person or persons who created the technology is still a mystery. Bitcoin offers the promise of lower transaction fees than traditional online payment mechanisms and is operated by a decentralized authority, unlike governmentissued currencies. There are no physical bitcoins, only balances kept on a public ledger that everyone has transparent access to, that -- along with all Bitcoin transactions -- is verified by a massive amount of computing power. Bitcoins are not issued or backed by any banks or governments, nor are individual bitcoins valuable as a commodity. Despite it not being legal tender, Bitcoin charts high on popularity, and has triggered the launch of hundreds of other virtual currencies collectively referred to as *Altcoins*. Lesson 3.1 **What is Blockchain?** **Blockchain** seems complicated, and it definitely can be, but its core concept is really quite simple. A blockchain is a type of database. To be able to understand blockchain, it helps to first understand what a database actually is. A ***database*** is a collection of information that is stored electronically on a computer system. Information, or data, in databases is typically structured in table format to allow for easier searching and filtering for specific information. What is the difference between someone using a spreadsheet to store information rather than a database? *Spreadsheets* are designed for one person, or a small group of people, to store and access limited amounts of information. In contrast, a database is designed to house significantly larger amounts of information that can be accessed, filtered, and manipulated quickly and easily by any number of users at once. Large databases achieve this by housing data on servers that are made of powerful computers. These servers can sometimes be built using hundreds or thousands of computers in order to have the computational power and storage capacity necessary for many users to access the database simultaneously. While a spreadsheet or database may be accessible to any number of people, it is often owned by a business and managed by an appointed individual that has complete control over how it works and the data within it. Lesson 3.2 **Storage Structure of blockchain** One key difference between a typical database and a blockchain is the way the data is structured. A blockchain collects information together in groups, also known as blocks, that hold sets of information. Blocks have certain storage capacities and, when filled, are chained onto the previously filled block, forming a chain of data known as the "*blockchain*." All new information that follows that freshly added block is compiled into a newly formed block that will then also be added to the chain once filled. A database structures its data into tables whereas a blockchain, like its name implies, structures its data into chunks (blocks) that are chained together. This makes it so that all blockchains are databases but not all databases are blockchains. This system also inherently makes an irreversible timeline of data when implemented in a decentralized nature. When a block is filled it is set in stone and becomes a part of this timeline. Each block in the chain is given an exact timestamp when it is added to the chain. **Lesson Proper for Week 4** Completion requirements Lesson 1.1 **What is a financial instrument?**             **Financial instruments** are assets that can be traded, or they can also be seen as packages of capital that may be traded. Most types of financial instruments provide efficient flow and transfer of capital all throughout the world\'s investors. These assets can be cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one\'s ownership of an entity. C:\\Users\\Laptop Supplier PH\\AppData\\Local\\Microsoft\\Windows\\INetCache\\Content.MSO\\B1A96737.tmp A financial instrument is a monetary contract between parties. We can create, trade, or modify them. We can also settle them. A financial instrument may be evidence of ownership of part of something, as in stocks and shares. Bonds, which are contractual rights to receive cash, are financial instruments. Checks (UK: cheques), futures, options contracts, and bills of exchange are also financial instruments. Securities, i.e., contracts that we give a value to and then trade, are financial instruments. Put simply; a financial instrument is an asset or package of capital that we can trade.  A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. The definition is wide and includes cash, deposits in other entities, trade receivables, loans to other entities. investments in debt instruments, investments in shares and other equity instruments. C:\\Users\\Laptop Supplier PH\\AppData\\Local\\Microsoft\\Windows\\INetCache\\Content.MSO\\FBAFE473.tmp **Understanding Financial Instruments**             Financial instruments can be real or virtual documents representing a legal agreement involving any kind of monetary value. Equity-based financial instruments represent ownership of an asset. Debt-based financial instruments represent a loan made by an investor to the owner of the asset. Foreign exchange instruments comprise a third, unique type of financial instrument. Different subcategories of each instrument type exist, such as preferred share equity and common share equity. International Accounting Standards (IAS) defines financial instruments as \"any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.\" Lesson 2.1 **Types of Financial Instruments**             Financial instruments may be divided into two types: cash instruments and derivative instruments. **Cash Instruments:** - The values of cash instruments are directly influenced and determined by the markets. These can be securities that are easily transferable. - Cash instruments may also be deposits and loans agreed upon by borrowers and lenders. **Derivative Instruments:** - The value and characteristics of derivative instruments are based on the vehicle's underlying components, such as assets, interest rates, or indices. - An equity options contract, for example, is a derivative because it derives its value from the underlying stock. The option gives the right, but not the obligation, to buy or sell the stock at a specified price and by a certain date. As the price of the stock rises and falls, so too does the value of the option although not necessarily by the same percentage. -  There can be over-the-counter (OTC) derivatives or exchange-traded derivatives. OTC is a market or process whereby securities--that are not listed on formal exchanges--are priced and traded **Lesson 2.2** **Types of Asset Classes of Financial Instruments**             Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based. **Debt-Based Financial Instruments** - Short-term debt-based financial instruments last for one year or less. Securities of this kind come in the form of T-bills and commercial paper. Cash of this kind can be deposits and certificates of deposit (CDs).           **  Exchange**-traded derivatives under short-term, debt-based financial instruments can be short-term interest rate futures. OTC derivatives are forward rate agreements. - Long-term debt-based financial instruments last for more than a year. Under securities, these are bonds. Cash equivalents are loans. Exchange-traded derivatives are bond futures and options on bond futures. OTC derivatives are interest rate swaps, interest rate caps and floors, interest rate options, and exotic derivatives. **Equity-Based Financial Instruments**            Securities under equity-based financial instruments are stocks. Exchange-traded derivatives in this category include stock options and equity futures. The OTC derivatives are stock options and exotic derivatives. **Special Considerations**             There are no securities under foreign exchange. Cash equivalents come in spot foreign exchange, which is the current prevailing rate. Exchange-traded derivatives under foreign exchange are currency futures. OTC derivatives come in foreign exchange options, outright forwards, and foreign exchange swaps. Lesson 3.1 **Primary Instrument**             A primary instrument is a financial investment whose price is based directly on its market value. A financial instrument can be any type of financial investment that is priced based on its own value.             Examples of primary instruments include stocks, bonds and currency, among others. Any spot market that trades the \'cash\' asset involves a primary instrument. **Understanding Primary Instruments** - Primary instruments are standard financial investments. They often trade on mainstream exchanges with high levels of liquidity. Their market value is determined based on assumptions about their individual characteristics. - Primary investments like stocks are what most beginning investors think of when they think about investing. This is because investing in primary instruments often requires only a general knowledge of markets and investment principles. - Understanding primary instruments provides the base knowledge for derivatives. Derivatives were created to hedge against some of the risks of primary instruments. Derivatives also provide products for alternative investing strategies that are based on the speculation of values of underlying primary instruments. Lesson 3.2 **Derivative Instruments**             Derivatives create an alternative product for investors seeking to benefit from changes in the market value of primary instruments. They are known as non-primary instruments. Call and put options, and futures are some of the derivatives that can be used to profit from primary instruments. Derivatives get their name because they are derived from the primary (underlying) asset.             Derivatives are generally more complex than primary instruments because of the pricing methodologies. Derivative products have values that are generated from the primary instrument. Options on stocks are some of the most common derivative products used by alternative investors. Black Scholes is the main methodology for calculating the price of derivative options on stocks. It determines the price of a derivative product by considering five input variables: the strike price offered by the option, the current stock price, the time to expiration of the option, the risk-free rate and volatility.             Black Scholes is used to calculate prices for call and put options. Call options offer an investment product for investors seeking to benefit from a rising stock price. Buying a call option gives an investor the right to buy a stock at a specified strike price. Buying a put option gives an investor the right to sell a stock when they estimate a price is falling.             Call and put options are two of the most common types of non-primary instruments traded in the market. Futures products are also non-primary instruments that allow investors to hedge against market movements of primary instruments. Futures contracts are typically priced from a cost of carry or expectancy model. They allow an investor to take a future bet on a primary instrument by buying a futures contract. Futures contracts can be bought for a variety of primary instrument investments. Currency futures which bet on future prices of currency values are some of the most common types of futures traded by investors. Lesson Proper for Week 5 ======================== Completion requirements Lesson 1.1 **Financial System**           A ***Financial system** *is a system that allows the exchange of funds between financial market participants such as lenders, investors, and borrowers. Financial systems operate at national and global levels. They consist of complex, closely related services, markets, and institutions intended to provide an efficient and regular linkage between investors and depositors.           In other words financial system can be known where ever the exist the exchange of financial medium(money) while there is an reallocation of funds into the needy areas (financial markets, business firms, banks) to utilize the potential of ideal money and place them in use to get benefits out of them. This whole mechanism is known as financial system.           Money, credit, and finance are used as medium of exchange in financial systems. They serve as a medium of known value for which goods and services can be exchanged as an alternative to bartering. A modern financial system may include banks (public sector or private sector), financial markets, financial instruments, and financial services. Financial systems allow funds to be allocated, invested, or moved between economic sectors. They enable individuals and companies to share the associated risks. Lesson 1.2 **Functions of financial system**           The Financial system is one of the most important inventories of modern society. The phenomenon of imbalance in the distribution of capital or funds exists in every economic system. There are areas or people with surplus funds, while other areas or people are facing a deficit. A financial system functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. It is a composition of various institutions, markets, regulations and laws, practices, money managers, analysts, transactions, and claims & liabilities.           The financial system helps determine both the cost and the volume of credit. This system can affect a rise in the cost of funds, thus adversely affecting the consumption, production, employment, and growth of the economy. Vice-versa, lowering the cost of credit can have a positive effect and enhance all the above factors. Clearly, a financial system has an impact on the basic existence of an economy and its citizens. 1. **The Savings Function**: As already stated, public savings find their way into the hands of those in production through the financial system. Financial claims are issued in the money and capital markets, which promise future income flows. The funds, in the hands of the producers, resulting in the production of better goods and services and an increase in society\'s living standards. When savings flow decline, however, the growth of investment and living standards begins to fall. 2. **Liquidity Function:** Money in the form of deposits offers the least risk of all financial instruments. But its value mostly eroded by inflation. That is why one always prefers to store funds in financial instruments like stocks, bonds, debentures, etc. However, in such investments (i) a greater level of risk is involved, (ii) and the degree of liquidity (i.e., conversion of the claims into money) is less. The financial markets provide the investor with the opportunity to liquidate the investments. 3. **Payment Function:** The financial systems offer a very convenient mode of payment for goods and services. The check system, credit card systems et al are the easiest methods of payment in the economy; they also drastically reduce the cost and rime of transactions. 4. **Risk Function:** The financial markets provide protection against life, health, and income risks. These are accomplished through the sale of life, health, and property insurance policies. Overall, they provide immense opportunities for the investor to hedge himself/herself against or reduce the possible risk involved in various instruments. 5. **Policy Function:** Most governments intervene in the financial system to influence macroeconomic variables like interest rates or inflation. For example, the federal bank or a central bank does indulge in several cuts in CRR and try to force the interest rates down and increase the availability of credit-at cheaper rates to the corporates. Lesson 1.3 **Basic financial concepts\ **          The basic financial concepts needed to thrive financially are highlighted throughout our site. However, we\'ve listed them here with links to the detailed pages. You must understand all of these if you are to really understand your own personal finances and learn how to drastically increase your chances of building long term wealth. **List of Basic Financial Concepts:** 1. ***The Time Value of Money.** *By far the most important financial concept, describes how important the value of time is in building wealth. Money invested today is worth more than money invested at any point in the future. That\'s because it has more time to grow and compound. It is also the main reason that you\'ll want to get started with your investing as early as possible. 2. ***Diversify your Risks and Investments.** *Another important concept to keep your finances balanced. Don\'t keep all of your money in just a few assets like your house or your company stock. Make sure that you spread your investments over many different asset classes. Also, make sure that if you hold a lot of mutual funds, that they do not overlap, or you may not be diversified as you think. 3. ***The Compounding Effect of Money.** *Maybe the second most important basic financial concept to understand. Understanding this is key to being able to forecast future growth. Your money may grow at the same rate each year in terms of percent, but in terms of actual dollar growth, compounding means that your money will grow faster and faster each year as a result of earning money not just on your investment, but also on the returns from that investment. 4. ***Understand the Stock Market. ***A basic understanding of the stock market can be applied to your everyday finances to help you manage your money better. Find out how understanding the stock market can help you weather its highs and lows. After all, people fear what they don\'t understand and most beginners don\'t really understand the stock market. Heck, even most advanced investors don\'t understand the stock market. 5. ***Keep a Household Budget.** *This basic financial concept is needed to really understand the breakdown of your personal finances and to learn how to optimize them. If there is one tool you use to keep your spending in check and help you save money each month and year, it should be a well-crafted budget worksheet. 6. ***Opportunity Costs.** *Understand that wherever you spend your time and money is a cost that you cannot spend elsewhere. The money spent on a car could be invested in the stock market. The car will decline in value while the investments will thrive. Make each decision while paying attention to other ways that you could spend or invest that money. Choose the opportunity that maximizes your long term wealth. 7. ***Interest Rates.** *You must understand how interest rates and overall rate of returns affect almost everything in your financial life. For example, investing your money at 7% versus 5%, over 40 years, means that you will have twice as much money, that\'s right, twice as much money, for retirement. This is also the precise reason that it is so important to lower your investment fees. Lesson 2.1 **Financial Asset**           A ***financial asset*** is a liquid asset that gets its value from a contractual right or ownership claim. Cash, stocks, bonds, mutual funds, and bank deposits are all are examples of financial assets. Unlike land, property, commodities, or other tangible physical assets, financial assets do not necessarily have inherent physical worth or even a physical form. Rather, their value reflects factors of supply and demand in the marketplace in which they trade, as well as the degree of risk they carry. Lesson 2.2 **Understanding a Financial Asset**           Most assets are categorized as real, financial, or intangible. Real assets are physical assets that draw their value from substances or properties, such as precious metals, land, real estate, and commodities like soybeans, wheat, oil, and iron.           Intangible assets are the valuable property that is not physical in nature. They include patents, trademarks, and intellectual property.           Financial assets are in-between the other two assets. Financial assets may seem intangible---non-physical---with only the stated value on a piece of paper such as a dollar bill or a listing on a computer screen. What that paper or listing represents, though, is a claim of ownership of an entity, like a public company, or contractual rights to payments---say, the interest income from a bond. Financial assets derive their value from a contractual claim on an underlying asset.           This underlying asset may be either real or intangible. Commodities, for example, are the real, underlying assets that are pinned to such financial assets as commodity futures, contracts, or some exchange-traded funds (ETFs). Likewise, real estate is the real asset associated with shares of real estate investment trusts (REITs). REITs are financial assets and are publicly traded entities that own a portfolio of properties. Lesson 2.3 **Common Types of Financial Assets** According to the commonly cited definition from the International Financial Reporting Standards (IFRS), financial assets include: - Cash - Equity instruments of an entity---for example a share certificate - A contractual right to receive a financial asset from another entity---known as a receivable - The contractual right to exchange financial assets or liabilities with another entity under favorable conditions - A contract that will settle in an entity\'s own equity instruments           In addition to stocks and receivables, the above definition comprises financial derivatives, bonds, money market or other account holdings, and equity stakes. Many of these financial assets do not have a set monetary value until they are converted into cash, especially in the case of stocks where their value and price fluctuate. Aside from cash, the more common types of financial assets that investors encounter are: - Stocks are financial assets with no set ending or expiration date. An investor buying stocks becomes part-owner of a company and shares in its profits and losses. Stocks may be held indefinitely or sold to other investors. - Bonds are one way that companies or governments finance short-term projects. The bondholder is the lender, and the bonds state how much money is owed, the interest rate being paid, and the bond\'s maturity date. - A certificate of deposit (CD) allows an investor to deposit an amount of money at a bank for a specified period with a guaranteed interest rate. A CD pays monthly interest and can typically be held between three months to five years depending on the contract. Lesson 2.4 **Pros and Cons of Highly Liquid Financial Assets**           The purest form of financial assets is cash and cash equivalents---checking accounts, savings accounts, and money market accounts. Liquid accounts are easily turned into funds for paying bills and covering financial emergencies or pressing demands.           Other varieties of financial assets might not be as liquid. Liquidity is the ability to change a financial asset into cash quickly. For stocks, it is the ability of an investor to buy or sell holdings from a ready market. Liquid markets are those where there are plenty of buyers and plenty of sellers and no extended lag-time in trying to execute a trade.           Liquid assets like checking and savings accounts have a limited return on investment (ROI) capability. ROI is the profit you receive from an asset divided by the cost of owning that asset. In checking and savings accounts the ROI is minimal. They may provide modest interest income but, unlike equities, they offer little appreciation. Also, CDs and money market accounts restrict withdrawals for months or years. When interest rates fall, callable CDs are often called, and investors end up moving their money to potentially lower-income investments. **Pros:** - Liquid financial assets convert into cash easily. - Some financial assets have the ability to appreciate in value. - The accounts are insured in a certain amount. **Cons:** - Highly liquid financial assets have little appreciation - Illiquid financial assets may be hard to convert to cash. - The value of a financial asset is only as strong as the underlying entity.           Liquid Assets Pros and Cons The opposite of a liquid asset is an illiquid asset. Real estate and fine antiques are examples of illiquid financial assets. These items have value but cannot convert into cash quickly.           Another example of an illiquid financial asset are stocks that do not have a high volume of trading on the markets. Often these are investments like penny stocks or high-yield, speculative investments where there may not be a ready buyer when you are ready to sell. Lesson 2.5 **Financial Intermediary**           A ***financial intermediary*** is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment bank, mutual fund, or pension fund. Financial intermediaries offer a number of benefits to the average consumer, including safety, liquidity, and economies of scale involved in banking and asset management. Although in certain areas, such as investing, advances in technology threaten to eliminate the financial intermediary, disintermediation is much less of a threat in other areas of finance, including banking and insurance. Lesson 2.6 **How a Financial Intermediary Works**           A non-bank financial intermediary does not accept deposits from the general public. The intermediary may provide factoring, leasing, insurance plans or other financial services. Many intermediaries take part in securities exchanges and utilize long-term plans for managing and growing their funds. The overall economic stability of a country may be shown through the activities of financial intermediaries and the growth of the financial services industry.           Financial intermediaries move funds from parties with excess capital to parties needing funds. The process creates efficient markets and lowers the cost of conducting business. For example, a financial advisor connects with clients through purchasing insurance, stocks, bonds, real estate, and other assets. Banks connect borrowers and lenders by providing capital from other financial institutions and from the Federal Reserve. Insurance companies collect premiums for policies and provide policy benefits. A pension fund collects funds on behalf of members and distributes payments to pensioners. Lesson 2.7 **Types of Financial Intermediaries** **          Mutual funds** provide active management of capital pooled by shareholders. The fund manager connects with shareholders through purchasing stock in companies he anticipates may outperform the market. By doing so, the manager provides shareholders with assets, companies with capital and the market with liquidity. Lesson 2.8 **Benefits of Financial Intermediaries**           Through a financial intermediary, savers can pool their funds, enabling them to make large investments, which in turn benefit the entity in which they are investing. At the same time, financial intermediaries pool risk by spreading funds across a diverse range of investments and loans. Loans benefit households and countries by enabling them to spend more money than they have at the current time.           Financial intermediaries also provide the benefit of reducing costs on several fronts. For instance, they have access to economies of scale to expertly evaluate the credit profile of potential borrowers and keep records and profiles cost-effectively. Last, they reduce the costs of the many financial transactions an individual investor would otherwise have to make if the financial intermediary did not exist. Lesson 2.9 **Example of a Financial Intermediary**           The goal was creating easier access to funding for startups and urban development project promoters. Loans, equity, guarantees, and other financial instruments attract greater public and private funding sources that may be reinvested over many cycles as compared to receiving grants.           One of the instruments, a co-investment facility, was to provide funding for startups to develop their business models and attract additional financial support through a collective investment plan managed by one main financial intermediary. Lesson 3.1 **Financial Markets** \*          **Financial markets ***refer broadly to any marketplace where the trading of securities occurs, including the stock market, bond market, forex market, and derivatives market, among others. Financial markets are vital to the smooth operation of capitalist economies. Lesson 3.2 **Understanding the Financial Markets**           Financial markets play a vital role in facilitating the smooth operation of capitalist economies by allocating resources and creating liquidity for businesses and entrepreneurs. The markets make it easy for buyers and sellers to trade their financial holdings. Financial markets create securities products that provide a return for those who have excess funds (Investors/lenders) and make these funds available to those who need additional money (borrowers).           The stock market is just one type of financial market. Financial markets are made by buying and selling numerous types of financial instruments including equities, bonds, currencies, and derivatives. Financial markets rely heavily on informational transparency to ensure that the markets set prices that are efficient and appropriate. The market prices of securities may not be indicative of their intrinsic value because of macroeconomic forces like taxes.           Some financial markets are small with little activity, and others, like the New York Stock Exchange (NYSE), trade trillions of dollars of securities daily. The equities (stock) market is a financial market that enables investors to buy and sell shares of publicly traded companies. The primary stock market is where new issues of stocks, called initial public offerings (IPOs), are sold. Any subsequent trading of stocks occurs in the secondary market, where investors buy and sell securities that they already own. Lesson 3.3 **Types of Financial Markets** ***Over-the-Counter Markets *-**An over-the-counter (OTC) market is a decentralized market---meaning it does not have physical locations, and trading is conducted electronically---in which market participants trade securities directly between two parties without a broker. ***Bond Markets ***-A bond is a security in which an investor loans money for a defined period at a pre-established interest rate. You may think of a bond as an agreement between the lender and borrower that contains the details of the loan and its payments. Bonds are issued by corporations as well as by municipalities, states, and sovereign governments to finance projects and operations. The bond market also is called the debt, credit, or fixed-income market. ***Money Markets *-**Typically the money markets trade in products with highly liquid short-term maturities (of less than one year) and are characterized by a high degree of safety and a relatively low return in interest. At the wholesale level, the money markets involve large-volume trades between institutions and traders. At the retail level, they include money market mutual funds bought by individual investors and money market accounts opened by bank customers. Individuals may also invest in the money markets by buying short-term certificates of deposit (CDs), municipal notes, or Treasury bills, among other examples. ***Derivatives Market *-**A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Derivatives are secondary securities whose value is solely derived from the value of the primary security that they are linked to. In and of itself a derivative is worthless. Rather than trading stocks directly, a derivatives market trades in futures and options contracts, and other advanced financial products, that derive their value from underlying instruments like bonds, commodities, currencies, interest rates, market indexes, and stocks. ***Forex Market *-**The forex (foreign exchange) market is the market in which participants can buy, sell, exchange, and speculate on currencies. As such, the forex market is the most liquid market in the world, as cash is the most liquid of assets. The currency market handles more than \$5 trillion in daily transactions, which is more than the futures and equity markets combined. As with the OTC markets, the forex market is also decentralized and consists of a global network of computers and brokers from around the world. The forex market is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. Top of Form