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Principles of Finance

Summary

Principles of FinanceSummary

Summary

12.1 Overview of US Financial Markets

One way to parse financial markets is by the maturity of financial instruments. With this dichotomy, we explored the money market and the capital market. The money market consists of short-term securities and the capital market of longer-term securities. The capital market discussion focused on debt and equity as financial instruments used to finance longer-term capital financing needs. IPOs or SPACs are vehicles for raising new equity. Most trading on organized exchanges or over-the-counter markets is for used, or secondary, securities.

12.2 Historical Picture of Inflation

The Federal Reserve considers moderate inflation rates optimal in their oversight of the US economy. We measure inflation by comparing the price of a bundle or basket of goods over time and documenting how prices change. Since not everyone consumes similar baskets of goods, we calculate several different measures of inflation. The most commonly quoted measure of inflation uses changes in the Consumer Price Index (CPI).

12.3 Historical Picture of Returns to Bonds

Historical bond yields are published going back hundreds of years but are only reliably available for the last 100 years or so. In large part, the returns realized on portfolios of bonds have been smaller and less variable than the returns realized for equities.

12.4 Historical Picture of Returns to Stocks

Stocks have produced the greatest average annual rates of return of the money and capital market assets discussed in this chapter. Stockholders bear more risk than bondholders or money market investors and receive on average higher average annual returns. Despite the relatively high average annual rate of return for portfolios of stock, history shows that the equity markets earn negative annual returns about 25% of the time. The negative returns realized by equities occur far more often than the negative results realized by money market or debt market instruments.

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