. 16
( 33)


Section 2 (pages 292“298)
Identifying Key Terms 4. Describe the paper currencies used from the
On another sheet of paper, place each of the vocabulary terms period of the American Revolution to the time of
in its correct historical period(s). Some terms will appear the Civil War.
under more than one period.
5. Explain the importance of the greenback during
Historical Periods: the Civil War.
a. Colonial: 1607“1776
6. Describe four disadvantages of a gold standard.
b. Pre -Civil War: 1789“1861
7. Evaluate modern money as a medium of exchange.
c. Civil War“Pre-Depression: 1861“1929
d. Depression: 1929“1939
Section 3 (pages 300“305)
e. World War II“FIRREA: 1940“1989
f. 1989“present 8. Describe the main difference between the Federal
Reserve System and the National Banking System.
1. United States note _____
9. Explain why many banks failed during the Great
2. commercial bank _____
3. Continental dollar _____
10. Describe two evolutionary trends in banking that
4. deregulation _____ emerged in the 1990s.
5. Federal Reserve System _____
Thinking Critically
6. gold certificate _____
1. Understanding Cause and Effect How did high
7. gold standard _____
interest rates affect the S&L industry in the early
8. inconvertible fiat money standard _____
9. legal tender _____
2. Making Comparisons Why were coins a more
10. mutual savings bank _____ desirable form of money than paper during the
11. national bank _____ colonial period? Create a table like the one below
to help you organize your answer.
12. NOW account _____
13. savings and loan association _____ Kinds of Advantages Disadvantages
14. silver certificate _____
15. specie _____
16. Treasury coin note _____

Applying Economic Concepts Technology Skill
1. Money Ask your friends, parents, and neighbors if Using the Internet The money supply of the United
they have any examples of old currency. If so, make States, much like that of the major industrialized
a note of (a) the name of the currency (gold certifi- countries, is a managed money supply. The govern-
cate, silver certificate, United States note, etc.); ment or its designated agent tries to control the
(b) the date on the currency; and (c) any mention quantity, composition, and even the quality of the
of backing (silver certificates backed by silver dol- money supply. The two agencies that make United
lars). Describe the role this money played in United States currency are the Bureau of the Mint and the
States history. Bureau of Engraving and Printing. What are the roles
of these two agencies? Use the Internet to find out
2. Barter Assume that you live in a barter society.
about the operations of one of these two currency-
Organize a list of 10 items that you use fre-
making institutions.
quently, and then identify alternate goods of com-
parable worth that you would be willing to trade To begin, log on to the Internet and access a World
for them. Wide Web search engine. Search by selecting one of
the listed categories or by typing in the subject you
want to find, such as Bureau of the Mint or Bureau of
Math Practice Engraving and Printing. Next, enter words like the
following to focus your search: currency, United States
The table below provides information on the num-
Mint, and counterfeiting.
ber and total assets of FDIC-insured commercial
banks. Study the data and then design a graph to Gather your findings. Using the findings, create a
present this information. pamphlet that could be distributed by either bureau
to describe its role in the creation of American
Total Assets Number of Institutions
Less than $25 million 1,404
$25 to $50 million 2,107
$50 to $100 million 2,598
$100 to $300 million 2,937
$300 to $500 million 585 Developing Multimedia Presentations
Examine the list of topics below. Choose one
$500 to $1 billion 393
of the topics and explain how you would use
More than $1 billion 537
at least three types of media in a presenta-
tion to best teach the topic to your class.
Total Institutions 10,561
• Trade in colonial America
• Origins of the dollar
Thinking Like an Economist • Establishment of a national bank”
Alexander Hamilton™s view and
Thomas Jefferson™s view
Over time different financial institutions”state
banks, national banks, S&Ls, MSBs, and credit • Currencies around the world
unions”have lost some of their individual identities • Banking during the Civil War
and have become more and more like each other. Is • Roosevelt™s bank holiday during the
this an outcome that could have been predicted by Great Depression
an economist? Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

Setting Up the Workshop
Prepare a report on the process you would
follow to purchase a home. The report will be
five pages long. This will include a cover sheet,
three pages of text, and a bibliography on the
fifth page. The outline of your report should be
similar to the following:
I. Title page, including title, date, student™s
name, and class
II. Background
A. Education
B. Occupation
III. Price of house
A. Payments
B. Taxes
Buying a Home IV. Procedure followed and paperwork
From the classroom of . . . V. Location of home
VI. Decisions
Hal Kraynek
A. Reason for home location
Valley High School B. Insurance choice
Santa Ana, California C. Payment plan
VII. Bibliography, including names and titles of
The ability to buy a home is usually the people who helped you, Internet Web sites,
result of proving to a lending institution title companies, newspapers, banks, county
that your salary is sufficient to make the tax collector, flyers, realtors, and so forth
monthly mortgage payments. Also, the The report will contain at least the following
lending institution will demand evidence information:
that the amount you will pay for the house REQUIRED:
is a reasonable amount for the neighbor- ❏ Occupation (both you and your partner)
❏ Salary (yours and partner™s)
hood, the size, and the condition of the
❏ Education (yours and partner™s)
house. Buying a home is usually a lengthy,
❏ Mortgage rates
complex process. ❏ Loaning institute
Select a partner to work with. Imagine ❏ Taxes
that you and your partner have completed ❏ Loan amount
❏ Interest rate
your education and successfully acquired
❏ Down payment
jobs in your respective fields. You both have
❏ Type of loan
saved money all those years and are now ❏ Savings and loan companies, credit unions
ready to purchase a home. You will com- ❏ Number of years
bine your salaries to buy this home. ❏ Procedure followed to acquire the loan

❏ Qualifications needed for loan STEP 5
❏ Examples of paperwork involved in the
Research to find out what is involved with
application process
purchasing a house: what papers are needed;
❏ Location of home
time spent in escrow; fees; charges; interest
OPTIONAL: rates for 15-, 20-, and 30-year mortgages;
❏ Other interesting information payment rates; types of homeowners™ insur-
❏ Visual aids ance; notes; differences in buying a new
❏ Pamphlets/brochures home or an older home; repair expenditures;
landscape costs; location of schools and shop-
ping; and the type of neighborhood you are
Procedures interested in.

Write and submit your report, following the
Establish your education and professions. List
criteria outlined above.
any specialized training, and degrees or certifi-
cates achieved.

Summary Activity
Discuss with the other groups what problems
Describe your job, city or locale of employ-
you encountered and how you solved them.
ment, what company, if you are self-employed,
and your salary.

Based on your salaries and where you work,
decide where you want to live, and what price
range of house you can afford.

Compile places you might go for infor“
mation and help. This might include
Internet sites, title companies,
friends, family, newspapers,
and all types of lending
institutions, and real
estate advertising
sources in your

Do you save your
money? In Chapter 12,
you will learn about the role
that savings plays in the
economy. To learn about
investment strategies, view the
Chapter 13 video lesson:
Saving and Investing

Chapter Overview Visit the Economics: Principles
and Practices Web site at epp.glencoe.com and
click on Chapter 12”Chapter Overviews to pre-
view chapter information.

Financial investors daily buy and sell the
stock of thousands of corporations.
Savings and the Financial System
Main Idea financial institution, finance company, bill consolidation
The components of a financial system work together loan, premium, mutual fund, net asset value (NAV), pen-
to transfer savings to investors. sion, pension fund, real estate investment trust (REIT)

Reading Strategy
Graphic Organizer As you read the section, complete
After studying this section, you will be able to:
a graphic organizer like the one below by identifying
1. Explain why saving is important for capital
how saving and savings differ.
2. Explain how the financial system works to transfer
SAVING Definition Example funds from savers to borrowers.
3. Understand the role of the major nondepository
financial institutions in the financial system.
SAVINGS Definition Example

Applying Economic Concepts
Key Terms Financial Assets Do you have a checking account, sav-
saving, savings, financial system, certificate of deposit, ings account, or government savings bond? If so, you
financial asset, financial intermediary, nonbank have one or more financial assets.

or an economic system to grow, it must pro-
Cover Stor y duce capital”the equipment, tools, and
machinery used in the process of production.
To produce capital, people must be willing to save
The Golden so that productive resources are released for use
elsewhere. To the economist, saving means the
Years absence of spending, while savings refers to the
Many people think of dollars that become available when people abstain
Boston as the birthplac from consumption. After all, there are only two
of democracy in ou things you can do with your income”spend it or
country. They may no
save it.
realize that it is also th
Competitive markets are remarkably innovative,
birthplace of the democ The Spirit of ™76 as the example in the cover story illustrates. The cre-
tization of investing. It
was there, 75 years ag ation of the mutual fund industry is just one of
created the first mutua
at three stock salesmen many examples describing how our financial system
th e
at was once an exclusiv
nd and opened up wh evolves to meet the needs of savers and investors.
just about everyone.
ovince of the affluent to
pr its
ts Investors Trust made
When the Massachuset ts and
it had $50,000 in asse
debut in March 1924, Saving and Capital Formation
ts, the
By pooling investmen
owned 45 stocks. . . . ible
erican companies access When people save, they make funds avail-
fund made shares in Am n was
. . (the) true innovatio
to a broader market . able. When businesses borrow these sav-
est, at
deem shares upon requ
allowing investors to re ings, they can produce new goods and services,
rlying stocks.
market value of the unde build new plants and equipment, and create more
port, April 5, 1999
jobs. Saving makes economic growth possible.
”U.S. News & World Re

Suppose two entrepreneurs want to set up their Financial Intermediaries
own businesses. Lisa wants to open a pet shop, You have just read about two of the main parts
while Juanita™s lifelong dream is to run a photogra- of the financial system. The first is the funds that
phy studio. How do they go about it? Lisa saves her the saver transfers to the borrower. The second is
income, keeping her money in a bank account. the financial assets or receipts that certify that the
When she saves enough money to invest, Lisa can loans were made. The other parts of the financial
set up her pet shop. system, illustrated in Figure 12.1, are the savers,
Eager to start her business immediately, Juanita borrowers, and institutions that bring the surplus
decides to borrow the money she needs from funds and financial assets together.
a bank. If other people have been saving some Many surplus funds are placed with financial
of their income, like Lisa, the bank should have intermediaries, financial institutions that lend the
the funds to lend her. If people have been spend- funds that savers provide to borrowers. Financial
ing all of their income, however, the bank might intermediaries include depository institutions, life
not be able to give Juanita the loan even if it insurance companies, pension funds, and other
wanted to. institutions that channel savings from savers to
For investment to take place, someone in the borrowers. These institutions are especially helpful
economy must save. An individual can save as well to small savers who have only limited funds to
as invest, as Lisa did. Or, a person may invest using invest.
money others have saved, as Juanita did. When
people save, they provide money for others to bor-
row and use, making investments possible. The Circular Flow of Funds
Figure 12.1 shows the circular flow that takes
place when funds are transferred from savers to
Financial Assets and the Financial borrowers. Savers can provide their funds directly
to the borrower or indirectly through the many
System financial intermediaries in the economy such as
For people to use the savings of others, the banks and credit unions. The borrowers then gen-
economy must have a financial system”a erate the financial assets, which return to the
network of savers, investors, and financial institu- lender.
tions that work together to transfer savings to Any sector of the economy can supply savings,
investors. but households and businesses are the most
important. As shown in Figure 12.1, savers provide
some funds directly to borrowers, as when house-
Financial Assets holds or businesses purchase bonds directly from
the government or businesses.
People can save in a number of ways. They can
Any sector of the economy can borrow, but gov-
open a savings account. They can purchase a
ernments and businesses are the largest borrowers.
certificate of deposit”a receipt showing that an
If a corporation borrows directly from savers, or
investor has made an interest-bearing loan to a
indirectly from savers through financial intermedi-
bank”or a government or corporate bond. In
aries, the corporation will issue a bond or other
each case, the savers obtain receipts for the funds
financial asset to the lender. Likewise, when the
they save.
government borrows, it issues government bonds
Economists call these receipts financial
or other financial assets to the lender.
assets”claims on the property and the income of
As a result, almost everyone participates in, and
the borrower. These receipts are assets because
benefits from, the financial system. The smooth flow
they are property that has value. They represent
of funds through the system helps ensure that savers
claims on the borrower because they specify the
will have an outlet for their savings. Borrowers, in
amount loaned and the terms at which the loan
turn, will have a source of financial capital.
was made.

Figure 12.1

Overview of the Financial System
Financial Intermediaries

Commercial Banks
Savings & Loan Associations
Savings Banks
Savers Borrowers
Mutual Savings Banks
Credit Unions
Households, Businesses Governments, Businesses
Life Insurance Companies
Mutual Funds
Pension Funds
Real Estate Investment Trusts
Finance Companies

Using Charts Financial intermediaries help channel surplus funds from savers to borrowers, who
put the money to work. What do lenders receive in return for their funds?

Nonbank Financial Intermediaries easy terms without actually carrying the loan full
term, absorbing losses for an unpaid account, or
Savings banks, credit unions, commercial taking customers to court if they do not pay.
banks, and savings associations obtain funds Some finance companies make loans directly to
when their customers or members make regular consumers. These companies generally check a
deposits. Another important group of financial inter- consumer™s credit rating and will make a loan only
mediaries includes nonbank financial institutions” if the individual qualifies. Because they make some
nondepository institutions that channel savings to risky loans, and because they pay more for the
borrowers. Finance companies, life insurance compa- funds they borrow, finance companies charge more
nies, pension funds, and real estate investment trusts than commercial banks for loans. Many consumer
are examples of nonbank financial institutions. finance companies offer bill consolidation loans.
This is a loan consumers use to pay off other bills.
Finance Companies
Life Insurance Companies
A finance company is a firm that specializes in
making loans directly to consumers and in buying Another financial institution that does not get
installment contracts from merchants who sell its funds through deposits is the life insurance
goods on credit. Many merchants, for example, can- company. Although its primary purpose is to pro-
not afford to wait years for their customers to pay vide financial protection for survivors of the
off high-cost items on an installment plan. Instead, insured, it also collects a great deal of cash.
the merchant sells the customer™s installment con- The head of a family, for example, purchases a life
tract to a finance company for a lump sum. This insurance policy to leave money for a spouse and
allows the merchant to advertise instant credit or children in case of his or her death. The premium is

the price the insured pays for this policy and is usu- Pension Funds
ally paid monthly, quarterly, or annually for the Another nondepository financial institution is
length of the protection. Because insurance compa- the pension fund. A pension is a regular payment
nies collect cash on a regular basis, they often lend intended to provide income security to someone
surplus funds to others. who has worked a certain number of years, reached
a certain age, or suffered a certain kind of injury. A
pension fund is a fund set up to collect income
Mutual Funds
and disburse payments to those persons eligible for
A mutual fund is a company that sells stock in retirement, old-age, or disability benefits.
itself to individual investors and then invests the In the case of private pension funds, employers
money it receives in stocks and bonds issued by regularly withhold a percentage of workers™ salaries
other corporations. Mutual fund stockholders to deposit in the fund. During the 30- to 40-year lag
receive dividends earned from the mutual fund™s between the time the savings are deposited and the
investments. Stockholders can also sell their mutual time the workers generally use them, the money is
fund shares for a profit, just like other stocks. usually invested in corporate stocks and bonds.
Mutual funds allow people to play the market Government pension funds are similar to private
without risking all they have in one or a few com- ones in that the government makes regular contri-
panies. The large size of the typical mutual fund butions to the fund that will pay benefits later.
makes it possible to hire a staff of experts to ana-
lyze the securities market before buying and selling
Real Estate Investment Trusts
securities. Their large size also allows them to buy
Still another nonbank financial institution is the
many different stocks and bonds.
real estate investment trust (REIT)”a company
The net asset value (NAV)”the net value of the
organized primarily to make loans to construction
mutual fund divided by the number of shares
companies that build homes. REITs help provide
issued by the mutual fund”is the market value of
billions annually for home construction.
a mutual fund share.

Checking for Understanding 5. Explain the role of the major nondepository
1. Main Idea Using your notes from the graphic financial institutions in the financial system.
organizer on page 313, describe the difference 6. Financial Assets An I.O.U. that you draft and
between saving and savings. give to a friend in payment of a debt is an
2. Key Terms Define saving, savings, financial example of a financial asset. Explain why this
is so.
system, certificate of deposit, financial asset,
financial intermediary, nonbank financial
institution, finance company, bill consolida-
tion loan, premium, mutual fund, net asset
value (NAV), pension, pension fund, real 7. Understanding Cause and Effect What is
estate investment trust (REIT). necessary before investment can take place?
Reviewing Objectives 8. Making Generalizations Why might an
3. Explain why saving is required for capital individual choose to borrow money from a
formation. finance company that charges higher inter-
est rates than commercial banks do?
4. Describe how the financial system works to
transfer funds from savers to borrowers. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

In the late 1960s, Lewis, then
a financial analyst for a bank,
attended a conference held to
encourage initiative in African
American capitalism. One idea
captured him: that someone could
publish a magazine targeted at
African American women.
Lewis launched the first issue of
Essence in May 1970. The stylish
magazine, which featured full-page
color photos of African American
models and cutting-edge articles,
became a great success.
ECI is also a major investor in
Managing Money: that she only competes against her- Amistad Press, a respected book
self. But Hayes™s gusto for athletics publishing company that focuses
Helen Young seems a clear reflection of the zeal on minority authors and titles.
she brings to bear in business. Essence Art Reproductions markets
Hayes reproductions of fine art created
by African American artists.
Building a Business: Lewis™s success is the result of
the age-old formula of good ideas
Helen Hayes is the type of per-
Edward T. Lewis combined with hard work. His
son people trust. In fact, people
legacy is ECI.
have entrusted her with more than (1940“)
$23 billion of their money.
As chairman and CEO of
Hayes is one of the most suc-
Essence Communications, Inc.
cessful mutual fund managers in
(ECI), Edward T. Lewis heads one
the world.
of the largest African American
Picking the right stocks, espe-
businesses in the United States.
cially foreign ones, takes research.
His struggle to make Essence maga-
But what sets Hayes apart, and is a
zine a success shows determination
key to her success, is her uncanny
and entrepreneurial skill.
ability to read people. When she
meets with corporate executives,
for example, she pays a great deal
of attention to body language,
which she maintains can reveal as
much, or more, about a company
Examining the Profiles
than what the executive says.
In her spare time, Hayes trains 1. Making Comparisons What similari-
for and competes in triathlons” ties and differences do you see in
Hayes™s and Lewis™s careers?
grueling races that combine swim-
ming, bicycling, and running. She 2. For Further Research Review several
claims she™s not very good, and issues of Essence magazine. Write an
analysis of the magazine™s editorial

Investment Strategies
and Financial Assets
Main Idea Retirement Account (IRA), Roth IRA, capital market,
To invest wisely, investors must identify their goals money market, primary market, secondary market
and analyze the risk and return involved.
Reading Strategy After studying this section, you will be able to:
Graphic Organizer As 1. Identify four important investment considerations.
you read the section, 2. Describe the three characteristics of bonds.
identify at least four 3. Describe the characteristics of major financial assets.
financial assets. 4. Understand four views of markets for financial
Key Terms
Applying Economic Concepts
risk, 401(k) plan, coupon, maturity, par value, current
yield, municipal bond, tax-exempt, savings bond, Risk-Return Relationship Riskier projects must offer
Treasury note, Treasury bond, Treasury bill, Individual higher returns to be attractive.

Cover Stor y
efore you invest in a financial asset, it helps
to have a basic understanding of investment
considerations. Possessing this information
Popular Plan Has will help you make your own investment goals and
Attracted $1 Trillion decide whether a plan like the 401(k) is right for you.
In just 15 years, 401(k)
m an
been transformed fro
Basic Investment Considerations
x code
obscure section of the ta
™s most
into corporate America It is important to consider several factors
popular retirement bene
when you invest in financial assets. The first
Today, 25 million peop
The 401(k) provides a concerns the relationship between risk and return.
have about $1 trillion in nest egg for millions.
ing a The second has to do with the investor™s personal
in 401(k) plans, trigger
t plan- investment goals. The third deals with avoiding
revolution in retiremen rkers
ey managers out of wo
ning that™s made mon some types of investments, and the last deals with
the corner office.
from the factory floor to the consistency of investing.
vering as many employee
But with 401(k)s now co 1(k)s
an . . . analysis of the 40
as traditional pensions, dis-
ployers finds dramatic The Risk-Return Relationship
at the nation™s largest em
parities in the plans™ ge One of the most important relationships in the
rence could easily amou
For individuals, the diffe they market is the relationship between risk and
s of dollars. For society,
to hundreds of thousand or.
gap between rich and po return. Risk is a situation in which the outcome
could further widen the
is not certain, but probabilities for each possible
”USA Today, April 23,
outcome can be estimated. Investors realize that

financial assets are risky. Assets such as notes, bills, knowing a few fundamentals can help you make
and bonds may go up or down in price, or the good choices.
agency that issued the asset may even fail to redeem One rule that many investors follow is this: If an
it, leaving the lender with a loss. As a result, investment seems too complicated, then ignore it
investors demand a higher return to compensate for and invest in something else. Another often-cited
higher risk. This relationship between risk and rule is that any investment that seems too good to
return is illustrated in Figure 12.2, which shows that be true probably is. A few investors do get lucky,
riskier assets offer higher returns to attract investors. but most build wealth because they invest regu-
As an investor, your first consideration should be larly, and they avoid the investments that seem too
the level of risk that you can tolerate. For example, far out of the ordinary.
if someone offers you a risky deal that doubles your
money, it may be better to focus on the chances of
getting your money back rather than on the size of
Most successful investors invest consistently
the return. If you are uncomfortable with high lev-
over long periods of time. In many cases, the
els of risk, then consider another investment.
amount invested is not as important as investing
on a regular basis.
Investment Objectives Figure 12.3 shows how a small deposit of $10
Another factor to consider is the reason for per month would grow over a 5- to 30-year period
investing. If your goal is to save for retirement, you at various interest rates. The balance in the account
might want to purchase assets that simply appreci- accumulates fairly quickly, even at modest interest
ate in value rather than generate current income. If rates. Because $10 is a small amount, imagine how
your purpose is to accumulate reserves to fund a
vacation or to cover living expenses during periods
of unemployment, a strategy that focuses on the
accumulation of assets that are highly liquid, or eas-
Figure 12.2
ily converted into cash, might be better.
The source of income used for investment may
The Relationship Between
help determine which assets are purchased. If you
receive a steady salary and almost no other income,
Risk and Return
a payroll deduction plan that puts money into a
special retirement fund like a 401(k) or government
bonds might be best. If you receive bonuses, royal-
ties, or other occasional payments, corporate
Required Return in

Junk Bonds
bonds or some other large-denomination financial
Speculative Stock
asset might be preferable.
Common Stock
In the end, each investor must consider his or
% per Year

Preferred Stock
her own circumstances and personal investment
Investment-Grade Bonds
goals. Investors have a large number of financial
Prime Commercial Paper
assets, equities, and other investments from which
U.S. Treasury Bills
to choose. The investor™s knowledge of his or her
own needs is important in making these decisions.
Increasing Degrees of Risk

Using Graphs U.S. Treasury bills are
Most analysts advise investors to stay with what regarded as the safest investment. Why
they know. Thousands of investments are available, do investors require higher returns for
and many are complicated. Although you do not some investments?
have to understand them all to be a good investor,

the account would grow if the deposit was for $25, your employer matches your contribution at 50 cents
$50, or even $100 a month! Many investment on the dollar, you have an immediate 50 percent
advisers tell people to save something every return on the investment”even before the funds are
month, even if it is only a small sum. invested. Figure 12.4 illustrates that an annual
contribution of $2,000 with a 25 percent employer
match can provide a substantial retirement fund in
401(k) Plans 30 years.
A program that has become increasingly popular The 401(k) is popular because it provides a
among investors is the 401(k) plan”a tax-deferred simple, consistent, and relatively safe way for
investment and savings plan that acts as a personal employees to save”and you can take the 401(k)
pension fund for employees. To contribute to the with you if you change jobs. In addition, you can
plan, employees authorize payroll deductions, borrow against the money before you retire at a sub-
which are invested in mutual funds or other invest- stantially reduced rate. You will, however, have to
ments approved by their companies. Contributing pay taxes on the earnings when you withdraw the
to a plan lowers your taxable income because you money at retirement.
don™t have to pay income taxes on the money you
contribute until you withdraw it. An added benefit
of a 401(k) plan is that more than 80 percent of
Bonds as Financial Assets
employers match an employee™s contributions, by
When the government or firms need to
typically 25 percent to 100 percent. This explains
borrow funds for long periods, they often
why individual plans vary widely from company to
issue bonds. Bonds are long-term obligations that
company, as noted in the cover story.
pay a stated rate of interest for a specified number
Returns on a 401(k) are especially high when the
of years.
employer provides matching funds. For example, if

Figure 12.3

The Power of Compound Interest
Annual Interest Value at End of Year
(in percent) 5 10 15 20 25 30
0 $600 $1,200 $1,800 $2,000 $2,500 $3,600
2 $630 $1,327 $2,097 $2,948 $3,888 $4,927
4 $663 $1,472 $2,461 $3,668 $5,141 $6,940
6 $698 $1,639 $2,908 $4,620 $6,930 $10,045
8 $735 $1,829 $3,460 $5,890 $9,510 $14,904
10 $774 $2,048 $4,145 $7,594 $13,268 $22,605
12 $817 $2,300 $4,996 $9,893 $18,788 $34,950

Using Tables This table shows the balance in an account if monthly deposits of $10 were
compounded monthly. How much interest is earned after the first 10 years at 6 percent?

Bond Components Figure 12.4
A bond has three main components: the
How Much Will You Have
coupon, or the stated interest on the debt;
the maturity, or the life of the bond; and the
at Retirement?
par value”the principal or the total amount
initially borrowed that must be repaid to the
lender at maturity.
Suppose, for example, a corporation sells a 6 $200,000
percent, 20-year, $1,000 par value bond that pays
interest semiannually. The coupon payment to the $175,000
holder is $30 semiannually (.06 times $1,000,
divided by 2). When the bond reaches maturity $150,000
after 20 years, the company retires the debt by pay-
ing the holder the par value of $1,000.
Bond Prices
401(k) Roth IRA
The investor views the bond as a financial asset
that will pay $30 twice a year for 20 years, plus a
Traditional IRA Basic Savings
final par value payment of $1,000. Investors can
offer $950, $1,000, $1,100, or any other amount
for this future payment stream. Investors consider
Data is based on:
changes in future interest rates, the risk that the
• $2,000 in income invested each year for 30 years
company will default, and other factors before they • 8% return on investment
decide what to offer. Supply and demand will then • Company matching 25% of employee
establish the final price of the bonds.
• 28% income tax; 20% capital gains tax
(paid yearly for basic savings)
Bond Yields
In order to compare bonds, investors usually Source: Quicken.com, 1999
compute the bond™s current yield, the annual inter-
Using Graphs Retirement investment plans
est divided by the purchase price. If an investor paid
provide various returns. How much more
$950 for the bond described above, the current yield
would a traditional IRA earn over a basic
would be $60 divided by $950, or 6.32 percent. If
savings plan?
the investor paid $1,100 for the bond, the current
yield would be $60 divided by $1,100, or 5.45 per-
cent. Although it may appear as if the issuer fixes the
return on a bond when the bond is first issued, the
Bond Ratings
interest received and the price paid determine the
Fortunately, investors have a way to check the
actual yield on the bond.
quality of bonds. Two major corporations,
Because the credit-worthiness, or financial health,
Standard & Poor™s and Moody™s, publish bond rat-
of corporations and governments differ, all 6 per-
ings. They rate bonds on a number of factors,
cent, 20-year, $1,000 bonds will not cost the same.
including the basic financial health of the issuer, the
Bonds are not insured, and there are no guarantees
ability to make the future coupon and principal pay-
that the issuer will be around in 20 years to redeem
ments, and the issuer™s past credit history.
the bond. Therefore, investors will pay more for
The bond ratings, shown in Figure 12.5, use letters
bonds issued by an agency with an impeccable credit
scaled from AAA, which represents the highest
rating. Investors will pay less for a similar bond if it
investment grade, to D, which generally stands for
is issued by a corporation with a low credit rating.

Figure 12.5

Bond Classifications
Standard & Poor™s Moody™s
Highest Investment Grade AAA Aaa Best Quality
High Grade AA Aa High Quality
Upper Medium Grade A A Upper Medium Grade
Medium Grade BBB Baa Medium Grade
Lower Medium Grade BB Ba Possesses Speculative Elements
Speculative B B Generally Not Desirable
Vulnerable to Default CCC Caa Poor, Possibly in Default
Subordinated to Other Debt Rated CCC CC Ca Highly Speculative, Often in Default
Subordinated to CC Debt C C Income Bonds Not Paying Income
Bond in Default D D Interest and Principal Payments in Default
Sources: Standard & Poor™s Corporation, Moody™s

Using Tables Standard & Poor™s Corporation and Moody™s publish bond ratings. Junk bonds, those
with ratings of BB or Ba and lower, are generally the riskiest types of bonds. How do bond ratings
affect the price of bonds?

default. If a bond is in default, the issuer has not kept Certificates of Deposit
up with the interest or the par value payments. These Certificates of deposit (CDs) are one of the most
ratings are widely publicized, and investors can find common forms of investments available. Many peo-
the rating of any bond they plan to purchase. ple think of them as just another type of account
Bonds with high ratings sell at higher prices than with a depository institution, but they are really loans
do bonds with lower ratings. A 6 percent, 20-year, investors make to financial institutions. Because
$1,000 par value bond with an AAA-grade rating banks and others count on the use of these funds for
may sell for $1,100 and have a current yield of 5.45 a certain time period, they usually impose penalties
percent. Another 6 percent, 20-year, $1,000 par value when people try to cash in their CDs early.
bond issued by a different company may have a BBB CDs are attractive to small investors because they
rating, and may therefore only sell for $950 because can cost as little as $100. Investors can also select the
of the higher risk. The second bond, however, has a length of maturity, giving them an opportunity to
higher current yield of 6.32 percent. This points out tailor the expiration date to future expenditures such
the basic nature of the risk-return relationship”riskier as college tuition, a vacation, or some other expense.
investments require higher returns to offset the risk. Finally, CDs issued by commercial banks, sav-
ings banks, and savings associations are included in
the $100,000 FDIC insurance limit. The National
Financial Assets and Their Credit Union Association insures most CDs issued
by credit unions.
The modern investor has a wide range of
Corporate Bonds
financial assets from which to choose. These
include certificates of deposit, bonds, treasury notes Corporate bonds are an important source of cor-
and bills, and individual retirement accounts. They porate funds. Some individual corporate bonds
vary in cost, maturity, and risk. have par values as low as $1,000, but par values of

$10,000 are more common. The actual prices of parks and football stadiums or to finance libraries,
the bonds are usually different from the par values parks, and other civic improvements.
because supply and demand for the bonds deter- Municipal bonds are attractive investments for
mine the price. several reasons. First, they are generally regarded
Investors usually decide on the highest level of as safe because state and local governments do
risk they are willing to accept, and then they try to not go out of business. Because governments have
find a bond that has the best current yield. “Junk” the power to tax, it is generally presumed that
bonds”exceptionally risky bonds with a Standard they will be able to pay interest and principal in
& Poor™s rating of BB or lower, or a Moody™s rating the future.
of Ba or lower”carry a high rate of return as com- More importantly, municipal bonds are generally
pensation for the possibility of default. tax-exempt, meaning that the federal government
Investors usually purchase corporate bonds as does not tax the interest paid to investors. In some
long-term investments, but they can also be liqui- cases, the states issuing the bonds also exempt the
dated, or quickly sold, if the investor needs cash interest payments from state taxes, which makes
for other purposes. The Internal Revenue Service them very attractive to investors. The tax-exempt
considers the interest, or coupon, payments on feature also allows the governmental agencies to pay
corporate bonds as taxable income, a fact investors a lower rate of interest on the bonds, thereby low-
must consider when they invest in bonds. ering their cost of borrowing.

Municipal Bonds
Government Savings Bonds
Municipal bonds (or “munis”) are bonds issued
The federal government generates financial
by state and local governments. States issue bonds
assets when it sells savings bonds. Savings bonds
to finance highways, state buildings, and some
are low-denomination, nontransferable bonds
public works. Cities issue bonds to finance baseball

mutual funds today exist for just that purpose. Even
though the United States market has been prosper-
INVESTING GLOBALLY ous, shifting some assets overseas can serve as a
safety net if the United States market plunges.
Is it risky to invest in markets around the world? Stock markets around the world generally do not
Some economists argue that investing a portion experience simultaneous highs and lows, so main-
of your money in overseas markets is safe and taining a level of profit making can be steady. Many
profitable. overseas companies are restructuring to become
more efficient, creating healthy investment oppor-
Many people think that there are too many
tunities for American investors.
uncertainties associated with investing in overseas
markets. Governments can be unstable and eco-
nomic information about the region may be
Critical Thinking
sketchy. Countries can devalue their currencies or
maintain poor accounting standards. 1. Analyzing Information What are the argu-
Economists, however, believe that investing a ments against investing in overseas markets?
portion of one™s money in Latin American, Asian, or
2. Making Generalizations Why is it impor-
European companies is a wise strategy, and many
tant to diversify investments throughout
different regions rather than in investing in
a single region?

issued by the United States government, usually Treasury Notes and Bonds
through payroll-savings plans. When the federal government borrows funds for
These bonds are usually available in denomina- periods longer than one year, it issues Treasury
tions ranging from $50 to $10,000, and they are notes and bonds. Treasury notes are United States
purchased at a discount from their redemption government obligations with maturities of two to
amount. For example, a new $50 savings bond 10 years, while Treasury bonds have maturities
may be obtained today for $25, but it could take ranging from more than 10 to as many as 30 years.
up to 18 years before it could be redeemed for the The only collateral that secures both is the faith
full $50, depending on the interest rate. The gov- and credit of the United States government.
ernment pays interest on these bonds, but it Treasury notes and bonds come in denomina-
builds the interest into the redemption price tions of $5,000 for maturities of two to three
rather than sending checks to millions of investors years, and denominations of $1,000 for maturities
on a regular basis. longer than four years. The government also keeps
Savings bonds are attractive because they are computerized records of its debt holders so that it
easy to obtain and there is virtually no risk of can make periodic interest payments to those
default. They cannot be sold to someone else if the individuals.
investor needs cash, but they can be redeemed Although these financial assets have no collat-
early, with some loss of interest, if the investor eral or backing, they are popular because they are
must raise cash for other purposes. Most investors generally regarded as the safest of all financial
tend to hold long-term savings bonds, treating assets. Due to the trade-off between risk and return,
them as a form of automatic savings. however, these assets also have the lowest returns of
all financial assets.

Treasury Bills
Federal government borrowing generates other
financial assets known as Treasury bills. A Treasury
bill, also known as a T-bill, is a short-term obliga-
Do you enjoy scouting
tion with a maturity of 13, 26, or 52 weeks and a
financial trends and doing
minimum denomination of $10,000.
research? Then a career as a
T-bills do not pay interest directly, but instead
stockbroker might be the
are sold on a discount basis, much like government
right one for you.
savings bonds. For example, an investor may pay
The Work the auction price of $9,300 for a 52-week bill that
The stockbroker™s duties matures at $10,000. The $700 difference between
include handling individual the amount paid and the amount received is the
investment accounts and investor™s return. The investor is receiving $700 on
advising customers on the a $9,300 investment, for a return of $700 divided
purchase or sale of securi- by $9,300, or 7.5 percent.
ties. They must supply the
latest price quotations on
Individual Retirement Accounts
stocks and keep informed about the financial activities
of corporations issuing stock. The ability to act quickly is
Individual Retirement Accounts (IRAs) are
helpful in building and keeping a strong customer base.
long-term, tax-sheltered time deposits that an
Qualifications employee can set up as part of a retirement plan. If
the worker™s spouse does not work outside the
Stockbrokers are college graduates with sales ability and
home, up to $2,000 per year can be deposited in a
good communication skills. Many hold degrees in busi-
separate account for each spouse.
ness administration, with a specialization in finance.

Money Markets
INFOBYTE When investors speak of the money market, they
mean a market where money is loaned for periods of
less than one year. The financial assets that belong to
Treasury Bonds A Treasury bond refers to a
the money market are shown in the left-hand col-
Treasury security with a maturity greater than 10
umn of Figure 12.6. Note that a person who owns a
years. The only difference between a Treasury
CD with a maturity of one year or less is involved in
bond and a Treasury note is the longer maturity
of the bond. Coupon interest on a Treasury bond the money market. If the CD has a maturity of more
is paid semiannually. Treasury bond issuance was than one year, the person is involved in the capital
recently increased from two auctions per year to market as a supplier of funds.
three, settling on the 15th of February, August, Money market mutual funds are issued by stock-
and November. The 30-year bond is considered
brokers and other institutions. These firms pool the
the “benchmark” bond in determining interest
deposits by their customers to purchase stocks or
rate trends.
bonds. Mutual funds usually pay slightly higher
interest rates than banks.

The worker deducts this deposit from his or her
Figure 12.6
taxable income at the end of the year, thereby shel-
tering the $2,000 from income taxes. Taxes on the
Financial Assets and
interest and the principal will eventually have to be
paid, but it gives the worker an incentive to save
Their Markets
today, postponing the taxes until the worker is retired
and in a lower tax bracket. IRAs are not transferable, Money Market Capital Market
and penalties exist if they are liquidated early. (less than 1 year) (more than 1 year)
Figure 12.4 on page 321 also shows a Roth
IRA”an IRA whose contributions are made after savings bonds
taxes so that no taxes are taken out at maturity. Money market
Primary mutual funds
This type of IRA may work well for someone who Money market
plans to retire in a high tax bracket. Small CDs mutual funds
Small CDs
Corporate bonds
Markets for Financial Assets International bonds
Jumbo CDs Jumbo CDs
Investors often refer to markets according to Treasury bills Municipal bonds
the characteristics of the financial assets Treasury bonds
traded in them. These markets are not really separate Treasury notes
entities, and many overlap to a considerable degree.
Using Charts If the length of maturity is
important, the market is sometimes called a
Capital Markets
money or capital market. If the ability to sell
When investors speak of the capital market, the asset to someone other than the original
they mean a market where money is loaned for issuer is important, the market may be
more than one year. Long-term CDs and corporate described as being a primary or secondary
and government bonds that take more than a year market. Why do some financial assets,
to mature belong in this category. Capital market like CDs, appear in more than one
assets are shown in the right-hand column of market?
Figure 12.6.

Primary Markets Investment
Another way to view financial markets is to
focus on the liquidity of a newly created financial
asset. One market for financial assets is the
primary market, a market where only the original
issuer can repurchase or redeem a financial asset.
Government savings bonds and IRAs are in this
market because they are both nontransferable.
Small CDs are in the primary market because
investors tend to cash them in early, rather
than try to sell them to someone else, if they
need cash.

Secondary Markets
If a financial asset can be sold to someone other
than the original issuer it becomes part of the sec-
ondary market. The secondary market is a market
in which existing financial assets can be resold to
new owners.
The major significance of the secondary market is
the liquidity it provides to investors. If a strong sec-
ondary market exists for a financial asset, investors
Markets for Financial Assets Investing always
know that, other than the fees paid to handle the
includes some risk. What is the difference
transaction, the assets can be liquidated fairly between a capital market and a money market?
quickly and without penalty.

Checking for Understanding 6. Differentiate between the four markets of
1. Main Idea What rules do many investors fol- financial assets.
low in regard to investment goals?
Applying Economic Concepts
2. Key Terms Define risk, 401(k) plan, coupon, 7. Risk-Return Relationship If you had money
maturity, par value, current yield, municipal to invest, in which financial asset(s), if any,
bond, tax-exempt, savings bond, Treasury would you choose to invest? Explain how
note, Treasury bond, Treasury bill, Individual you arrived at your answer.
Retirement Account (IRA), Roth IRA, capital
market, money market, primary market,
secondary market.
3. List four important investment considerations.
8. Making Generalizations Review the four
4. Identify the three main characteristics of basic investment considerations. Which do
bonds. you think is most important? Explain your
5. Describe the characteristics of major financial
assets. Practice and assess key social studies skills with
the Glencoe Skillbuilder Interactive Workbook,
Level 2.

AUGUST 10, 1998
What expectations might significantly
alter current spending and saving?
Economists develop models that explain
the saving habits of people at various
levels of income. A new model has been
proposed that suggests why the wealthy
save their money.

A Penny Earned
Is a Penny
Wealth is an accumulation of value. Spending wealth on
luxuries, like expensive cars, is an option. So, too, are saving
and investing.

economic services”including political power.
It is possible to have more money than you
Or, as Howard Hughes once put it, “money is
need. As billionaire H.L. Hunt said in the ™70™s:
the measuring rod of power.”
“For practical purposes, someone who has
$200,000 a year is as well off as I am.” So why do ”Reprinted from August 10, 1998 issue of Business Week, by special
the rich continue to pile up wealth? permission, copyright © 1998 by The McGraw-Hill Companies, Inc.
High-income households save more than
either of two standard economic models would
predict, says Johns Hopkins University econo-
mist Christopher D. Carroll. Contrary to the
Examining the Newsclip
“life-cycle” model, the rich save far more than
they need to support themselves in old age. 1. Analyzing Information Describe the two economic
And the “dynastic” model, which suggests that models developed to explain why high-income house-
the rich want to leave large bequests to their chil- holds save money.
dren, doesn™t work either. Carroll cites a study of 2. Summarizing Information How does Christopher
Internal Revenue Service data showing that the Carroll explain the saving pattern of high-income
childless wealthy don™t spend down assets more households?
rapidly than those who leave bequests to their 3. Making Generalizations Explain why you agree or dis-
children. agree with the following statement: The more wealth
Carroll suggests a new explanation: a “capital- households have accumulated, the weaker the incentive
ist spirit” model, in which the rich value wealth to save in order to accumulate additional wealth.
for its own sake. Even unspent wealth can bring

Investing in Equities,
Futures, and Options
Main Idea Average (DJIA), Standard & Poor™s 500 (S&P 500), bull
Equities, or stocks, represent ownership of a market, bear market, spot market, futures contract,
corporation. futures market, option, call option, put option,
options market
Reading Strategy
Graphic Organizer
As you read the sec- After studying this section, you will be able to:
exchanges 1. Describe the major stock exchanges.
tion, list three differ-
2. Explain how stock market performance is measured.
ent organized stock
Applying Economic Concepts
Key Terms Futures Exchanges Have you ever negotiated to
equities, Efficient Market Hypothesis (EMH), portfolio receive your allowance early, or asked to be paid right
diversification, stockbroker, securities exchange, seat, away for a service to be completed later? Read to find
over-the-counter market (OTC), Dow-Jones Industrial out how this corresponds to a futures market.

Cover Stor y
n addition to financial assets, investors may buy
equities. These are stocks that represent owner-
ship shares in corporations. The markets for
Rich Going Online to Resea equities are reasonably competitive because there are
a large number of buyers and sellers, and investors
and Trade Stocks possess reasonably good information.
Two-thirds of the most Advances in technology, as noted in the cover
affluent Americans us story, make this process even more competitive. A
computers to resear majority of investors now use the Internet to acquire
investments, while alm the information they need to make their decisions.
a third trade online, a su
vey reveals today. Online market analysis
ll inten-
The findings wi
Market Efficiency
sify concern of the future ™s
e U.S. following last week
ditional stockbrokers in th
tra Many things influence the price of equi-
l Lynch, the largest U
nouncement that Merril
an .
an online trading service ties. Some companies may have relatively
tail broker, was launching
re si-
t the most lucrative bu few outstanding shares to be traded, while others
These people represen ers
d for full-service brok have a large number. Some companies are prof-
ss for private banks an
d PaineWebber. itable; others are not. Expectations also affect
such as Merrill Lynch an e
the extent to which th stock prices. For example, two companies may be
“We were surprised by ..
braced technology. .
fluent really have em equal in all respects, but one may have far better
af ey
r habits and the way th
ople are changing thei prospects for growth.
[claimed an analyst].
nduct commerce . . . ,” As a result, stock prices can vary considerably
co 99
June 10, 19
”The Financial Times, from one company to the next. The difficulty

One implication for the investor is that if all
stocks are priced about right, it does not matter
which ones you purchase. You might be lucky and
pick a stock about to go up, or you might get
unlucky and pick a stock about to go down. Because
of this, portfolio diversification”the practice of
holding a large number of different stocks so that
increases in some can offset unexpected declines in
others”is a popular strategy.
There are different ways to purchase equities.
Opening an Internet account with a discount bro-
kerage firm is one means. The investor can then
buy, sell, and monitor his or her stock portfolio
from a personal computer. Or, the investor may
enlist the assistance of a stockbroker”a person
who buys or sells equities for clients. The broker
arranges to have the stocks purchased at a stock
exchange, or supplies the securities from an inven-
Price Factors Equities entitle the buyer to a
tory, or buys them from some other broker.
certain part of the future profits and assets of
the corporation selling the stock. What factors
influence the price of equities?
Organized Stock Exchanges
A number of organized securities exchanges
facing the investor, then, is to decide which to
exist”places where buyers and sellers meet to
buy”and which to avoid. Fortunately, the answer is
trade securities. An organized exchange gets its
simpler than you might imagine.
name from the way it conducts business. Members
The Efficient Market Hypothesis (EMH)”the
pay a fee to join, and trades can only take place on
argument that stocks are always priced about right
the floor of the exchange.
and that bargains are hard to find because they are
followed closely by so many investors”is often used
to help explain the pricing of equities. A leading The New York Stock Exchange
expert on the topic explains how this might happen:
The oldest, largest, and most prestigious of the
Essentially, the EMH states that there are some organized stock exchanges in the United States is
100,000 or so full-time, highly trained, profes- the New York Stock Exchange (NYSE), located on
sional analysts and traders operating in the market Wall Street in New York City. This exchange, like
and following some 3,000 major stocks. If each most other organized exchanges, has certain rules
analyst followed only 30 stocks, there would still be for both its members and the corporations listed
1,000 analysts following each stock. Further, these on the exchange.
analysts work for organizations such as Merrill
Lynch and Prudential Insurance, which have bil-
lions of dollars available with which to take
advantage of bargains. As new information about
a stock becomes available, these 1,000 analysts all
receive and evaluate it at approximately the same
Student Web Activity Visit the Economics: Principles
time, so the price of the stock adjusts almost imme-
and Practices Web site at epp.glencoe.com and click
diately to reflect new developments.
on Chapter 12”Student Web Activities for an activ-
”from Eugene F. Brigham™s Fundamentals of ity on the New York Stock Exchange.
Financial Management

Figure 12.7

The New York Stock Exchange
52 Weeks Yld Vol Net
Hi Lo Stock Sym Div % PE 100s Hi Lo Close Chg
10 10 “
12 1 8 8 9 16 1.04 10.4 9
EquityOne 283
EQY 10 3 8 14
46 48
56 1 2 37 1 4 + 1
EsteeLaudr A .20 .4 45 4612 48

8 1 4 4 11 16 67 8 61 2 6
FrontrOil ... 22 80
FTO 3 16
37 16 3 8 Hasbro HAS .24 1.5 12 33793 16 7 16 15 13 16 16 “ 12

Reading the Financial Page Figure 12.7 shows examples of stocks traded on the New York Stock
Exchange. The price of a share of stock generally goes up and down throughout the day as the
conditions of supply and demand change. At the end of the business day, each stock has a closing
price. Of the stocks shown, which made the biggest gain on this particular day?

The NYSE has about 1,400 seats, or memberships, For many years, the AMEX was the second
that allow access to the trading floor. Large brokerage largest organized exchange in the country behind
companies, such as Merrill Lynch, may own as many the NYSE. Its growth then slowed, and some of the
as 20 seats at any given time. The members may pay regional exchanges overtook the AMEX. Overall,
several million dollars for each seat. Members have the companies represented on the AMEX tend to
the right to elect their own directors and vote on the be smaller and more speculative than those listed
rules and regulations that govern the exchange. on the NYSE.
The NYSE lists stocks from more than 3,000
Regional Stock Exchanges
companies. The firms must meet stringent require-
ments related to profitability and size, which virtually The regional exchanges include the Chicago,
guarantee that the companies will be among the Pacific, Philadelphia, Boston, and Memphis
largest, most profitable publicly held companies. exchanges, along with some smaller exchanges in
Figure 12.7 shows how prices are listed on the NYSE.
other cities. Many of these exchanges originally
During the last 12 months, Hasbro sold for as listed corporations that were either too small or too
much as $37 and as little as $16.37 a share. Its annual new to be listed on the NYSE or the AMEX.
dividend (Div) is $.24, which is paid in four equal Today, however, many stocks are listed on both the
installments. The yield (Yld) is the dividend divided NYSE and a regional exchange. The regional stock
by the closing price. The PE, or price-earnings ratio, exchanges also meet the needs of the smaller and
is a stock™s price divided by annual earnings of each middle-sized corporations in their regions.
share of common stock outstanding. Hasbro closed
at $.50 lower than the day before, as indicated by
Global Stock Exchanges
1/2 under Net Change (Net Chg).
Stock exchanges can be found throughout the
world. Exchanges operate in such cities as Sydney,
The American Stock Exchange Tokyo, Hong Kong, Singapore, Johannesburg, and
Frankfurt. Developments in computer technology
Another prestigious national exchange is the
and electronic trading have linked these markets so


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