6. Saving, Investment and the Financial System Flashcards
What is the financial system
it consists of the group of institutions in the economy that help to match one person’s savings with another person’s investment
what does the financial system acheive
it moves the economy’s scarce resources from SAVERS to BORROWERS
Two categories of financial institutions + examples of each
Financial markets: share market and the bond market.
Financial intermediaries: banks, managed funds.
how do bonds work?
consumers give money to businesses and at the end of the bond term they pay them back - interest is paid on it.
what is the term when you sell shares to raise money?
equity financing, the share purchaser own a part of the company
what is the term when you trade bonds?
debt financing, you just lend money
what are junk bonds?
bonds offered by start-up companies that usually disappear after short amount of time
what is the credit risk of a bond?
The probability that the borrower will fail to pay some of the interest or principal
which of bonds and shares have higher risk and higher returns?
Shares offer the higher risk (when a company goes bankrupt, the bank claims first, then the bond holders then shareholders)
they also offer the largest potential return (% of profit)
Why are financial intermediaries important? (one reason covered)
small businesses like grocers can only raise money by borrowing from a bank. Only large companies can use bonds/shares
What is a medium of exchange provided by the bank?
Cheques. They are items that people can easily use to engage in transactions.
stores and bonds are __________ just like a bank
stores of value for people
alternative name for managed funds?
mutual fund
How do managed funds work?
Managed funds sells shares to the public and then use the proceeds to buy a portfolio of various types of stocks and bonds or both. They charge commission.
how do financial systems help
they facilitate long term economic growth, increasing GDP and increasing the quality of life for all
in a closed market, what is the relationship between savings and investments?
savings = investments
what is a closed market?
a market with no imports or exports
what are loanable funds?
all income people have chosen to save and lend out as opposed to using it for consumption
term deposit
depositing money and being paid interest regularly
where does demand for loanable funds come from?
households ands firms that wish to borrow money by selling financial assests
what is the price of a loan
interest on the loan
what determines the real interest rate?
the equilibrium of supply and demand for loanable funds
calculate real interest rate from nominal
nominal interest rate - inflation rate
how can the government affect the loanable fund market?
taxes and saving (incentives to save)
taxes and investment
government budget deficits
how can the government reduce incentive to save
by taxing interest
how will reducing tax on savings interest affect the supply demand curve for loanable funds?
Shifts supply curve to the right meaning lower interest rate for same amount of loanable funds(y axis is interest rate, x axis is loanable funds)
What does an investment tax credit do?
Increases demand for loanable funds, shifts demand curve to the right, results in higher interest rate and greater quantity saved
What is a budget deficit?
When a government spends more than it receives in tax (not necessarily a bad thing) This is called government debt
How does government budget deficit affect the loanable fund market and what is this known as?
It reduces the supply of loanable funds as they borrow the supply, it is known as crowding out (the deficit borrowing crowds out private borrowers)
How does government budget deficit affect interest rate and investment?
supply of loanable funds decreases so interest rate increases and investment decreases as supply shifts left
definition of national saving and equation
National saving is the total disposable income in the economy after paying for government purchases and consumption
S = YD - C - G
where YD is gross national disposable income
definition of private saving and equation
Private saving is the amount of disposable income that households have left after paying taxes and consumption
= YD - T - C
definition of public saving and equation
The amount of tax revenue that the government has left after paying for its spending
= T - G
What is gross national disposable income?
GDP + NFI, where NFI is the net factor income
