banks and finance Flashcards
interest rate
what it costs you to borrow money (when money is limited you pay more for it)
MRT- borrowing
tradeoff between current and future consumption
real interest rate
adjusting for inflation
interest rate- demand
number of people who have access to credit markets, uncertainty of making new investments
interest rate- supply
people increasing savings (old people), access to foreign capital, uncertainty over the state of the economy (great depression)
benefits of debt
to make an investment today that will hopefully pay off in the future (car, education, house)
to avoid liquidating assets to make payments (selling the things you have)
consumption smoothing
have a decent standard of living your whole life.
tax smoothing
borrowing helps governments overcome gaps in taxes and revenues.
discount rates
concern about the future or immediate gratification
myopia reasons
uncertainty about the future incentives spending more money.
discount rate formula
value today / value tmr
individuals borrow at the point where…
MRS = MRT
discount rate = interest rate
supply of credit
interest rates are determined by supply and demand
principal agent problem
borrowing is another incomplete contract - you can’t make sure if they’re gonna pay back or put it to good use.
how do we overcome p.a problem?
equity, collateral (these help create compatible incentives)