Chapter 10 Flashcards
Savings-investment spending identity
Savings and investment spending are always equal for the economy as a whole
Budget surplus
The difference between tax revenue and government spending when tax revenue exceeds government spending
Budget deficit
The difference between tax revenue and government spending when government spending exceeds tax revenue
Budget balance
The difference between tax revenue and government spending
National savings
The sum of private savings and the budget balance, is the total amount of savings generated within the economy
Savings (national) = savings (government) + savings (private)
“investment spending”
spendingon new physical capital
“making an investment”
The act of purchasing an asset such as a share of stock, a bond, or existing real estate
net capital inflow
The total inflow of funds into a country minus the total outflow of funds out of a country
national cost
the interest that must eventually be paid to a foreigner
dollar ofinvestment spending financed by a capital inflow > dollar investment spending financed by national savings
Net capital inflow formula
Net capital inflow = imports - exports
Investment spending formula (with capital inflow)
Investment Spending = National Savings + Net capital inflow
Savings in a closed economy
Savings = National savings
Open economy savings
Savings = national savings + capital inflow
lonable funds market
A hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders
present value
The amount of money needed today in order to receive X at a future date given the interest rate
present value formula
X = 1,000 / (1 + r)
1,000 is money you want to have in one year
x = present value of money
r = interest rate
Cause demand curve for lonable funds to shift
Changes in perceived business opportunities
Changes in government borrowing
crowding out
Occurs when a government budget deficit drives up the interest rate and leads to reduced investment spending
Shifts of the supply of Lonable funds
Changes in private savings behavior
Changes in net capital inflows
Real interest rate =
Real interest rate = nominal interest rate - inflation rate
Fisher effect
An increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged
wealth
the value of its accumulated savings
financial asset
a paper claim that entitles the buyer to future income from the seller
physical asset
a tangible object that can be used to generate future income
liability
a requirement to pay income in the future
4 types of financial assets
Loans
stocks
bonds
bank deposits
3 problems for borrowers and lenders
transaction costs
risk
desire for liquidity
transaction costs
the expenses of negotiating and executing a deal
risk-averse
a person who is more sensitive to a loss than to a gain of an equal dollar
diversification
Investing in several different things so that the possible losses are independent events
liquid
If an asset can be quickly converted into cash with relatively little loss of value
illiquid
An asset that cannot be quickly converted into cash with relatively little loss of value
loan
a lending agreement between an individual lender and an individual borrower
default
Occurs when a borrower fails to make payments as specified by the loan or bond contract
securitization
process of pooling individual loans and selling shares in that pool
loan-backed security
An asset created by pooling individual loans and selling shares in that pool
Financial intermediary
An institution that transforms the funds it gathers from many individuals into financial assets
Types of financial intermediaries
mutual funds
pension funds
life insurance companies
banks
pension fund
A type of mutual fund that holds assets in order to provide retirement income to its members
Life insurance company
Sells policies that guarantee a payment to a policyholder’s beneficiaries when the policyholder dies
bank deposit
A claim on a bank that obliges the bank to give the depositor his or her cash when demanded
Bank
a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investment spending needs of borrowers
efficient markets hypothesis
Asset prices embody all publicly available information
random walk
the movement over time of an unpredictable variable
behavioral finance
The study of how investors in financial markets often make predictably irrational choices
loss aversion
unwilling to sell an unprofitable asset and accept the loss
herd mentality
buyinig an asset when its price has already been driven high and selling it when its price has already been driven low
