Chapter 14: Finance Flashcards
What are traditional markets?
G+S that help match with those willing to sell
What is included in the Financial system?
it is made up of savers and borrowers in a market where people trade different financial products
banks act as intermediaries - lend out money
the financial system provides liquidity and diversity risk
Investing
lenders may not get their money back, it is risky game
when individuals buy shares of part of a company. if the company grows, they gain money.
3 transactions in the Financial market
- Information asymmetry
- when someone in a transaction knows more than another person
- Adverse selection
- when buyers and sellers know different informaiton about the quality of G+S and the riskiness of the deal
- Moral Hazard
- when people behave riskier and make decisions based on their insurance
What is the Market for loanable funds?
where those who want to save supply funds & those who want to borrow invest demand funds.
savers supply money to borrowers to pay for their investment spending needs.
the rate of interest is the same for borrowers and lenders
the Equlibrium rate determines the Interest rate, and the amount traded in the market.
saving = supply for loans
investing = demand for loans
what is the Real intrest rate?
the price of money
money that you pay in the future for transfers in the past.
Saving- investment Identity
Y = C + I + G + NX
it is closed in one economy, doesn’t include NX
soo… Y = C + I + G
National savings
the total income in the economy that is left over after paying for consumption and government spending.
National savings = Y - C - G = I
so now, National savings = Investment
National savings = public savings + private saving
Changes in the cost of borrowing
Cost of Borrowing = interest rate
the higher the cost of borrowing, the less households want to borrow, and banks want to lend out more money.
the lower the cost of borrowing, the more households want to borrow, and banks want to lend out less money.
Why do we save?
saving decisions reflect Trade-offs between spending now, or saving to spend in the future.
Wealth
Economic conditions
Expectations about the future economy
Uncertinty
Borrowing constraints
Social Welfare policies
Culture
Why do we invest?
Investment decisions reflect a Trade-off between potential profits and the cost of borrowing money considering:
1. expectation about the money you can make
2. uncertainty about future economic decisions
3. changes in the Gov.’s Deficit/Surplus
What can cause changes in interest rates?
- Time - if you take out a longer loan, it costs more
- Riskiness of the transaction - if you are a high risk borrower, the bank will not lend you money based on your history.
different types of interest rates
Credit risk: the chance that the envestor won’t be repaid for the amount of money they originally paid for.
Risk Free Rate: the interest rate that you would get if there was no default risk
Risk premium: difference between the risk free rate and the interest rate investors must pay.
What are 3 functions of the Financial system?
- act as intermediaries
- Provide Liquidity
- diversity risk
What are 3 major Financial assets?
- Equity - when you hold shares in a company
- Debt - a bond is an IOU paper that says you borrowed money from someone
- loans: when taking out a loan, banks look for collateral and your financial reccord - Derivatives - financial products based on the value of another product
- future contracts: the buyer of a future contract agrees to pay a future price.
- most trading happens through future contracts.
