Chapter 26: Saving, Investment, and the Financial System

Question 1

Financial system

Answer 1

The group of institutions in the economy that help match borrowers and lenders.

Question 2

Financial markets

Answer 2

Financial institutions through which savers can directly lend to borrowers

Question 3

(a) Financial intermediaries

(b) Why do other intermediaries only offer savers a “store of value” ?

Answer 3

(a) Financial institutions through which savers can indirectly lend to borrowers
(b) Because their saving is not as accessible

Question 4

(a) Bank
Banks (b)____ on deposits and charge a slightly
higher rate on (c)____

Answer 4

(a) Institution that collects deposits and makes loans
(b) pay interest
(c) their loans

Question 5

(a) Medium of exchange

(b) Why do banks create a “medium of exchange” when they accept a deposit ?

Answer 5

(a) Spendable asset such as a checking deposit

(b) Because individuals can write checks against the deposit to engage in transactions

Question 6

Bond

Answer 6

Certificate of indebtedness or IOU (I owe you)

Question 7

Stock

Answer 7

Certificate of ownership of a small portion of a large firm

Question 8

(a) Mutual fund

(b) What is one target of mutual fund ?

Answer 8

(a) Institution that sells shares and uses the proceeds to buy a diversified portfolio (group of stocks and/or bonds)
(b) It allows small savers access to professional money managers

Question 9

Closed economy

Answer 9

An economy with no international transactions

Question 10

National saving (often referred to as simply saving)

Answer 10

The income that remains after consumption expenditures and government purchases

Question 11

Private saving = Y – T – C

Answer 11

The income that remains after consumption expenditures and taxes

Question 12

Public saving = T – G

Answer 12

The tax revenue that the government has left after paying for its spending

Question 13

Budget surplus

Answer 13

An excess of tax revenue over government spending causing public saving to be positive

Question 14

Budget deficit

Answer 14

A shortfall of tax revenue relative to government spending that causes public saving to be negative

Question 15

Government debt

Answer 15

The accumulation of past budget deficits

Question 16

Investment

Answer 16

Expenditures on capital equipment and structures

Question 17

Market for loanable funds

Answer 17

The market in which those who want to save supply funds and those who want to borrow to invest demand funds

Question 18

(a) Demand for loanable funds

It comes from (b)____

Answer 18

(a) The amount of borrowing for investment desired at each real interest rate
(b) national saving

Question 19

(a) Supply of loanable funds

It comes from (b)____.

Answer 19

(a) The amount of saving made available for lending at each real interest rate
(b) households and firms wishing to borrow to invest

Question 20

Crowding out

Answer 20

A decrease in investment as a result of government borrowing

Question 21

bond market

Answer 21

large borrowers borrow directly from the public by selling bonds

Question 22

What does a bond specify?

Answer 22

• date of maturity (the date the loan will be repaid)

- principal (the amount borrowed and to be repaid at maturity)

Question 23

Bond issues differ in three main ways

Answer 23

• terms (time to maturity)
• credit risk (probability of default)
• types of tax treatment

Question 24

Why are Longer-term bonds riskier ?

Answer 24

Because Longer-term bonds usually pay higher interest and the owner of the bond may need to sell it before maturity at a depressed price

Question 25

Junk bonds

Answer 25

exceptionally risky bonds

Question 26

Why do municipal bonds pay lower interest?

Answer 26

Becasue the interest received from owning a municipal bond (bond issued by state or local government) is tax exempt

Question 27

stock market

Answer 27

large firms raise funds for expansion by taking on additional “partners” or owners of the firm

Question 28

Why is the sale of stock called "equity finance" while the sale of bonds is called "debt finance" ?

Answer 28

Owners of stock share profits or losses of the firm while owners of bonds receive fixed interest payments as creditors. => The stockholder accepts more risk than the bondholder accepts but has a higher potential return

Question 29

Stocks don’t mature or expire and are traded on (a)___ such as the New York Stock Exchange and NASDAQ Stock prices are determined by (b)____ and (c)____ of the firm’s future profitability

Answer 29

(a) stock exchanges (b) supply and demand (c) reflect expectations

Question 30

Why do small businesses usually borrow from banks?

Answer 30

Because they are too small to sell stock or bonds

Question 31

There are two reasons why index funds outperform actively managed funds: - First, it is hard to pick stocks whose prices will rise (a)____ - Second, (b)____ by rarely buying and selling and by not having to pay the salaries of professional money managers.

Answer 31

(a) because market price of stock is already good reflection of company’s true value. (b) index funds keep costs low

Question 32

"supply of loanable funds" comes from (a)____. | "Demand for loanable funds" comes from (b)____

Answer 32

(a) national saving | (b) households and firms wishing to borrow to invest

Question 33

(a) Reduced taxation on interest and dividends (b) Reduced taxation if one invests (c) A reduction in government debt and deficits

Answer 33

(a) Real interest rates fall while saving and investment rise. (b) Real interest rates, saving, and investment rise. (c) Real interest rates fall, and saving and investment rise.

Question 34

Which is both a "store of value" and a "common medium of exchange" ?

Answer 34

checking account balances

Question 35

stock index

Answer 35

an average of an important group of stock prices.

Question 36

store of value

Answer 36

The function of an asset that can be saved, retrieved and exchanged at a later time. The most common store of value in modern times has been money, currency, or a commodity like a precious metal, cryptocurrency or financial capital.

Question 37

beat index funds

Answer 37

buy all of the stocks in a stock index without the aid of ac tive management

Question 38

National Income Accounts

Answer 38

The record in relationship among income, output, | saving, investment, expenditures, taxes, and so on

Question 39

date of maturity

Answer 39

the date the loan will be repaid

Question 40

principal

Answer 40

the amount borrowed and to be repaid at maturity