Chapter 26: Saving, Investment, and the Financial System Flashcards
Financial system
The group of institutions in the economy that help match borrowers and lenders.
Financial markets
Financial institutions through which savers can directly lend to borrowers
(a) Financial intermediaries
(b) Why do other intermediaries only offer savers a “store of value” ?
(a) Financial institutions through which savers can indirectly lend to borrowers
(b) Because their saving is not as accessible
(a) Bank
Banks (b)____ on deposits and charge a slightly
higher rate on (c)____
(a) Institution that collects deposits and makes loans
(b) pay interest
(c) their loans
(a) Medium of exchange
(b) Why do banks create a “medium of exchange” when they accept a deposit ?
(a) Spendable asset such as a checking deposit
(b) Because individuals can write checks against the deposit to engage in transactions
Bond
Certificate of indebtedness or IOU (I owe you)
Stock
Certificate of ownership of a small portion of a large firm
(a) Mutual fund
(b) What is one target of mutual fund ?
(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
Closed economy
An economy with no international transactions
National saving (often referred to as simply saving)
The income that remains after consumption expenditures and government purchases
Private saving = Y – T – C
The income that remains after consumption expenditures and taxes
Public saving = T – G
The tax revenue that the government has left after paying for its spending
Budget surplus
An excess of tax revenue over government spending causing public saving to be positive
Budget deficit
A shortfall of tax revenue relative to government spending that causes public saving to be negative
Government debt
The accumulation of past budget deficits
Investment
Expenditures on capital equipment and structures
Market for loanable funds
The market in which those who want to save supply funds and those who want to borrow to invest demand funds
(a) Demand for loanable funds
It comes from (b)____
(a) The amount of borrowing for investment desired at each real interest rate
(b) national saving
(a) Supply of loanable funds
It comes from (b)____.
(a) The amount of saving made available for lending at each real interest rate
(b) households and firms wishing to borrow to invest
Crowding out
A decrease in investment as a result of government borrowing
bond market
large borrowers borrow directly from the public by selling bonds
What does a bond specify?
- date of maturity (the date the loan will be repaid)
- principal (the amount borrowed and to be repaid at maturity)
Bond issues differ in three main ways
- terms (time to maturity)
- credit risk (probability of default)
- types of tax treatment
Why are Longer-term bonds riskier ?
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
Junk bonds
exceptionally risky bonds
Why do municipal bonds pay lower interest?
Becasue the interest received from owning a municipal bond (bond issued by state or local government) is tax exempt
stock market
large firms raise funds for expansion by taking on additional “partners” or owners of the firm
Why is the sale of stock called “equity finance” while the sale of bonds is called “debt finance” ?
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
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
(a) stock exchanges
(b) supply and demand
(c) reflect expectations
Why do small businesses usually borrow from banks?
Because they are too small to sell stock or bonds
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.
(a) because market price of stock is already good reflection of company’s true value.
(b) index funds keep costs low
“supply of loanable funds” comes from (a)____.
“Demand for loanable funds” comes from (b)____
(a) national saving
(b) households and firms wishing to borrow to invest
(a) Reduced taxation on interest and dividends
(b) Reduced taxation if one invests
(c) A reduction in government debt and deficits
(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.
Which is both a “store of value” and a “common medium of exchange” ?
checking account balances
stock index
an average of an important group of stock prices.
store of value
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.
beat index funds
buy all of the stocks in a stock index without the aid of ac tive management
National Income Accounts
The record in relationship among income, output,
saving, investment, expenditures, taxes, and so on
date of maturity
the date the loan will be repaid
principal
the amount borrowed and to be repaid at maturity
