Chapter 8 Flashcards
What is the financial system?
group of institutions in the economy that help to match one person’s saving with another person’s investment
What are the 2 types of financial institutions?
- Financial Markets
2. Financial Intermediaries
What are financial markets?
financial institutions through which savers can directly provide funds to borrowers (stocks, bonds)
What are financial intermediaries?
financial institutions through which savers can indirectly provide funds to borrowers (banks, mutual funds)
What is a bond?
a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond - time it will be repaid (date of maturity), and the rate of interest ; an IOU
What is credit risk?
probability that the borrower will fail to pay some of the interest or principle.
Who would get the best interest rate for a bond?
Canadian Government (low credit risk) -> provincial/territorial -> corporate -> shaky corps (high credit risk)
What is a stock?
a claim to partial ownership in a firm and therefore, some profits that the firm makes
Which is higher risk? A stock or a bond? Why?
Stocks are higher risk because they only get a return when the company makes profits
Bonds are less risky, only get the principle and interest, but get paid first
How do banks participate as financial intermediaries?
Banks pay depositors interest on their money and make loans to people who want to borrow at slightly higher interest rates
What is a mutual fund?
an institution that sells shares to the p
What is a mutual fund?
an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds; allows people with small amounts of money to diversify
What is national saving?
total income in the economy that remains after paying for consumption and government purchases (NX =0 in closed economy) ; S
What is the equation for national saving?
S = I
I = Y - C - G
S = (Y - T - C) + (T - G)
S: national saving
Y-T-C: private saving
T-G: public saving
What is private saving?
the income that households have left after paying for taxes and consumption; HH receive incomes of Y, pay taxes of T and spend C on consumption
What is public saving?
the tax revenue that the government has left after paying for its spending; receives T in tax revenue, and spends G on goods and services
What is a budget surplus?
excess of tax revenue over government spending; T>G; positive number
What is a budget deficit?
shortfall of tax revenue from government spending; G>T; negative number
What is investment?
the purchase of new capital such as equipment and buildings
What is investment?
the purchase of new capital such as equipment and buildings`
What is the market for loanable funds?
the market in which those who want to save, supply finds and those who want to borrow, to invest and demand funds
What is the difference between nominal and real interest rate?
nominal - what is reported; monetary return to saving and cost of borrowing
real - nominal corrected for inflation
What are the 3 policies that affect the economy’s saving and investment?
- saving incentives
- investment incentives
- government budget deficits and surpluses
What is crowding out?
decrease in investment that results from government borrowing
What is a vicious cycle?
cycle that results when deficits reduce the supply of loanable funds, increase interest rates, discourage investment, and result in slower economic growth; slower growth leads to lower tax revenue and higher spending on income support programs, & the result can be even high deficits
What is a virtuous cycle?
cycle that results when surpluses increase the supply of loanable funds, reduce interest rates, stimulate investment, and result in faster economic growth; faster growth leads to higher tax revenue and lower spending on income support programs, and the result can be even higher budget surpluses
