Chapter 8

Question 1

What is the financial system?

Answer 1

group of institutions in the economy that help to match one person’s saving with another person’s investment

Question 2

What are the 2 types of financial institutions?

Answer 2

1. Financial Markets

2. Financial Intermediaries

Question 3

What are financial markets?

Answer 3

financial institutions through which savers can directly provide funds to borrowers (stocks, bonds)

Question 4

What are financial intermediaries?

Answer 4

financial institutions through which savers can indirectly provide funds to borrowers (banks, mutual funds)

Question 5

What is a bond?

Answer 5

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

Question 6

What is credit risk?

Answer 6

probability that the borrower will fail to pay some of the interest or principle.

Question 7

Who would get the best interest rate for a bond?

Answer 7

Canadian Government (low credit risk) -> provincial/territorial -> corporate -> shaky corps (high credit risk)

Question 8

What is a stock?

Answer 8

a claim to partial ownership in a firm and therefore, some profits that the firm makes

Question 9

Which is higher risk? A stock or a bond? Why?

Answer 9

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

Question 10

How do banks participate as financial intermediaries?

Answer 10

Banks pay depositors interest on their money and make loans to people who want to borrow at slightly higher interest rates

Question 11

What is a mutual fund?

Answer 11

an institution that sells shares to the p

Question 12

What is a mutual fund?

Answer 12

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

Question 13

What is national saving?

Answer 13

total income in the economy that remains after paying for consumption and government purchases (NX =0 in closed economy) ; S

Question 14

What is the equation for national saving?

Answer 14

S = I
I = Y - C - G
S = (Y - T - C) + (T - G)

S: national saving
Y-T-C: private saving
T-G: public saving

Question 15

What is private saving?

Answer 15

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

Question 16

What is public saving?

Answer 16

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

Question 17

What is a budget surplus?

Answer 17

excess of tax revenue over government spending; T>G; positive number

Question 18

What is a budget deficit?

Answer 18

shortfall of tax revenue from government spending; G>T; negative number

Question 19

What is investment?

Answer 19

the purchase of new capital such as equipment and buildings

Question 20

What is investment?

Answer 20

the purchase of new capital such as equipment and buildings`

Question 21

What is the market for loanable funds?

Answer 21

the market in which those who want to save, supply finds and those who want to borrow, to invest and demand funds

Question 22

What is the difference between nominal and real interest rate?

Answer 22

nominal - what is reported; monetary return to saving and cost of borrowing
real - nominal corrected for inflation

Question 23

What are the 3 policies that affect the economy’s saving and investment?

Answer 23

1. saving incentives
2. investment incentives
3. government budget deficits and surpluses

Question 24

What is crowding out?

Answer 24

decrease in investment that results from government borrowing

Question 25

What is a vicious cycle?

Answer 25

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

Question 26

What is a virtuous cycle?

Answer 26

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