Chapter 9 - Financial Markets

Question 1

Equilibrium: Quantity Supplied = Quantity Demanded

• If Qs > Qd there is a ___
• If Qs < Qd there is a ___

Answer 1

Qs > Qd = Surplus

Qs < Qd = Shortage

Question 2

The “Invisible Hand” Affect

When there is a Surplus, Qs > Qd, ___ will bid down the interest rates.

When there is a Shortage, Qs < Qd, ___ will bid up the interest rates.

Answer 2

Savers

Borrowers

Question 3

Saving:

Investment:

Answer 3

Saving: Income that is not spent on consumption goods.

Investment: The purchase of new capital goods.

Question 4

4 Major Factors that determine the supply of savings:

Answer 4

1. Smoothing Consumption
2. Impatience
3. Marketing and Psychological Factors
4. Interest Rates (i)

Question 5

Time Preference:

Answer 5

The desire to have goods and services sooner rather than later. (All else being equal)

Question 6

Market of Loanable Funds:

Answer 6

Occurs when suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers). Trading in the market for loanable funds determines the equilibrium interest rate.

Question 7

If there is a shortage of loanable funds, the interest rates will ___.

Answer 7

Increase

Question 8

Financial Intermediaries (Banks, Bond Markets, and Stock Markets):

Answer 8

Reduce the costs of moving loanable funds. Mobilize savings toward productive uses.

Question 9

Collateral:

Answer 9

Something of value that by agreement becomes the property of the lender if the borrower defaults.

Question 10

T-Bonds:
T-Notes:
T-Bills:
Zero-Coupon Bonds:

Answer 10

T-Bonds: 30 Year Bonds; Pay interest every 6 Months.
T-Notes: Maturity of 2 - 10 years; Pay interest every 6 Months.
T-Bills: Maturity of few days - 26 weeks; Pay only at maturity.
Zero-Coupon Bonds: Pay only at maturity.

Question 11

Crowding Out:

Answer 11

The decrease in private consumption and investment that occur when government borrowers more.

Question 12

Arbitrage:

Answer 12

The buying and selling of equally risky assets; arbitrage ensures that equally risky assets earn equal returns.

Question 13

Default Risk:

Answer 13

The risk that a the borrower will not pay the loan back.

Question 14

Stock/Share:

Initial Public Offering (IPO):

Answer 14

A certificate of ownership in a corporation.

The first time a corporation sells stock to the public in order to raise capital.

Question 15

Why Financial Intermediations Fail:

Answer 15

• Insecure Property Rights - Scares people from saving.
• Controls on Interest Rates - Cause shortages.
• Politicized Lending - Lending based on political connections.
• The larger the fraction of Gov owned banks, the worse a countries GDP Per Capita Growth and Productivity Growth.
• Trust - Banks keep trust in borrowers to avoid failing.
  (Examples: Argentina froze bank accounts in 2001, Russia confiscated the value of shareholders holdings in Yukos, Cypress in 2013.)

Question 16

Usery Laws:

Answer 16

Impose a ceiling on interest rates that can be charged on a loan. This creates a shortage of savings.

Question 17

Owner Equity:

Leverage Ratio:

Answer 17

The value of the asset minus the debt: E=V-D

The ratio of debt to equity: D/E

Question 18

Securitization:

Answer 18

Assets are bundled together and sold to outside parties as liquid financial assets.

Question 19

The 2007-2008 crisis was brought about by high ___ and falling ___.

Answer 19

Leverage, Asset prices