Exam 2 Flashcards
Define Investment
incur some upfront cost today in hopes of receiving future-benefits
Macroeconomics definition of investment
spending on new capital assets that increase the economy’s productive capacity
Define saving
the money you have leftover after paying for your spending
capital stock
total quantity of capital at a point in time
Define business investment
spending by businesses on new capital investments
Define inventories
raw materials, work in progress, unsold goods
Housing investment
spending on building new houses or apartments as well as improvements to existing housing
Compound interest
you earn interest not only on your initial deposit but also on your previously earned interest, so your wealth compounds
Define present value
amount of money that you’d invest today in order to produce an equivalent benefit in the future
depreciation rate
the proportion of an investment’s remaining productive capacity you lose each year due to depreciation
Rational rule for investors
pursue an investment opportunity if the present value of future revenue exceeds the up-front cost
Factors that shift investment
interest rates, rational rule for investors:
- technological advances
- expectations
- corporate taxes
- lending standards and cash reserves
Define market for loanable funds
market for funds used to buy, rent, or build capital
what does the market for loanable funds determine?
long-run real interest rate and the quantity of investment
the price of a loan is equal to what
real interest rate
Define neutral real interest rate
interest rate that operates when the economy is in neutral (producing neither above/below its potential)
How is supply shifted in the loanable funds market?
If there is a change in savings by those who supply loanable funds–> private savers, government, foreigners
Specific shifts in supply of loanable funds
- changes in personal savings rates
- budget deficit or surplus shifts gov. spending
- Global shocks shift foreign saving
Specific shifts in demand of loanable funds
- techological advances
- expectations
- corporate tax
- Easier lending standards/ cash reserves
Three types of investment
business, inventories, and housing investment
Define crowding out
phenomena where government needs to borrow money and crowd out money that could have been used by firms
How does the bank earn profit?
By putting your money to work after you put it in a bank
Functions of banks
- pool savings from many savers
- spread the risk of lending money across many borrowers
- solve information problems
- provide payment services
- create long-term loans from short-term deposits
Define maturity transformation
using short-term loans to make long-term loans– ensures investors can fund long-term projects
Bank run
occurs when many customers try to withdraw their savings at the same time–> can cause a bank to collapse
Fire sale
a quick sale due to financial distress
Deposit insurance
makes bank runs less likely and ensures you will always get your savings back even if your bank collapses
shadow banks
not real banks not covered by deposit insurance
Bond market
where the “big dogs” go to borrow the big bucks
Bond
an IOU that spells out the terms of a loan
Borrower is also known as
the issuer
The principal
how much money has to be repaid
The maturity date
when the loan must be repaid
Coupons
the interst promised to be payed
Functions of the bond market
- Channels funds from the savers to the borrowers
- Funds gov. debt
- Spreads risk by issuing money to many companies
- Creates liquidity
Liquidity
the ability to quickly and easily convert your investments to cash with little or no loss in value
Default risk
cost of not getting paid– assigns credit ratings to businesses to ensure this does not happen
Term risk
arrises when there is uncertainty about future interest rates
Liquidity risk
when your bond will be hard to sell–> need to sell an asset quickly, might not be able to get a good price for it
What is the safest investment
US gov bonds
What does a stock represent
partial ownership in a firm– when you own a stock in a company, you own a share in that company
Dividends
tallies up its profits and pays some as dividends
retained earnings
profits not sent out as dividends which are reinvested into the company
Functions of stocks
- channel funds from savers to investors
- reallocate control
- creates liquidity and makes it easier to own stocks
IPO
initial public offering of stock to potential investors
stock price
how much a company is worth
stock price chart
shows how risky a stock is over time
Market capitalization
value of the entire company
Efficient market hypothesis
at any point in time, financial prices reflect all publicly available information.
- Impossible to predict the stock’s value
- Financial prices move unpredictably
Federal funds rate
rate banks charge each other for overnight loans
Reserve requirements
minimum amount of reserves that each bank must hold
Open market trading desk
where fed buys and sells gov. bonds overnight w agreement to buy back next day at a higher price
Floor framework
floor on how low of an interest rate a financial institution will be willing to lend another
Discount rate
banks offer collateral and get a loan from the fed that helps them meet the reserve requirements
Yield
a way of measuring expected returns from a bond
What is a treasury bond used for
to pay for deficit spending
Speculative bubbles
the price of an asset rises above its fundamental value (highly inflated prices)
Greater fool theory
you can always find someone else to buy your stock
Mutual funds
a fund that buys a portfolio of stocks and bonds on your behalf
Index funds
A mutual fund that consists of a broad market index
Excess reserves
amount banks have on their reserves above the required amount creates a minimum interest floor
Globalization
increasing global integration of economies, cultures, political institutions and ideas
Financial inflows
foreigners investing in the United states–> funds flow into the U.S.
Financial outflows
Americans investing their money in other countries–> funds flow out of the U.S.
Financial flows
investment in foreign physical assets financial assets and loans
Portfolio investment
foreigners buy american stocks or bonds
Deposits and loans
foreigners lend money to americans
when financial flows start rising
- countries remove capital controls
- Deregulation of the financial sector
- Large institutional investors
- Technology
- Financial innovation
Appreciate
currency becomes more expensive
Depreciate
currency becomes cheaper
Shifts in demand currency
- Exports from the U.S.
- Strengths of the global economy
- Barriers to trade in foreign market
- Domestic innovation and marketing
- Foreign Prices
- Domestic prices
- Financial inflows in the U.S.
- interest rate differentials
- Business profitability
- Political risk
- Expected exchange rate movements
Shifts in supply currency
- Imports in the U.S.
- strength if the domestic economy
- trade barriers protecting domestic producers
- foreign innovation and marketing
- domestic prices
- foreign prices
- Financial outflows from the U.S.
- interest rate differentials
- business profitability
- political risk
- expected exchange rate movements
What does the real exchange rate measure?
(un) competitiveness of american products
- low real exchange rate means goods are competitive
real trade-weighted index
evaluates American competitiveness relative to a weighted average of dozens of our most important trading partners
Quantitative anchoring
prices in the previous period is an anchor for what you think prices would be next period
Moral anchoring
psychological thinking says most of what determines human thinking is a result of stories and justification, not numbers
Absolute advantage
being the most efficient in finishing a task
Comparative advantage
the ability to do a task at a lower opportunity cost
What factors shape comparative advantage?
- Having abundance of certain resources/inputs
- Develop a specialized skill
- Exploit the benefits of mass production
Foreign direct investment
a new building/company or plant, other physical assets
Purchasing power parity
two currencies can buy the same amount of goods
Aggregate expenditure
describes everyone’s spending plans
When does the macroeconomic equilibrium occur
when aggregate expenditure is equal to GDP
short-run
year to year ups and downs
long-run
economy’s potential output
potential output
level at which all resources are fully employed
output gap
measures the gap between actual and potential output a a percentage of potential output
IS curve
illustrates the link between interest rates, GDP and the output gap
MP curve
how changes in the risk premium affect the real interest rate
Multiplier
summarizes effect of an initial burst of spending on output
Positive output gap
economy is overheating, producing too much
Negative output gap
some resources are not used to full capcity
Okun’s rule
for every percentage point that actual output falls below potential output the unemployment rate is around half a percentage higher
Who determines the risk premium
financial markets
