Lecture 7 Flashcards
What are financial markets?
institutions through which savers can directly provide funds to borrowers
What are the two different type of financial markets?
- share market
- bond market
Both bond and share markets are ways to link up people who have and people who need what?
funds
What are share (stock) sales?
this is the issuing of new stocks, not just buying and selling existing stocks so now you have a share of the profits
What is a bond?
this is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond
What does a bond identify?
- the time at which the principal of the loan will be repaid (the date of maturity)
- and the rate of interest that will be paid periodically until the loan matures
Governments issuing bonds is a way to promise to pay back loanable funds and can be on-sold. True or false?
true
What does interest on a bond depend on?
it’s maturity date and also the credit risk associated with the bond
Longer maturity dates are risky/riskier. Why?
risker
This is because the bond holder has to wait longer to be repaid and there is always the possibility they have to sell, perhaps at a reduced price
What is credit risk?
this is the probability that a borrower fails to pay some or even all of the interest or principal - the greater the risk, the greater the interest rate
What are shares?
These represent a claim to partial ownership in a firm which means that owning a share establishes a claim to the profits that the firm makes.
What is the purpose of shares?
To raise funds for capital
Can shares be on-sold to someone else?
yes
Compared to bonds, shares offer a ________ risk and a ________ reward
higher
higher
After shares are initially sold by the company to the public, they are traded among shareholders on stock exchangers on stock markets, true or false?
true
What are share prices determined by?
supply and demand (which depends on people’s perception of the corporation’s future profitability)
What is the share index?
an average of a group of _______ prices which provides an index of the overall level of share ______
an average of a group of share prices which provides an index of the overall level of share prices
What is a share price?
the _____ and _______ price reported _______
the opening and closing price reported daily
What is a dividend?
profits paid to share holders
What is the price-earning-ratio in terms of shares?
this is the price of the _______ per amount ________ earned per _________ - it is an indicator for future ________ or perhaps _____ or if _________ or ___________
this is the price of the share per amount corporation earned per share - it is an indicator for future performances or perhaps share or if undervalued or overvalued
What are financial intermediaries?
these stand between borrowers and saver, thus enabling savers to indirectly provide funds to borrowers
How do banks act as intermediaries?
they collect deposits from savers (who pay interest) and use these deposits to loan to borrowers (at a higher interest rate)
banks also play a role in providing a medium of exchange
What are managed funds?
These can be intermediaries: an institution that puts your funds around for you to manage your risk and you get a good return
In a closed economy, NX =
0
In a closed economy, net foreign income =
0
Give examples of net foreign income
us giving foreign aid, UK pensions coming into NZ
If, in a closed economy, NX = 0 and NFO = 0, Y =
C + I + G
*not C + I + G + NX
If Y = C + I + G then Y - C - G = I and Y - C - G = S, this implies that ______ = _______ where S = ________ and I = ___________
S = I
S = national savings I = investment
For a closed economy, savings must equal what? Why is this?
investment
because what is not being spent in the government or by the public is what is being saved and therefore it is not going into the economy
What does investment mean in this sense?
this is the demand for loanable funds
If interest rates increase what can change?
the supply and demand for loanable funds
how do we define national savings?
__________ __________ income that remains after paying for __________ and __________ purchases
national disposable income that remains after paying for consumption and government purchases
S = Y - C - G
if we let T denote tax revenue minus transfer payments, S = Y - C - G and therefore S = (Y - T - C) + (T - G).
What do these components mean?
Y - C - G is the private savings which is the gross national income that households have left after paying for consumption and taxes
(T-G) is the public savings which is tax revenue minus government purchases
Savings can be determined by the
interest rate
If the tax revenue is greater than the government purchases, there is a
surplus
If the tax revenue is less than the government purchases, there is a
deficit
If T>G, the government runs a budget surplus and so what happens to S?
S (ie. national savings) increases
If T
S (ie. national savings) decreases
Where does the supply of loanable funds come from?
savers
Where does the demand of loanable funds come from?
investors
What is the equilibrium price in the market for loanable funds called?
the real interest rate
What is the real interest rate?
the inflation-corrected interest rate
What are three fiscal policies that affect the market for loanable funds?
- taxes and saving
- taxes and investment
- government budget deficits
What happens to the supply of loanable funds when the interest rate increases?
it becomes more attractive to save and so people have more loanable funds and therefore S increases
Who demands loanable funds?
What effect does a higher interest rate have of the demand for loanable funds?
firms wanting to start up, if there is a higher interest rate, it is more expensive to get loanable funds and so the demand decreases
One of the fiscal policies that affect market for loanable funds is taxes and saving. What is the effect of the government decreasing taxes on saving?
- reducing the tax on savings makes it more attractive to save because you pay less tax on the interest earned
- this means that more people are going to save and so there is an increase in the supply of loanable funds
- this causes the interest rate to fall and the quantity of loanable funds to increase
One of the fiscal policies that affect market for loanable funds is taxes and investment. What is the effect of an investment tax credit?
- if firms can show that they are doing investment they can get investment tax credit (which makes it more attractive to do investment)
- this means that the demand for loanable funds increases because it has become more attractive to do investing
- the demand curve shifts to the right which means that the interest rate increases and the quantity of loanable funds increases
One of the fiscal policies that affect market for loanable funds is government budget deficits. What is the effect of crowding out due to government deficits?
- the government budget deficit means T < G which means that savings in the economy are going down (public savings is negative) so the interest rate goes up as a result and quantity of loanable funds goes down
- when governments run a budget deficit, they reduce national savings which reduces national saving, which results in a rising interest rate and falling investment
- the decrease in investment that results from government borrowing is called crowding out
- because investment is important for long-run economic growth, government budget deficits reduce the economy’s growth rate
