Savings, Investment + Financial System

Question 1

What is a Financial System?

Answer 1

Consists of Financial Institutions that help match Savings with Investments
- Matches Savers + Borrowers

Question 2

Define Financial Markets

Answer 2

Markets where Savers can Directly provide Funds to Borrowers

Question 3

What are the 2 Important types of Financial Markets?

Answer 3

Bond Market + Stock Market

Question 4

What are Bonds?

Answer 4

Certificate of Indebtedness

• Have a Maturity date, Coupon Rate + Market price
• Rate of Interest reflects ‘Credit Risk’
• -> Long term bonds usually pay Higher Interest

Question 5

What is a Stock?

Answer 5

Claim to Partial Ownership in a firm

– Therefore- a Claim on its Profits (Dividends)

Question 6

Where are Stocks Traded?

Answer 6

Organised Stock Exchange

Question 7

What are the Prices of Stocks determined by?

Answer 7

Demand + Supply

Expected Profitability

Question 8

What is Equity?

Answer 8

Sale of Stock to raise Money

Question 9

What is a Stock Index?

Answer 9

Average of a Group of Stock Prices

- Can indicate Future Economic conditions

Question 10

What are Financial Intermediaries?

Answer 10

Institutions where Savers Indirectly provide funds to Borrowers
- e.g. Banks + Mutual Funds

Question 11

How do Banks work?

Answer 11

• Take in Deposits from Savers- in return Bank pays ‘Deposit Rate’
• Loan out Deposits to Borrowers- charge Interest Rate on Loans

Question 12

What is a Mutual / Investment Fund?

Answer 12

Institution that Sells Shares to Public

- Uses proceeds to buy a Portfolio of Stocks + Bonds

Question 13

What are the Advantages of Mutual/Investment Funds?

Answer 13

• People with little money can diversify- but pay a management fee
• Diverse Portfolio–> Reduces Risk
• Access to Professional Money managers- but in an Efficient Market- Prices may NOT be correctly priced

Question 14

Accounting Identity of a Closed Economy

Answer 14

NX = 0 => Y = C + I + G

Question 15

Accounting Identity of an Open Economy

Answer 15

NX ≠ 0 - Unless X = Z

Y = C + I + G + NX

Question 16

Define National Saving

Answer 16

Total Income in Economy after paying for C + G

S = Y - C - G (= I)

Question 17

What is Private Saving?

Answer 17

Y - T - C

Income of Households after paying for Spending- Taxes + Consumption

Question 18

What is Public Spending?

Answer 18

T - G

Question 19

How is National Saving calculated?

Answer 19

National Saving = Public Saving + Private Saving

Question 20

When is there a Budget Surplus?

Answer 20

T - G > 0

Question 21

When is there a Budget Deficit?

Answer 21

T - G < 0

Question 22

During a Budget Deficit, where does the Gov. borrow Money from?

Answer 22

Bonds + GILTS

Question 23

What is the Supply of Loanable Funds?

Answer 23

Savings - Public + Private

Question 24

What is Demand for Loanable Funds?

Answer 24

Private Investments

Question 25

Why are Public Investments NOT included in Demand for Loanable Funds?

Answer 25

Already Included in G

Question 26

What is the Price of a Loan?

Answer 26

Real Interest Rate

Question 27

How does the Interest Rate affect the Market for Loanable Funds?

Answer 27

Increased I.R –> Decreased Qd + Increased Qs

Decreased I.R –> Increased Qd + Decreased Qs