UNIT 5 VOCABULARY: THE FINANCIAL SECTOR

Question 1

Interest Rate:

Answer 1

The cost of borrowing money is expressed as a percentage of the loan amount. It is also the return earned on savings or investments.

Question 2

Savings-Investment Spending Identity:

Answer 2

An economic principle states that total savings in an economy must equal total investment spending. In other words, the amount saved by households and businesses is used to fund investments.

Question 3

Budget Surplus:

Answer 3

The situation where government revenues exceed government expenditures over a specific period. A budget surplus indicates that the government is saving or paying down debt.

Question 4

Budget Deficit:

Answer 4

The situation where government expenditures exceed government revenues over a specific period. A budget deficit indicates that the government is borrowing money to cover the shortfall.

Question 5

Budget Balance:

Answer 5

The difference between government revenues and expenditures. It can be a surplus, deficit, or balanced budget depending on whether revenues are greater than, less than, or equal to expenditures.

Question 6

National Savings:

Answer 6

The total amount of savings in an economy, which includes both private savings (by households and businesses) and public savings (by the government). National savings are crucial for funding investment and economic growth.

Question 7

Capital Inflow:

Answer 7

The movement of financial capital into a country from foreign investors. It can include investments in stocks, bonds, and other assets. Capital inflows can affect exchange rates and the balance of payments.

Question 8

Wealth:

Answer 8

The total value of all assets owned by an individual or a country, minus liabilities. It includes financial assets, physical assets, and any other forms of wealth.

Question 9

Financial Asset:

Answer 9

An asset that represents a claim to future cash flows or returns, such as stocks, bonds, or savings accounts.

Question 10

Physical Asset:

Answer 10

Tangible items that have value, such as real estate, machinery, or commodities. They are used in production or consumption and are not easily converted to cash.

Question 11

Liability:

Answer 11

A financial obligation or debt that an individual or organization owes to others. Examples include loans, mortgages, and bonds.

Question 12

Transaction Costs:

Answer 12

The costs associated with buying or selling financial assets, such as brokerage fees, commissions, and other charges. They can affect the efficiency and profitability of financial transactions.

Question 13

Financial Risk:

Answer 13

The potential for financial loss or the variability in returns associated with investments or financial decisions. Risks can come from market fluctuations, interest rate changes, or credit defaults.

Question 14

Diversification:

Answer 14

The strategy of spreading investments across different assets or asset classes to reduce overall risk. Diversification aims to minimize the impact of a single asset’s poor performance on the entire investment portfolio.

Question 15

Liquid:

Answer 15

Describes assets that can be quickly and easily converted into cash without significantly affecting their price. Examples include cash and marketable securities.

Question 16

Illiquid:

Answer 16

Describes assets that are not easily converted into cash or may require a significant discount to sell quickly. Examples include real estate and specialized equipment.

Question 17

Loan:

Answer 17

A financial agreement where a lender provides money to a borrower with the expectation that it will be repaid with interest over a specified period.

Question 18

Default:

Answer 18

The failure to meet the legal obligations of a loan, such as missing a payment or failing to repay the principal or interest as agreed.

Question 19

Loan-Backed Securities:

Answer 19

Financial instruments that are backed by a pool of loans, such as mortgages or auto loans. Investors receive payments based on the repayments made by borrowers of the underlying loans.

Question 20

Financial Intermediary:

Answer 20

An institution or individual that facilitates the flow of funds between savers and borrowers. Examples include banks, credit unions, and investment firms.

Question 21

Mutual Fund:

Answer 21

An investment vehicle that pools money from multiple investors to purchase a diversified portfolio of stocks, bonds, or other securities. It is managed by professional fund managers.

Question 22

Pension Fund:

Answer 22

A type of investment fund that collects and invests money on behalf of employees to provide retirement benefits. Contributions are typically made by both employees and employers.

Question 23

Life-Insurance Company:

Answer 23

An organization that provides life insurance policies, which offer financial protection to beneficiaries in the event of the policyholder’s death. These companies also invest in premiums to generate returns.

Question 24

Bank Deposit:

Answer 24

Money is placed into a bank account by individuals or businesses. Bank deposits can earn interest and are typically insured up to a certain limit.

Question 25

Banks:

Answer 25

Financial institutions that accept deposits, provide loans, and offer a range of financial services. Banks play a crucial role in the financial system by facilitating transactions and providing credit.

Question 26

Money:

Answer 26

A system or medium used to facilitate the exchange of goods and services. It generally takes the form of currency, bank deposits, or other instruments that serve as a measure of value.

Question 27

Currency in Circulation:

Answer 27

The physical money (coins and paper bills) is actively used by the public for transactions. It excludes money held by banks and other financial institutions.

Question 28

Checkable Bank Deposits:

Answer 28

Funds held in bank accounts that can be accessed using checks or debit cards. These deposits are part of the money supply and are used for everyday transactions.

Question 29

Money Supply:

Answer 29

The total amount of money available in an economy at a particular time. It includes currency in circulation, checkable bank deposits, and sometimes other forms of money.

Question 30

Medium of Exchange:

Answer 30

One of the primary functions of money; it facilitates transactions by serving as an intermediary in the exchange of goods and services. Money is accepted in payment for goods and services.

Question 31

Store of Value:

Answer 31

One of the primary functions of money; it allows people to save purchasing power for future use. Money maintains its value over time, making it a reliable way to store wealth.

Question 32

Unit of Account:

Answer 32

One of the primary functions of money; it provides a standard measure of value, making it easier to compare the value of different goods and services.

Question 33

Commodity Money:

Answer 33

Money that has intrinsic value because it is made of a commodity that is valuable on its own, such as gold or silver coins. The value of commodity money comes from the material it is made of.

Question 34

Commodity-Backed Money:

Answer 34

Money that is backed by a commodity, such as gold or silver, which can be exchanged for the commodity on demand. It has value because it can be redeemed for a physical asset.

Question 35

Fiat Money:

Answer 35

Money that has no intrinsic value but is declared to be legal tender by the government. Its value comes from the trust and acceptance of the people, not from any physical commodity.

Question 36

Monetary Aggregate:

Answer 36

A measure of the total money supply in an economy. Common aggregates include M1 (currency and checkable deposits) and M2 (M1 plus savings accounts and other near-moneys).

Question 37

Near-Moneys:

Answer 37

Financial assets that are not as liquid as cash or checkable deposits but can easily be converted into cash or checkable deposits. Examples include savings accounts and certificates of deposit (CDs).

Question 38

Present Value:

Answer 38

The current value of a sum of money that is to be received or paid in the future, discounted at a specific interest rate. It represents how much a future amount of money is worth today. Present value calculations are used to evaluate investments and financial decisions by determining how much future cash flows are worth in today’s terms.

Question 39

Bank Reserves:

Answer 39

The portion of a bank’s deposits that are held in cash or deposited with the central bank and are not used for lending or investing. Reserves ensure that banks can meet withdrawal demands and regulatory requirements.

Question 40

T-Account:

Answer 40

A simplified accounting tool used to track the financial transactions of a bank. It consists of two columns: one for debits and one for credits. The format resembles the letter “T” and helps illustrate changes in account balances.

Question 41

Reserve Ratio:

Answer 41

The fraction of deposits that a bank is required to hold in reserves and not lend out. It is expressed as a percentage of total deposits. For example, a 10% reserve ratio means a bank must hold 10% of its deposits as reserves.

Question 42

Required Reserve Ratio:

Answer 42

The minimum percentage of deposits that banks are required to keep as reserves, as mandated by the central bank. This ratio is set to ensure that banks have enough funds available for withdrawals and to control the money supply.

Question 43

Bank Run:

Answer 43

A situation where a large number of customers withdraw their deposits from a bank simultaneously due to fears that the bank may fail. Bank runs can lead to liquidity problems and financial instability.

Question 44

Deposit Insurance:

Answer 44

A guarantee is provided by the government or an insurance agency that protects depositors by covering their account balances up to a certain limit if a bank fails. In the U.S., the Federal Deposit Insurance Corporation (FDIC) provides this protection.

Question 45

Reserve Requirement:

Answer 45

The amount of funds that a bank must hold in reserve against deposits, as set by the central bank. It is a regulatory measure used to ensure banks maintain liquidity and stability.

Question 46

Discount Window:

Answer 46

A facility provided by the central bank where banks can borrow short-term funds at a specified interest rate, known as the discount rate. It helps banks manage temporary liquidity needs and maintain stability.

Question 47

Excess Reserves:

Answer 47

Funds that a bank holds in reserve beyond the required minimum. Excess reserves can be used for additional lending or investment opportunities. They provide banks with extra liquidity.

Question 48

Monetary Base:

Answer 48

The total amount of a country’s currency in circulation plus reserves held by banks at the central bank. It includes physical currency and reserve balances and is a key component of the money supply.

Question 49

Money Multiplier:

Answer 49

The ratio of the total amount of money that banks generate with each dollar of reserves. It measures the maximum potential increase in the money supply resulting from an increase in bank reserves. The money multiplier is calculated as 1 divided by the reserve ratio.

Question 50

Central Bank:

Answer 50

A national institution responsible for managing a country’s monetary policy, overseeing the banking system, and providing financial stability. The central bank regulates money supply, sets interest rates, and acts as a bank for the government and other banks. Examples include the Federal Reserve (U.S.), the European Central Bank (ECB), and the Bank of England.

Question 51

Commercial Bank:

Answer 51

A financial institution that provides a wide range of services to individuals and businesses, including accepting deposits, providing loans, and offering checking and savings accounts. Commercial banks focus on everyday banking services and earn profits through interest on loans and fees. Examples include JPMorgan Chase, Bank of America, and HSBC.

Question 52

Investment Bank:

Answer 52

A financial institution that specializes in providing services related to capital markets, such as underwriting new securities, facilitating mergers and acquisitions, and advising on financial strategies. Investment banks do not typically take deposits but focus on large-scale financial transactions and advisory services. Examples include Goldman Sachs, Morgan Stanley, and Barclays Investment Bank.

Question 53

Savings and Loan (S&L) Association:

Answer 53

A financial institution that primarily focuses on accepting savings deposits and making mortgage loans. Savings and loans are designed to help individuals save money and obtain loans for purchasing homes. They are also known as thrift institutions or savings banks. Examples include local or regional savings banks.

Question 54

Federal Funds Market:

Answer 54

The market where banks lend reserve balances to other banks overnight, usually to meet reserve requirements. Transactions in this market involve short-term loans between banks, and the interest rate on these loans is known as the federal funds rate.

Question 55

Federal Funds Rate:

Answer 55

The interest rate at which banks lend reserve balances to other banks overnight in the federal funds market. It is a key tool for the central bank (e.g., the Federal Reserve in the U.S.) to influence monetary policy, affecting overall economic activity, inflation, and employment.

Question 56

Discount Rate:

Answer 56

The interest rate charged by the central bank to commercial banks for short-term loans is provided through the discount window. It is used to manage liquidity and influence the money supply. A lower discount rate encourages banks to borrow more and lend more, while a higher rate discourages borrowing.

Question 57

Open-Market Operations (OMOs):

Answer 57

The buying and selling of government securities (such as Treasury bonds) by the central bank to regulate the money supply and influence interest rates. When the central bank buys securities, it adds money to the banking system, lowering interest rates and increasing the money supply. Conversely, selling securities withdraws money from the system, raising interest rates and decreasing the money supply.

Question 58

Short-Term Interest Rates:

Answer 58

The interest rates on financial products or loans with a short duration, typically less than one year. These rates are influenced by central bank policies and market conditions. Short-term interest rates often reflect the cost of borrowing money for brief periods and can impact consumer and business borrowing decisions. Examples include the rates on Treasury bills or short-term loans.

Question 59

Long-Term Interest Rates:

Answer 59

The interest rates on financial products or loans with a longer duration, typically more than one year. These rates are influenced by factors such as inflation expectations, economic growth projections, and the central bank’s long-term monetary policy. Long-term interest rates affect the cost of borrowing for extended periods and are commonly associated with long-term bonds or mortgages.

Question 60

Money Market:

Answer 60

A segment of the financial market where short-term borrowing and lending occur, typically involving instruments with maturities of one year or less. The money market includes various financial instruments such as Treasury bills, commercial paper, and certificates of deposit. It is a key area for managing short-term liquidity and implementing monetary policy.

Question 61

Loanable Funds Market:

Answer 61

The marketplace where borrowers (such as individuals, businesses, and governments) seek funds to borrow and lenders (such as banks and investors) provide those funds. The interest rate is determined by the supply of and demand for these funds.

Example: If a company wants to expand and needs a loan, it will enter the loanable funds market to find a lender who is willing to provide the necessary capital.

Question 62

Rate of Return:

Answer 62

Definition: The gain or loss made from an investment, expressed as a percentage of the original amount invested. It measures how profitable an investment is.

Example: If you invest $1,000 in stocks and make $100 in profit, your rate of return is 10% ($100 profit divided by $1,000 investment).

Question 63

Crowding Out:

Answer 63

Definition: A situation where increased government borrowing leads to higher interest rates, which then reduces private sector borrowing and investment. When the government borrows more, it increases the demand for loanable funds, pushing up interest rates and making it more expensive for businesses and individuals to borrow.

Example: If the government issues a lot of new bonds to finance its spending, it might raise interest rates, making it harder for businesses to get loans for their own projects, thus reducing private investment.