Saving, Investment, and the Financial System (Chapter 8) (5/4/16)
Saving, Investment, and the Financial System (Chapter 8) (5/4/16) ECON 222 001
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This 3 page Class Notes was uploaded by Julia List on Sunday May 8, 2016. The Class Notes belongs to ECON 222 001 at California Polytechnic State University San Luis Obispo taught by Fisher in Spring 2016. Since its upload, it has received 336 views.
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Date Created: 05/08/16
Saving, Investment, and the financial system (Chapter 8) Who brings the saver and borrower together? o System of financial intermediation Financial system is grouped into two categories o Financial markets Institution through which a person who wants to save can directly supply funds to a person who wants to borrow The owner of shares of Intel stock is a part owner of Intel, while the owner of an Intel bond is a creditor of the corporation. Bond market Certificate of indebtedness that specifies obligations of the borrower to the holder of the bond (IOU) Date of maturity- time when loan will be repaid Characteristics o Term- length of time until bond matures Long term bonds are riskier – higher interest rate o Credit risk Probability that borrower will fail to pay some of the interest or principle (failure- default) Government bonds = safe= low interest rate o Tax treatment Way the tax laws treat the interest earned on the bond Taxable income- portion of interest is paid to income taxes Municipal bonds- government bonds- not required to pay income tax Stock market Stock=ownership in a firm o Sale of stock to raise money called equity finance o Sale of bonds- debt finance Stock index- average of group of stock prices o Characteristics Price Dividend (how much of the profits come back to stockholders?) Price- earning ratio- (price of stock/ corporations earning per share) Average is 15, a higher P/E indicates that a corporations stock is expensive relative to recent earnings o Financial intermediaries Financial institution through which savers indirectly provide funds to borrowers Banks- Take deposits from people who want to save and use these deposits to make loans to others o Banks pay depositors interest and charge higher interest on loans A medium of exchange- an item people can use to engage in transactions- banks provide checks to facilitate the movement of goods and services Mutual Funds- institution that sells shares to the public and uses the proceeds to buy a selection or portfolio of various types of stocks, bonds, etc System of financial intermediation matches savers with borrowers o Determine credit worthiness of projects o Holds long term assets and creates short term liabilities Financial intermediary pays athlete a low interest rate and lends out to the doctor at a high interest rare How does a firm borrow o Borrow directly from commercial bank (small business does this) o Float a bond ( o Issue more stock Yields o Always calculated as percent per annum Characteristics of a bond o Maturity The longer to maturity, the cheaper they are o Risk Risky bonds are cheap o Liquidity Illiquid bonds are cheap o Currency of denomination Foreign bonds pay out in foreign currency Investment o I=Y-C-G o Savings=investment Saving o Public saving- amount of tax revenue the government has after paying for spending T-G usually negative Budget surplus T-G positive Deficit T-G negative o Private saving- amount of income household have left after paying taxes and consumption Y(income earned) – T(taxes)-C(consumption) o S=I (savings must equal investment for the economy as a whole) o National saving=private+public saving Supply and demand for market for loanable funds o Supply People who have extra income they want to save and lend out When a household buys a bond from a firm or deposits in a band SAVINGS IS SOURCE OF SUPPLY OF LOANABLE FUNDS o Demand Households and firms that borrow to make investments Mortgages, or firms that borrow to buy new equipment or build factories o Interest rate is the price of a loan o Probable conditions: Supply and demand depends on the real interest rate (corrected for inflation Change in tax law to encourage Americans to save more, supply curve to right Investment tax credit- tax advantage to firm building new factory or buying new equipment, demand shift up Budget runs a deficit- supply of loanable funds decreases, supply curve to left MINDTAP NOTES Suppose RoboTroid, a robotics firm, is selling bonds to raise money for a new lab—a practice known as debt finance. Buying a bond issued by RoboTroid would give Hubertan IOU, or promise to pay, from the firm. In the event that RoboTroid runs into financial difficulty, Hubert and the other bondholders will be paid first. True or false o Expectations of a recession that will reduce economy-wide corporate profits will likely cause the value of Hubert's shares to decline. o RoboTroid earns revenue when Hubert purchases 100 shares, even if he purchases them from an existing shareholder. o The Dow Jones Industrial Average is an example of a stock exchange where he can purchase RoboTroid stock.x Stock=equity, bonds=debt saving investment Dina borrows money to build a new lab for her x engineering firm. Charles purchases a certificate of deposit at his x bank. Juanita purchases stock in NanoSpeck, a biotech x firm. Gilberto takes out a mortgage for a new home in x Detroit. Crowding out is the reduction in the level of investment that occurs when the government borrows to finance a budget deficit. This change in spending causes the government to run a budget surplus, which increase national saving.
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