EECON 2102, week 8 notes
EECON 2102, week 8 notes ECON 2105
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This 7 page Class Notes was uploaded by Randi on Friday October 7, 2016. The Class Notes belongs to ECON 2105 at University of Georgia taught by McWhite in Summer 2016. Since its upload, it has received 3 views. For similar materials see Macroeconomics in Macro Economics at University of Georgia.
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Date Created: 10/07/16
Week 8 Notes ECON 2105 PROF. MCWHITE Financing Growth • For a company to have long term growth, there must be an adequate level of investment • 2 groups in the financial markets: 1. Those that have funds that they choose no to use at the present (lenders) 2. Those who have an immediate need for capital to invest in an idea/project (borrowers) • A financial market is a means to bring the above two groups together o This is the “loanable funds market” o Future production depends on present investment which needs funding • 2 ways to get funds 1. Direct: stocks and bonds 2. Indirect: banks (and others) *most of us deal within the indirect method • The stock market is borrowing/lending by selling rights to potential profits • Generally speaking in the stock market: o Stock or equity in the company is sold o There is no guarantee of payment o Only select groups of people receive dividends • Large corporations can issue stock o Corporations receive funds at the initial price offering (IPO), not as share prices rise o You buy shares from brokers (not directly from the company) • Bond o A bond is a debt instrument with a fixed interest payment o Bonds are less risky than stocks o Bonds can be wither long-‐term or short-‐term *Long-‐term bonds have higher rates of interest • Most of our dealings with financial markets are through Indirect funding o The US banking system is the most common example Week 8 Notes • Bank o Maintain deposits of customers o Also give out loans § Banks consolidate small individual savings and lend those to investors • Demand: Those looking to spend money now • Supply: Those saving now • Like any market, there’s a price to borrow money o In the loanable funds market, this is called the interest rate • The interest rate is 1. An incentive to save instead of spend 2. The cost of spending money you don’t have • Increasing interest rates cause individuals to spend less and save more o Also causes firms/individuals to borrow less • In nominal terms: o The interest rate would not be adjusted for inflation • In real terms: o The interest rate would be the actual rate of return on funds • FISHER EQUATION Real Interest (r) = Nominal (i) – Inflation (π) Also can be written as: i = r + π Week 8 Notes What impacts demand for funds: • Productivity of capital • Expectations of investors • Expectations of inflation rate What impact supply of funds: • Discount rate of investors (also known as time preferences) o If someone saves money, it is said they have a low discount rate • Income/wealth changes • Consumption patterns (smoothing) o Consumption smoothing is being able to spread out income/spending in a way that is consistent and balanced way throughout the consumer’s lifetime • Relative saving options • Expectations of inflation rate o Inflation makes the real value of your debt go back down Week 8 Notes • Affect on supply and demand of loanable funds market when inflation is expected to increase Inflation S’ S D’ D Quantity of Loanable Funds • Affect on demand of loanable funds market when expectations of investors increase Example: Apple predicts that the economy is going to pick up. Inflation S D D’ Quantity of Loanable Funds Week 8 Notes • Affect on supply of loanable funds market if wealth increases o The amount of funds available is going to change Inflation S S’ D Quantity of Loanable Funds • Saving vs. Investing o If you put $200 in the bank this is saving o A company takes out a loan… this is investing • A decrease in income causes interest rates to increase • When people start retiring, they draw money out of the global funds market o This causes interest rates to go up o This means the loans you qualify for gets smaller • Bond prices and interest rates are inversely related • Face value o Bonds have a face value listed on them • Discount bond o Bond is sold for less than what it’s face value is o The face value is still due at maturity though Example: A bond is $1,000. It is sold for $900. Interest Rate: (1000-‐900)/(900) = 11.1% Week 8 Notes • Affect of supply of bond market when expectations of investors increase o When supply of bonds is going up, it drives the price down Price S S’ D Quantity • Bond market when wealth increases S D’ D Week 8 Notes • Default Risk o The chance that the borrower will not pay back the funds owed pay back their bonds) o Default risk (ρ) I = r + π + ρ *California and Illinois have the worst credit rating in the United States • The government spends more than it takes in • Deficit o Yearly difference between taxes and costs • Debt o The total of all deficits • Treasury Securities o Bonds sold by the federal government o T-‐Bills § Short-‐term bonds, less than 52 weeks until maturity o T-‐Notes § 1-‐10 years until maturity o T-‐Bonds § Longer than 10 years until maturity • Mortgages o Like stocks, mortgages became tradable assets • Securitization o Combining different assets (like mortgages) and then selling them to investors o Taking things that aren’t usually considered assets and making them tradable