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EECON 2102, week 8 notes

by: Randi

EECON 2102, week 8 notes ECON 2105

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About this Document

We started covering chapter 9 this week.
Class Notes
loanable funds markets, bonds, securities, Mortgages, supply, demand, Expectations, Taxes, securitization, nominal, real, indirect, Banking, finance
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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    


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