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34 Cards in this Set
- Front
- Back
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Define: financial system |
Consists of the group of institutions in the economy that help to match one person's saving with another person's investment. - Moves the economies' scarce resources from savers to borrowers - Coordinates the action of savers and borrowers |
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Define: financial market |
The institutions though which savers can directly provide fund to borrowers (share market, bond market) - Determine growth, SOL, GDP |
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Define: Financial intermediaries |
Financial institutions which though savers can indirectly provide funds to borrowers (Banks, managed funds) - Borrow indirectly from the bank - Stocks and bonds |
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Define: debt finance |
Browsing other people's money to suit your own finance |
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Define: equity finance |
Sale of a share to fund your company |
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Define: Banks (medium of exchange) |
In-between buyer and saver. - A medium of exchange is an item that people can easily use to engage in transactions - Stocks and bonds are a store of value for people just like bank deposits |
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Mutual funds |
- Diversify investments (don't put all money in one place to reduce risk) - This reduces risk but the shareholder has to accept both loss and gain - The mutual commission will charge a small amount for their services |
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Bond market |
Bond = a certificate of indebtedness that specifies obligation of the borrower to the holder of the bond |
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Characteristics of a bond |
Term = the length of the time until the bond matures Credit risk = the probability that the borrower will fail to pay some of the interest or principal Tax treatment: the way in which the tax laws treat the interest on the bond |
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Share market |
Share = claim to a partial ownership in a firm and is, therefore, a claim to the profits the firm makes. (equity financing) - Compared to a bond, shares offer both higher risk and potentially higher returns |
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Financial intermediary: Banks |
- Take deposits from people who want to save and use the deposits to make loans to people who want to borrow - Pay depositors interest on their deposits and charge borrowers slightly higher interest rates on their loans. - Banks help create a MEDIUM OF EXCHANGE by allowing people to write cheques against their deposits (facilitates purchase of G/S) |
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Financial intermediary: Managed funds |
= an institution that sells shares to the public and uses the proceeds to by a portfolio of various types of stocks and/or bonds. - They allow people with small amounts of money to diversify their investments easily. |
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Most important identities |
Y = C + I + G + NX Yd = Y + NFI (GNDI) Yd - C - G = (Y - C - G) + NFI S = (Y - C - G) + NFI S = Yd - C - G |
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National saving |
The total disposable income that remains after paying for consumption and government purchases. |
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Implications of a large negative NFI |
1. Saving as a proportion of GDP in NZ is rather low by international standards 2. Nonetheless, a low saving to GDP ratio does not mean that NZ residents consume too much and save too little |
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How saving and investment are related in an open economy |
S = (Y - C - G) + NFI Y = C + I + G + NX So, S = (C + I + G + NX - C - G) + NFI Simplified: S = I + (NX + NFI) |
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How saving and investment are related in a closed economy |
S = I NFI = 0 NX = 0 |
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Define: closed economies |
Ones that don't engage in international trade (NX = 0) adn does not allow residents to earn income across national borders (NFI = 0). Y - C - G = I So, S = I |
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Savings |
S = Yd - C - G Where Yd = Y + NFI and S = (Yd - T - C) + (T - G) |
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National saving |
S = Yd - C - G = the total disposable income in the economy that remains after paying for consumptions and government purchases. |
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Private saving |
S = Yd - T - C = the amount of disposable income that households have left after paying their taxes and paying for their consumption |
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Public saving |
S = T - C = the amount of tax revenue that the government has left after paying for its spending T > G = budget surplus (surplus = public saving) G > T = budget deficit |
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Market for loanable funds |
= the market in which those who want to save - supply funds - and those who want to borrow to invest - demand funds When S = D - allocating the economy's scarce resources to their most efficient use Links the present to the future - future generations will inherit the good/bad For an individual, S cannot equal I, but financial institutions make this possible. |
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Loanable funds |
Refers to all income that people have chosen to save and lend out, rather than to use for their own consumption (usually as bonds, shares, mutual funds, cash deposits) |
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SUPPLY of loanable funds |
Comes from people who have extra income they want to save and lend out by buying financial assets such as bonds, shares and term deposits. |
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DEMAND for loanable funds |
Comes frmo households and firms that want to borrow to make investments by setlling financial assets. |
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Saving and growth |
No saving = no growth |
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Interest rates |
Savers lend to investors at a price = interest rate Represents the amount that borrowers pay for loans and the amount that lenders receive on their saving The interest rate in the market for loanable funds is the REAL INTEREST RATE (where S=D) |
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Increase in the supply of loanable funds |
1. Tax incentives for saving increase the supply of loanable funds 2. Which reduces the equilibrium rate 3. Raises the equilibrium quantity of loanable funds |
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Increase in the demand of loanable funds |
1. An investment credit tax increases the demand for loanable funds 2. Raises the equilibrium interest rate 3. Raises the equilibrium quantity of loanable funds |
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Government policies: Incentives to save |
Taxes on interest income - reduce the future payoff from current saving, reducing the incentive to save. vice versa Increased consumption tax increases incentive to save High inflation = less purchasing power = more saving Changes supply of loanable funds |
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Government policies: Incentives to invest |
Investment tax credit increases the incentive to borrow Changes demand for loanable funds |
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Government policies: Government budget deficits and surplus |
The accumulation of deficits (G > T revenue) is called government debt (burden on future generations) Deficits make public saving negative (T - G) but don't impact demand - interest rates increase and discourage people from buying houses and building factories Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms = CROWDING OUT (fall in funds for private investment) Budget deficit shifts the supply curve left |
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Crowding out |
Refers to when government must finance its spending with taxes and/or with deficit spending, leaving businesses with less money and effectively "crowding them out. |
