Chap 8 solution - Ch 8 SOLUTIONS TO TEXTBOOK PROBLEMS Quick...

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Ch 8 SOLUTIONS TO TEXTBOOK PROBLEMS Quick Quizzes 1. A stock is a claim to partial ownership in a firm. A bond is a certificate of indebtedness. They are different in numerous ways: (1) a bond pays interest (a fixed payment determined when the bond is issued), while a stock pays dividends (a share of the firm’s profits that can increase if the firm is more profitable); (2) a bond has a fixed time to maturity, while a stock never matures; and (3) if a company that has issued both stock and bonds goes bankrupt, the bondholders get paid off before the shareholders, so stocks have greater risk and potentially greater return than bonds. Stocks and bonds are similar in that both are financial instruments that are used by companies to raise money for investment, both are traded on exchanges, both are subject to credit risk, and the returns to both are taxed (usually). 2. Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. Public saving is the amount of tax revenue that the government has left after paying for its spending. National saving is equal to the total income in the economy that remains after paying for consumption and government spending. Investment is the purchase of new capital, such as equipment or buildings. These terms are related in two ways: (1) National saving is the sum of public saving and private saving, by definition. (2) National saving equals investment.
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3. If more Canadians adopted a “live for today” approach to life, they would spend more and save less. This would shift the supply curve to the left in the market for loanable funds, causing the interest rate to rise. In equilibrium, there would be less saving and investment, and a higher interest rate. Questions for Review 1. The financial system's role is to help match one person's saving with another person's investment. Two markets that are part of the financial system are the bond market, through which large corporations, the federal government, or provincial and territorial governments borrow, and the stock market, through which corporations sell ownership shares. Two financial intermediaries are banks, which take in deposits and use the deposits to make loans, and mutual funds, which sell shares to the public and use the proceeds to buy a portfolio of financial assets. 2. It is important for people who own stocks and bonds to diversify their holdings because then they will have only a small stake in each asset, which reduces risk. Mutual funds make such diversification easy by allowing a small investor to purchase parts of hundreds of different stocks and bonds. 3. National saving is the amount of a nation's income that is not spent on consumption or government purchases. Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. Public saving is the amount of tax revenue that the government has left after paying for its spending. The three variables are related because national saving equals private
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