The Financial System

The Financial System - The Financial System The financial...

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The Financial System The financial system brings savers and investors together. Savings: income that is not used on current consumption and is put in the financial system to (hopefully) earn a return. Investment: spending on capital goods (typically physical capital) . I. Financial Markets: allow savers to provide borrowers funds directly. A. Bond Market (debt financing) Large corporations and the government can borrow directly from the public by issuing bonds (a certificate of debt). The savers (bond holders) earn a return by getting interest on the bond. 1. The term – time until maturity (payback). Longer terms →higher interest rates. 2. Credit Risk More risk →higher interest rates. 3. Taxes More tax →higher interest rates. B. Stock Market (equity financing) Stocks give a share of ownership of a corporation. Only initial stock sales get the firm funds for investment. Savers can earn returns in two ways. 1. If a company profits and increases its net worth then the stock price should rise, and the owner of the stock (the saver) can sell some of the stock on a secondary market. 2. Some companies give out a return to stockholders without the stockholder having to sell any of their stock. This direct return is a dividend.
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C. Dividends 1. Pre 1980s: dividends were common 2. 80s and 90s a. Techs and other start-ups paid no dividends: “signals” b. Some firms used the extra cash for stock “buy-backs” →increase in the price of the stock. 3.
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The Financial System - The Financial System The financial...

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