Final Notes - Chapter 8 Savings Investment and the...

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Chapter 8: Savings, Investment, and the Financial System Financial Institutions in the U.S. Economy o Financial system : the group of institutions in the economy that help to match one person’s saving with another person’s investment Moves the economy’s scarce resources from savers to borrowers o Financial Market : financial institutions through which savers can directly provide funds to borrowers Bond Market : borrowing directly from the public (debt financing) Bond : a certificate of indebtedness (an IOU) o Three characteristics A bonds term: the length of time until it matures Long-term bonds are riskier that short-term bonds Credit risk: the probability that the borrower will rail to pay some of the interest or principal Junk bond: very risky but pay high interest rates Tax treatment: the way the tax laws treat the interest earned on the bond Government issue bonds: the bond owners are not required to pay federal income tax on the interest income o Types of bonds Corporate Government and agency Municipal bonds (government issue bonds) Mortgage or asset backed bonds Stock Market (equity financing) Stock : a claim to partial ownership
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o Compared to bonds, stocks offer the holder both higher risk and potentially higher return o The prices at which shares trade on stock exchanges are determined by the supply and demand for the stock in these companies o Stocks performance is linked to company’s performance o If company runs into financial trouble, bond holders are paid first o Traded on stock exchanges (NYSE, NASDAQ) Stock Index : weighted average of major stocks o Ex. Dow Jones Industrial Average (30 companies) o Used to reflect overall economic activity o Financial Intermediaries : financial institutions through which savers can indirectly provide funds to borrowers Banks Primary job of banks is to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow They facilitate purchases of goods and services by allowing people to write checks against their deposits medium of exchange Mutual Funds: an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds The primary advantage of a mutual fund is that they allow people with small amounts of money to diversify Saving and Investment In the National Income Accounts o Some Important Identities Y = C + I + G + NX Y = GDP (GDP is divided into four components of expenditure) o C = consumption o I = investment o G = government spending
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