Notes 2-6 - The Link Between Savers and Borrowers The...

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The Link Between Savers and Borrowers The financial system is the group of institutions in the economy that help to match one person’s saving with another person’s investment. The financial system is then made up of financial institutions. It is important to note that the link between the saver and the buyer can be direct or indirect. If the link is direct, the borrower will borrow directly from the saver. This works through the financial markets. On the other hand, if the link is indirect, the borrower will borrow indirectly from the saver. This works through financial intermediaries. Financial Markets: Financial markets can be money markets or capital markets . Money markets are those markets in which only short-term debt (maturities of less than one year) instruments are traded. The capital market is that market in which longer-term debt instruments (maturities of more than one year) and equity instruments are traded. Money market instruments What are the instruments involved in the money market? Mostly short-term bonds, such as US treasury bills. Bonds are certificates of indebtedness that specify the obligations of the borrower to the holder of the bond (the lender). 1. US Treasury Bills Short-term debt instruments – these are issued in maturities of 9 week, 13 week or 26 week maturities. These are discount bonds – they are sold at a discount and pay a face value at maturity. No explicit interest is paid, but the interest payment is implicit. Low default risk because they are backed by the US government. They also have low interest rate risk and low inflation risk as well as low income risk. (This is because they are short-term instruments.) Note that default risk is also called credit risk. Capital Market Instruments
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Notes 2-6 - The Link Between Savers and Borrowers The...

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