Lecture_4 - Savings, Investment, and the Financial System...

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Savings, Investment, and the Financial System Saving, Investment, and the Financial System 0. The financial system consists of the group of institutions in the economy that help to match one person’s saving with another person’s investment. 1. It moves the economy’s scarce resources from savers to borrowers. FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY 2. The financial system is made up of financial institutions that coordinate the actions of savers and borrowers. 3. Financial institutions can be grouped into two different categories: 0. Financial markets 1. Financial intermediaries FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY 4. Financial Markets 2. Stock Market 3. Bond Market 5. Financial Intermediaries 4. Banks 5. Mutual Funds FINANCIAL INSTITUTIONS IN THE U.S. ECONOMY 6. Financial markets are the institutions through which savers can directly provide funds to borrowers. 7. Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. Financial Markets 8. The Bond Market 6. A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond. 7. Characteristics of a Bond
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Term: The length of time until the bond matures. 1. Credit Risk: The probability that the borrower will fail to pay some of the interest or principal. 2. Tax Treatment: The way in which the tax laws treat the interest on the bond. 0. Municipal bonds are federal tax exempt. Financial Markets 9. The Stock Market 8. Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes. 9. The sale of stock to raise money is called equity financing. 3. Compared to bonds, stocks offer both higher risk and potentially higher returns. 10.The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ. Financial Markets 10.The Stock Market 11.Most newspaper stock tables provide the following information: 4. Price (of a share) 5. Volume (number of shares sold) 6. Dividend (profits paid to stockholders) 7. Price-earnings ratio Financial Markets 11.Stocks vs. Bonds 0. Corporations issue stock to raise investment funds, allowing stockholders to own a piece of the company 1. Corporations issue bonds to borrow investment funds 2. By issuing debt, corporations can deduct the interest paid on the debt 3. Stockholders enjoy the greatest possible return, but are the last to be paid off in the event of a bankruptcy 4. Bond-holders are paid off first after employees in the event of a bankruptcy Financial Intermediaries 12. Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. Financial Intermediaries
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This note was uploaded on 05/04/2009 for the course ECON 202 taught by Professor Amsler during the Spring '08 term at Michigan State University.

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Lecture_4 - Savings, Investment, and the Financial System...

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