Ch.21_Financial_Money_Prices

Ch.21_Financial_Money_Prices - Ch. 21 The Financial System,...

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1 Ch. 21 The Financial System, Money, and Prices In this chapter, we will cover: - The role of banks and other financial intermediaries - The link between stocks and bonds - How the financial system allocates saving - The functions of money - How a central bank controls the money supply
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2 I. The Financial System and the Allocation of Saving to Productive Uses The financial system improves the allocation of saving because:
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3 A. The Banking System Consists of commercial banks, which are privately owned firms that accept deposits and make loans. They accept deposits from individuals and businesses and make loans. Other examples of financial intermediaries are savings and loans and credit unions. Services they provide:
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4 B. Bonds and Stocks 1. A bond is a legal promise to repay a debt. Principal is the amount originally lent. Maturation date the date at which the principal is repaid. Term is the length of time until maturation date. Coupon is the interest paid. If the principal = $1,000,000 and the coupon rate = 5%, then the annual coupon payment is $50,000. Price is the market value of a particular bond at a point in time. Credit Risk is the risk that borrower will go bankrupt and can’t repay. Riskier borrowers have to pay higher interest rates to compensate lenders for the risk. Tax treatment – interest paid on municipal bonds (issued by local govts) is exempt from federal taxes.
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2. The link between bond prices and interest rates When a bond is first issued, it has a coupon rate that remains constant over the life of the bond. Example: $1,000 bond with a 5% coupon rate, 2 year bond, issued Jan. 1, 2011. It pays $50 a year for 2 years, and then repays $1,000 on Dec. 31, 2012.
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Ch.21_Financial_Money_Prices - Ch. 21 The Financial System,...

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