6. Saving, Investment and the Financial System

Question 1

What is the financial system

Answer 1

it consists of the group of institutions in the economy that help to match one person’s savings with another person’s investment

Question 2

what does the financial system acheive

Answer 2

it moves the economy’s scarce resources from SAVERS to BORROWERS

Question 3

Two categories of financial institutions + examples of each

Answer 3

Financial markets: share market and the bond market.

Financial intermediaries: banks, managed funds.

Question 4

how do bonds work?

Answer 4

consumers give money to businesses and at the end of the bond term they pay them back - interest is paid on it.

Question 5

what is the term when you sell shares to raise money?

Answer 5

equity financing, the share purchaser own a part of the company

Question 6

what is the term when you trade bonds?

Answer 6

debt financing, you just lend money

Question 7

what are junk bonds?

Answer 7

bonds offered by start-up companies that usually disappear after short amount of time

Question 8

what is the credit risk of a bond?

Answer 8

The probability that the borrower will fail to pay some of the interest or principal

Question 9

which of bonds and shares have higher risk and higher returns?

Answer 9

Shares offer the higher risk (when a company goes bankrupt, the bank claims first, then the bond holders then shareholders)

they also offer the largest potential return (% of profit)

Question 10

Why are financial intermediaries important? (one reason covered)

Answer 10

small businesses like grocers can only raise money by borrowing from a bank. Only large companies can use bonds/shares

Question 11

What is a medium of exchange provided by the bank?

Answer 11

Cheques. They are items that people can easily use to engage in transactions.

Question 12

stores and bonds are __________ just like a bank

Answer 12

stores of value for people

Question 13

alternative name for managed funds?

Answer 13

mutual fund

Question 14

How do managed funds work?

Answer 14

Managed funds sells shares to the public and then use the proceeds to buy a portfolio of various types of stocks and bonds or both. They charge commission.

Question 15

how do financial systems help

Answer 15

they facilitate long term economic growth, increasing GDP and increasing the quality of life for all

Question 16

in a closed market, what is the relationship between savings and investments?

Answer 16

savings = investments

Question 17

what is a closed market?

Answer 17

a market with no imports or exports

Question 18

what are loanable funds?

Answer 18

all income people have chosen to save and lend out as opposed to using it for consumption

Question 19

term deposit

Answer 19

depositing money and being paid interest regularly

Question 20

where does demand for loanable funds come from?

Answer 20

households ands firms that wish to borrow money by selling financial assests

Question 21

what is the price of a loan

Answer 21

interest on the loan

Question 22

what determines the real interest rate?

Answer 22

the equilibrium of supply and demand for loanable funds

Question 23

calculate real interest rate from nominal

Answer 23

nominal interest rate - inflation rate

Question 24

how can the government affect the loanable fund market?

Answer 24

taxes and saving (incentives to save)

taxes and investment

government budget deficits

Question 25

how can the government reduce incentive to save

Answer 25

by taxing interest

Question 26

how will reducing tax on savings interest affect the supply demand curve for loanable funds?

Answer 26

Shifts supply curve to the right meaning lower interest rate for same amount of loanable funds(y axis is interest rate, x axis is loanable funds)

Question 27

What does an investment tax credit do?

Answer 27

Increases demand for loanable funds, shifts demand curve to the right, results in higher interest rate and greater quantity saved

Question 28

What is a budget deficit?

Answer 28

When a government spends more than it receives in tax (not necessarily a bad thing) This is called government debt

Question 29

How does government budget deficit affect the loanable fund market and what is this known as?

Answer 29

It reduces the supply of loanable funds as they borrow the supply, it is known as crowding out (the deficit borrowing crowds out private borrowers)

Question 30

How does government budget deficit affect interest rate and investment?

Answer 30

supply of loanable funds decreases so interest rate increases and investment decreases as supply shifts left

Question 31

definition of national saving and equation

Answer 31

National saving is the total disposable income in the economy after paying for government purchases and consumption S = YD - C - G where YD is gross national disposable income

Question 32

definition of private saving and equation

Answer 32

Private saving is the amount of disposable income that households have left after paying taxes and consumption = YD - T - C

Question 33

definition of public saving and equation

Answer 33

The amount of tax revenue that the government has left after paying for its spending = T - G

Question 34

What is gross national disposable income?

Answer 34

GDP + NFI, where NFI is the net factor income