AP Econ Unit 4 Vocab

Interest Rate

The price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year

Savings-Investment Spending Identity

An accounting fact that states that savings and investment spending are always equal for the economy as a whole

Budget Surplus

The difference between tax revenue and government spending when tax revenue exceeds government spending

Budget Deficit

The difference between tax revenue and government spending when government spending exceeds tax revenue

Budget Balance

The difference between tax revenue and government spending. A positive value is referred to as a budget surplus; a negative value is referred to as a budget deficit.

National Savings

The sum of private savings and the government’s budget balance; the total amount of savings generated within the economy

Capital Inflow

The net inflow of funds into a country; the difference between the total inflow of foreign funds to the home country and the total outflow of domestic funds to other countries.  A positive net value represents funds borrowed from foreigners to finance domestic investment; a negative net value represents funds lent to foreigners to finance foreign investment.

Wealth

The value of accumulated savings

Financial Asset

A paper claim that entitles the buyer to future income from the seller, including loans, stocks, bonds, and bank deposits

Physical Asset

A claim on a tangible asset that gives the owner the right to dispose of the object as they wish

Liability

A requirement to pay income in the future

Transaction Costs

The expenses of negotiating and executing a deal

Financial Risk

Uncertainty about future outcomes that involves financial losses and gains

Diversification

Investment in several different assets with unrelated, or independent, risks, so that the possible losses are independent events

Liquid

Describes an asset that can be converted into cash without much loss of value

Illiquid

Describes an asset that cannot be quickly converted into cash without much loss of value

Loan

A lending agreement between an individual lender and an individual borrower; usually tailored to the individual borrower’s needs and ability to pay, but carry relatively high transaction costs

Default

When a borrower fails to make payments as specified by the bond contract

Loan-Backed Securities

Assets created by pooling individual loans and selling shares in the pool

Financial Intermediary

An institution, such as a mutual fund, pension fund, life insurance company, or bank, that transforms the funds it gathers from many individuals into financial assets

Mutual Fund

A financial intermediary that creates a stock portfolio by buying and holding shares in companies and then selling shares of this portfolio to individual investors

Pension Fund

A type of mutual fund that holds assets in order to provide retirement income to its members

Life Insurance Company

A financial intermediary that sells policies guaranteeing a payment to a policyholder’s beneficiaries when the policyholder dies

Bank Deposit

A claim on a bank that obliges the bank to give the depositor his or her cash when demanded

Bank

A financial intermediary that provides liquid assets in the form of bank deposits to lenders and use those funds to finance the illiquid investments or investment spending needs of borrowers

Money

Any asset that can easily be used to purchase goods and services

Currency in Circulation

Actual cash held by the public

Checkable Bank Deposits

Bank accounts on which people can write checks

Money Supply

The total value of financial assets in the economy that are considered money

Medium of Exchange

An asset that individuals acquire for the purpose of trading for goods and services rather than for their own consumption

Store of Value

An asset that is a means of holding purchasing power over time

Unit of Account

A measure used to set prices and make economic calculations

Commodity Money

A medium of exchange that is a good, normally gold or silver, that has intrinsic value in other uses

Commodity-Backed Money

A medium of exchange that has no intrinsic value, whose ultimate value is guaranteed by a promise that it can be converted into valuable goods on demand

Fiat Money

A medium of exchange whose value derives entirely from its official status as a means of payment

Monetary Aggregate

An overall measure of the monetary supply. The most common money aggregates in the United States are M1, which includes currency in circulation, traveler’s checks, and checkable bank deposits, and M2, which includes M1 as well as near-moneys.

Near-Moneys

A financial asset that can’t be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits

Present Value

The amount of money needed at the present time to produce, at the prevailing interest rate, a given amount of money at a specific future time

Net Present Value

The present value of current and future benefits minus the present value of current and future costs

Bank Reserves

Currency held by banks in their vaults plus their deposits at the Federal Reserve

T-Account

A simple tool that summarizes a business’s financial position by showing, in a single table, the businesses’s assets and liabilities, with assets on the left and liabilities on the right

Reserve Ratio

The fraction of bank deposits that a bank holds as reserves. In the United States, the minimum required reserve ratio is set by the Federal Reserve.

Required Reserve Ratio

The smallest fraction of deposits that the Federal Reserve allows banks to hold

Bank Run

A phenomenon in which many of a bank’s depositors try to withdraw their funds due to fears of a bank failure

Deposit Insurance

A guarantee that a bank’s depositors will be paid even if the bank can’t come up with the funds, up to a maximum amount per account

Reserve Requirement

Rules set by the Federal Reserve that set the minimum reserve ratio for banks. For checkable bank deposits in the United States, the minimum reserve ratio is set at 10%.

Discount Window

An arrangement in which the Federal Reserve stands ready to lend money to banks

Excess Reserves

A bank’s reserves over and above the reserves required by law or regulation

Monetary Base

The sum of currency in circulation and bank reserves

Money Multiplier

The ratio of the money supply to the monetary base; indicates the total number of dollars created in the banking system by each $1 addition to the monetary base

Central Bank

An institution that oversees and regulates the banking system and controls the monetary base

Commercial Bank

A bank that accepts deposits and is covered by deposit insurance

Investment Bank

A bank that trades in financial assets and is not covered by deposit insurance

Savings and Loans (Thrifts)

Deposit-taking banks, usually specialized in issuing home loans

Leverage

The degree to which a financial institution is financing its investments with borrowed funds

Balance Sheet Effect

The reduction in a firm’s net worth from falling asset prices

Vicious Cycle of Deleveraging

Describes the sequence of events that takes place when a firm’s asset sales to cover losses produces negative balance sheet effects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset prices

Subprime Lending

Lending to home buyers who don’t meet the usual criteria for borrowing

Securitization

The pooling of loans and mortgages made by a financial institution and the sale of shares in such a pool to other investors

Federal Funds Market

The financial market that allows banks that fall short of reserve requirements to borrow funds from banks with excess reserves

Federal Funds Rate

The interest rate at which funds are borrowed and lent in the federal funds market

Discount Rate

The interest rate the Fed charges on loans to banks

Open-Market Operation

A purchase or sale of U.S. Treasury bills by the Federal Reserve, undertaken to change the monetary base, which in turn changes the money supply

Short-Term Interest Rates

The interest rate on financial assets that mature within less than a year

Long-Term Interest Rates

The interest rate on financial assets that mature a number of years into the future

Money Demand Curve

A graphical representation of the negative relationship between the quantity of money demanded and the interest rate. The curve slopes downward because, other things equal, a higher interest rate increases the opportunity cost of holding money.

Liquidity Preference Model of the Interest Rate

A model of the market for money in which the interest rate is determined by the supply and demand for money

Money Supply Curve

A graphical representation of the relationship between the quantity of money supplied by the Federal Reserve and the interest rate

Loanable Funds Market

A hypothetical market in which the demand for funds is generated by borrowers and the supply of funds is provided by lenders. The market equilibrium determines the quantity and price, or interest rate, of loanable funds.

Rate of Return

The profit earned on an investment project expressed as a percentage of its cost

Crowding Out

The negative effect of budget deficits on private investment, which occurs because government borrowing drives up interest rates

Fisher Effect

The principle by which an increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged