Chapter 9

what does the Financial System do

channels resources from saver to borrowers

Canada’s financial system is ___ sector and overseen by the ___

• private

• OSFI (Office of the Superintendent of Financial Institutions)

Financial Market

institutions where savers can directly give money to borrowers

what markets make up the financial market

bond and stock markets

Financial Security

document sold by borrowers to savers, outlining the terms of the money lending

Bond

IOUs that have interest and a maturity date

maturity date of a bond

when the loan will be repaid

term of a bond

the time until the maturity date

credit risk

the risk that the borrower defaults

default meaning

borrower doesn’t pay the loan back

gov vs corporate bonds

Gov

• safer

• lower interest

Corporate

• riskier

• higher interest

Longer term bond have ___ interest due to __ risk

higher, more

Stock

ownership of a part of a company and the right to a part of its profits

bondholders vs stockholders

Bondholders

• lend to the company

• safer

• receive fixed payments and must be paid before the company makes profit

Stockholders

• own a part of the company

• riskier

• higher returns

Financial Intermediaries and an example

Institutions where savers can indirectly lend to borrowers

• eg banks

equity financing vs debt financing

equity financing: companies selling stocks

debt financing: companies selling bonds

what do banks do

accept deposits from savers and lend to borrowers

where do banks earn money from

the interest rate difference between loans and deposits

why do small businesses borrow from banks

they don’t have reputation in stock/bond markets

mutual funds

shares sold by the bank to the public, and the money is invested in a diverse portfolio of stocks/bonds

Closed Economy

economy that doesn’t interact with other economies

In a closed economy, national saving ___ national investment

equals

equation of national saving. Define the terms

S = Y- C - G

S= (Y - T - C) + (T-G)

• S is national saving

• Y is GDP

• T is the net money gov gains from household

  • amount collected by taxing households - transfer payments paid to households (like EI)

• private saving (Y-T-C): household income after they pay taxes (T) and consumption (C)

• public saving (T-G): gov tax profit after gov spending (G)

when is there a budget surplus and budget deficit

• budget surplus if T > G

• budget deficit if G > T

Saving definition

when an individual’s income > consumption

Investment definition

purchasing capital (coffee maker, software)

For the whole economy and individuals, how do savings compare to investment

economy: equal

individuals: not equal

Market for loanable funds

market where savers deposit savings and borrowers get loans

loanable funds

all income that is saved and lent out

who supplies loanable funds
who demands loanable funds

• savers

• investors/borrowers

4 factors that determine supply of loanable funds

• Consumption smoothing

  people save money while working for retirement

• Impatience

  more impatient = less saving

• Psychological factors

  automatic enrolment in a savings plan = more saving

• Interest rates (”profit” from saving)

  higher interest = higher compensation = more saving

3 factors that determine demand of loanable funds

• Consumption smoothing

  students borrow to pay for school

  • Young: low income, borrow for university and home

  • Middle age: high income, save and pay off debt

  • Old age: retired, dissaving (consumption>income)

• Investment financing

  businesses need to borrow to buy equipment that will later generate profit

• Interest rates (”price” of borrowing)

  lower interest = more borrowing

  businesses only borrow when returns from investment are greater than real interest rate

2 factors that shift supply

• changes in private savings

  more private savings = more national saving = shift supply right

• changes in gov budget balance

  budget surplus = more national savings = shift supply right

  budget deficit = shift supply left

2 factors that shift demand

• changes in expectations of future business opportunities

  perceived better returns from investment = shift right

  also includes technological advancements, easier lending standards

• changes in gov policy

  tax credit for R&D or green tech = shift right

what is on the x and y axis of the loanable funds model

x: quantity of loanable funds

y: real interest rate

less supply causes __ interest rates

higher

crowding out

gov deficits increases interest rate and discourages investment

crowding out won’t occur if ____

the economy is underperforming

gov borrowing shifts ___, but private borrowing shifts ___

supply, demand