Unit 4: Financial Sector

loanable funds market

a hypothetical market that brings together those who want to lend money and those who want to borrow money

rate of return

the profit earned on the project expressed as a percentage of its cost on a project

crowding out

occurs when a government deficit drives up the interest rate and leads to reduced investment spending

Fisher effect

an increase in expected future inflation drives up the nominal interest rate by the same number of percentage points, leaving the expected real interest rate unchanged according to it.

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

savings and investment spending are always equal for the economy as a whole according to it

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

national savings

the sum of private savings and the budget balance, is the total amount of savings generate within the economy

capital inflow

equal to the total inflow of foreign funds minus the total outflow of domestic funds to other countries

wealth

the value of accumulated savings

financial asset

a paper claim that entitles the buyer to future income from the seller

physical asset

a claim on a tangible object that gives the owner the right to dispose of the object as he or she wishes

liability

a requirement to pay money in the future

transaction costs

are the expenses of negotiating and executing a deal

financial risk

uncertainty about future outcomes that involve financial losses and gains

diversification

an individual can engage in by investing in several different assets with unrelated risks

liquid

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

illiquid

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

default

occurs when a borrower fails to make payments as specified by the loan or bond contract

loan-backed security

an asset created by pooling individual loans and selling shares in that pool

financial intermediary

an institution that transforms the funds it gathers from many individuals into financial assets

mutual fund

a financial intermediary that creates a stock portfolio and then resells shares of this portfolio to individual investors

pension fund

a nonprofit institution that invests the savings of members and provides them with income when they retire

life insurance company

sells policies that guarantee 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 uses those funds to finance borrowers’ investment spending on illiquid assets.

money

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

currency in circulation

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

a means of holding purchasing power over time

unit of account

a measure used to set prices and make economic calculations

commodity money

a good used as a medium of exchange that has intrinsic value in other uses

commodity-backed money

a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods

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 money supply

near-moneys

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

future value

the amount of some current amount of money to which it will grow as interest accumulates over a specified period of time

present value

the amount of money you must lend out today in order to have $1 in one year. It is the value to you today of $1 realized one year from now. $1/(1+r)

net present value

the present value of current and future benefits minus the present value of current and future costs of a project

bank reserves

the currency that banks hold in their vaults plus their deposits at the Federal Reserve

T-account

a tool for analyzing a business’s financial position by showing, in a single table, the business’s assets and liabilities

reserve ratio

the fraction of bank deposits that a bank holds as reserves

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

guarantees 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 requirements

rules set by the Federal Reserve that determine the required reserve ratio for banks

discount window

the channel through which the Federal Reserve lends money to banks

excess reserves

a bank’s reserves over and above its required reserves

monetary base

the sum of currency circulation and bank reserves

money multiplier

the ratio of the money supply to the monetary base. It 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

accepts deposits and is covered by deposit insurance

investment bank

trades in financial assets and is not covered by deposit insurance

savings and loan (thrift)

type of deposit-taking bank, usually specialized in issuing home loans

federal funds market

allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves

federal funds rate

the interest rate that banks charge other banks for loans, as determined 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 government debt by the Fed

short-term interest rates

the interest rates on financial assets that mature within a year

long-term interest rates

interest rates on financial assets that mature a number of years in the future

money demand curve

shows the relationship between the quantity of money demanded and the interest rate

liquidity preference model of interest rate

the interest rate is determined by the supply and demand for money according to it

money supply curve

shows the relationship between the quantity of money supplied and the interest rate