Macro - The Financial System

What is the financial system?

the group of institutions that helps match the saving of one person with the investment of another

What are financial markets?

institutions through which savers can directly provide funds to borrowers

What are two examples of financial markets?

• The Bond Market

• The Stock Market

What is a bond?

a bond is a certificate of indebtedness

What is a stock?

a stock is a claim to partial ownership in a firm

How is a bond identified?

A bond is an IOU, identified by

• Date of maturity, or date of loan repayment

• yield, or interest rate

• principal, amount originally borrowed

What are the three characteristics that make bonds different?

1. Term

2. Credit risk

3. Text treatment

What is a term?

length of time until bond matures (perpetuity - bond never matures)

What is a credit risk?

Probability that borrow will default

What is tax treatment?

how taxt laws view interest income (municipal bonds)

What is equity finance?

selling stock to raise capital

what is debt finance?

selling bonds to raise capital

What three numbers should you pay attention to when tracking sock performance?

1. Price - cost of a single share

2. Dividend - share of profits paid out to stockholders

3. PE Ratio - share price divided by earnings per share

What are financial intermediaries?

institutions through which savers can indirectly provide funds to borrowers

What are examples of financial intermediaries?

commercial banks

mutual funds

What are mutual funds?

institutions that sell shares to the public and use the proceeds to buy a portfolio of socks and bonds

What are the advantages of intermediation?

• For banks, reduce search/monitoring costs and create of medium exchange

• For mutual funds, allow savers to diversify

What is private saving?

the portion of households’ income that is not used for consumption or paying taxes

What is the formula for private saving?

Private saving = Y - T - C

What is public saving?

tax revenue less government spending

What is the formula for public saving?

Public saving = T - G

What is budget surplus?

an excess of tax revenue over government spending

What is the formula for budget surplus?

Budget surplus = T - G = Public saving

What is budget deficit?

a shortfall of tax revenue from government spending

What is the formula for budget deficit?

Budget deficit = G - T = -(public saving)

What is national saving?

the portion of national income that is not used for consumption or government purchases

What is the formula for national saving?

• National saving = private saving + public saving

• (Y - T - C) + (T - G)

• Y - C - G

What is the formula for the national income accounting identity?

Y = C + I + G + NX

What is the formula for I?

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

Saving = Investment in a closed economy

What is private saving?

the income remaining after households pay their taxes and pay for consumption

What are examples of what households do with saving?

• Buy corporate bonds or equities

• Purchase a certificate of deposit at the bank

• Buy shares of a mutual fund

• Let accumulate in saving or checking accounts

What is investment?

Investment is the purchase of new capital

What does a supply-demand model of the financial system help us understand?

• How the financial system coordinates saving and investment

• How government policies and other factors affect saving, investment, and interest rates