AP Macro Unit 4 Vocab

4 Types of Financial Assets

Loans, bonds, loan-backed securities, and stocks.

Loans

Lending agreement between a borrower and a lender.

Bonds

An IOU issued by a borrower with interest.

Loan-Backed Securities

Also called a collateralized debt obligation (CDO). An asset created by pooling individual loans and selling shares in the pool.

Stocks

Shares of ownership in a company.

4 Types of Financial Intermediaries

Mutual funds, pension funds, life insurance companies, and banks.

Mutual Funds

A stock portfolio sold to individual investors.

Pension Funds

Collect savings of members and provide retirement income.

Life Insurance Companies

Sell policies that guarantee payment to beneficiaries upon death.

Banks

Provides liquid assets to lenders and gives loans.

3 Tasks of Financial Systems

Reducing transaction costs, reducing risk, and providing liquidity.

Transaction Costs

The expenses of negotiating and executing a deal.

Financial Risk

Uncertainty about future outcomes that involve financial losses and gains.

Reducing Financial Risk

Sell shares of companies. Diversification - investing in many types of assets.

Liquid

A characteristic of an asset. If it's liquid, it can easily be converted to cash without much loss of value.

3 Roles of Money

Medium of exchange, unit of account, and store of value.

Medium of Exchange

An asset that individuals acquire for the purpose of trading 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

3 Types of Money

Commodity, commodity-backed, and fiat.

Commodity Money

A good used as a medium of exchange that has intrinsic value in other uses (ex: gold).

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 other goods.

Flat Money

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

Savings-Investment Spending Identity

Savings and investment spending are always equal for the economy as a whole.

Budget Balancing Formula

If tax revenue(TR) - government spending(G) = 0, budget is

balanced. If TR>G, then there's a surplus. If TR<G, then there's a deficit.

Wealth

A household's current and accumulated savings, sometimes in the form of assets.

Financial Asset

A paper claim that entitles the buyer to future income from the seller.

Comparitive Liquidity

Money and checkable bank deposits are the most liquid. M1 is most liquid, followed by M2. Anything after that is highly illiquid

Money

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

Money Aggregate

An overall measure of the money supply. M1 and M2.

M1

Cash, travelers checks, and checkable bank deposits.

M2

M1 + near moneys (assets that can easily be converted into cash and checkable bank deposits) such as savings, money market funds, and time deposits.

Present Value Equation

pv = fv / (1+r)"

r = rate, n= years

Future Value Equation

- fv = pv (1+r)"

r = rate, n = years

Reserve Requirement

The minimum amount of reserves a bank must hold at any time. Based on the required reserve ratio - fraction/decimal/percent.

Loans from Banks

Banks take their deposits and loan them out, increasing the money supply.

Money Multiplier

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. Found by 1/reserve requirement.

Federal Reserve

Regulate banking system and controls money supply and interest rates, along with controlling federal funds rate and discount rate, and reserve requirement.

Federal Funds Rate

Interest rates that banks charge each other for loans. Set by Fed.

Discount Rate

Interest rates that Fed charges banks for loans. Set by Fed, typically higher than federal funds rate.

Functions of the Federal Reserve

Providing financial services, supervising and regulating banking institutions, maintaining the stability of the financial system, and conducting monetary policy.

Fed and Money Supply

Fed will buy or sell government bonds from/to banks to change money supply they have and what they can loan.

Opportunity Cost of Holding Money

 Holding money for convenience comes at the cost of losing interest by investing it.

Money Demand Curve

Indirect relationship between quantity of money demanded and nominal interest rate. A higher interest rate means more people will invest their money instead of demanding it in cash.

Shifts of Money Demand Curve

Changes in aggregate price level - over time, inflation occurs, demand shifts right. Changes in real GDP - more goods to buy increases money held to buy, demand shifts right, and vice versa. Changes in technology - easier to withdraw money, withdraw smaller amounts, demand shifts left.

Shifts of Money Supply Curve

Fed sets money supply to control interest rates and inflation.

Money Market Graph

Shows money demand and money supply curves. Economy will self-adjust until it reaches equilibrium. Shifts in curve will change equilibrium.

Loanable Funds Market

A hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply for funds provided by lenders.

Rate of Return

The profit earned a project expressed as a percentage of the cost.

= (Revenue - cost) / cost x 100

Demand for Loanable Funds

Indirect relationship between real interest rate and loanable funds demanded. Less people will borrow at higher at higher interest rates - they must need to have a rate of return higher than the interest rate

Supply for Loanable Funds

Direct relationship between real interest rate and loanable funds supplied. People will invest more at higher interest rates.

Shifts of the Demand for Loanable Funds

Changes in perceived business opportunities (ex: people borrowed more when they could begin to invest in internet-y stuff). Changes in government borrowing.

Crowding Out

When a government deficit drives up the interest rate and leads to reduced investment spending.

Shifts of the Supply for Loanable Funds

Changes in private savings behavior. Changes in capital inflows.

Government Savings

Governments have the potential to save when they're running a surplus.