Macroeconomics: Finance, Saving, and Investment

Vocabulary terms and core concepts covering Chapter 7: Finance, Saving, and Investment.

Finance

The lending and borrowing of funds.

Physical Capital

Physical tools, instruments, machines, buildings, and other items (such as pizza ovens) used to produce goods and services; often referred to simply as 'capital' by economists.

Financial Capital

The funds that firms use to purchase physical capital and that households use to purchase a home or invest in human capital.

Wealth

The total dollar value of the things that people own.

Saving

The amount of income that is not paid in net taxes or spent on consumption goods and services.

Capital Gains

An increase in the market value of assets that increases wealth without representing saving.

Capital Losses

A decrease in the market value of assets that decreases wealth.

Loan Market

A financial market in which banks lend funds directly to borrowers, such as through business loans, personal loans, or credit card balances.

Mortgage

A legal agreement securing a loan for a home, specifying that the lender gets the property if the borrower fails to make the agreed payments.

Bond

A promise issued by a firm or government to make specified payments on specified dates to the holder.

Treasury Bill (T-bill)

A highly reliable short-term bond issued by the US Treasury, an institution created in 1789 that has never defaulted on payments to lenders.

Mortgage-Backed Security (MBS)

A debt security created by packaging multiple mortgages together and selling the package as a bond, granting the buyer rights to the mortgage payments.

Stock

A certificate of ownership and a claim to a fraction of a firm's profits.

Financial Institution

A enterprise or firm that engages in both borrowing funds and lending funds.

Commercial Bank

A financial institution that accepts deposits, provides payment services, and issues loans (e.g., Bank of America, Wells Fargo, Chase).

Government-Sponsored Mortgage Lenders

Entities, specifically Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation), that buy mortgages from banks, package them, and sell mortgage-backed securities.

Mutual Fund

An investment vehicle that pools funds from numerous individual investors to purchase a diversified portfolio of stocks and/or bonds.

Pension Fund

A fund that collects contributions from firm earnings and employee wages to invest in stocks and bonds to provide retirement income.

Insurance Policy

A financial agreement where an insurer promises to pay monetary claims to the policyholder upon the occurrence of specified adverse events.

The Federal Reserve

The central bank of the United States that regulates private banks and the monetary system while actively buying and selling bonds and mortgage-backed securities.

Present Value

The current value of a future sum of money calculated using the formula $\text{Present value} = \frac{\text{Future value in } n \text{ years}}{(1 + r)^n}$, where $r$ is the interest rate.

Net Present Value (NPV)

A decision metric calculated as the present value of all future flows from an investment minus the initial cost of the decision.

Financial Decision Rule

A guiding principle stating that an investment or action should be undertaken if the net present value is positive, and rejected if negative.

Nominal Interest Rate

The interest rate stated in terms of current dollar amounts (pieces of paper) without adjusting for changes in the purchasing power of money.

Real Interest Rate

The nominal interest rate adjusted to eliminate the effects of inflation, approximated as $\text{Real interest rate} \approx \text{Nominal interest rate} - \text{Inflation rate}$.

Loanable Funds Market

The aggregate of all individual financial markets where borrowers demand funds and lenders supply funds.

Disposable Income

A household's total income remaining after paying taxes, which can be allocated to consumption or saving.

Default Risk

The probability that a borrower will fail to repay their debt as agreed.

Budget Surplus

A government financial state occurring when tax revenue exceeds government expenditures, resulting in an increased overall supply of loanable funds.

Budget Deficit

A government financial state occurring when government spending exceeds tax receipts, increasing the overall demand for loanable funds.

Crowding-Out Effect

The tendency for a government budget deficit to raise the real interest rate, which reduces private borrowing and private investment in capital.