AP Macroeconomics Unit 4

Financial system

Set of institutions that connect savers with borrowers

Financial Intermediary

An institution that transforms the savings from individuals into financial assets (for the saver) and liabilities (for the borrower)

Example of financial intermediary

Bank

Asset

Some item of value that is expected to provide the holder some future benefit

Liabilities

Requirements to pay money in the future

Real Asset / Physical Asset

A claim on a tangible object that gives the owner the right to use it as they wish

Financial asset

A contractual claim to something of value

Four types of financial assets

Bank deposits, stocks, bonds, and loans

Financial Risk

Any uncertainty about the future value of an asset

Bank Deposits / Demand Deposits

Money kept in a bank

Liquidity

How easily an asset converts to cash without loss of purchasing power

Return

Profit made on an asset

Bonds

Form of an IOUs (a promise to pay back some amount in the future)

Three features of bonds

Bond’s par, bond’s maturity, and bond’s coupon payments

Stock

A slice of ownership in a company

Most liquid forms of money

Cash and demand deposits

Bank

A financial institution that accepts deposits and makes loans

Central Bank / Reserve Bank / Banking Authority

An institution that manages a country’s money supply and monetary policy

Central bank in the US

Federal Reserve

3 functions of money

Medium of exchange, unit of account, store of value

Medium of Exchange

Must be accepted in exchange for goods and services

Unit of Account

Allows us to compare value of different items through prices

3 sources of money’s value

Commodity, representative, fiat

Commodity

Item has value of its own

Representative

Has no value of its own but represents value held somewhere else

Fiat

Money has value because government said so

Monetary Base

Sum of currency in circulation and reserve balances

Things included in M0 / M1

Currency, checkable deposits, noncheckable savings deposits, traveler’s check

M2

All of M1, small time deposits, money market mutual fund balances