Financial Institutions - Note 7

What is the main function of financial markets?

Channel funds from surplus savers to those with productive investment opportunities.

How do financial markets improve economic efficiency?

They allocate funds toward more productive uses.

What is a financial security?

A claim on an issuer's future income or assets.

What is a bond?

A debt security promising payments over a specified period.

What is common stock?

A share of ownership in a corporation.

Why do corporations issue common stock?

To raise funds for their activities.

What is an interest rate?

The cost of borrowing funds, expressed as a percentage.

Why are interest rates important?

They influence borrowing, saving, investment, and economic activity.

What is a financial intermediary?

An institution that obtains funds from savers and channels them to borrowers.

Name four types of financial institutions other than banks.

Insurance companies, finance companies, pension funds, and mutual funds.

What is financial innovation?

The development of new financial products and services.

What is a financial crisis?

Major disruption involving sharp asset-price declines and firm failures.

What is a business cycle?

Upward and downward movements in aggregate economic output.

How is money supply related to business cycles?

Changes in money supply can influence economic fluctuations.

What is inflation?

A continuing rise in the general price level.

How is the inflation rate defined?

The percentage change in the price level over a period.

What is the long-run relationship between money growth and inflation?

Higher sustained money growth is generally associated with higher inflation.

How does inflation affect purchasing power?

Higher prices reduce the purchasing power of money.

What relationship between money growth and long-term interest rates did the slides show before 1980?

They were closely related.

How has that relationship changed since 1980?

It has become less clear, although money growth remains relevant.

What is monetary policy?

Management of money supply and interest rates by the central bank.

Who conducts monetary policy in the United States?

The Federal Reserve System (Fed).

What is fiscal policy?

Government decisions about spending and taxation.

What is a budget deficit?

Government expenditures exceed tax revenues during a period.

What is a budget surplus?

Government tax revenues exceed expenditures during a period.

How do monetary and fiscal policy differ?

Monetary policy manages money and rates; fiscal policy manages spending and taxes.

What is the foreign exchange market?

The market where one currency is converted into another.

What is an exchange rate?

The price of one currency expressed in another currency.

What happens when a domestic currency depreciates?

More domestic currency is needed to buy a unit of foreign currency.

Why is the international financial system important?

Integrated financial markets transmit effects across national economies.