Unit 4: Financial Sector (copy)

Expected rate of return

The minimum return needed on an investment to justify the investment.

Liquidity

The ease with which a financial asset can be assessed and converted into cash.

Most liquid asset

Cash.

Rate of return

Net gain/loss of an investment over a specified period.

Risk

The chance that an outcome or an investment’s actual gains differ from the expected outcome.

Stock

A certificate that represents a claim to, or share of the ownership of a firm.

Equity financing

The firm’s method of raising funds for investment by issuing shares of stock to the public.

Bond

A certificate of indebtedness from the issuer to the bondholder.

Corporate bonds

Bonds that promise the bondholders the principal amount plus interest with repayment on a specific date.

Debt financing

A firm’s way of raising investment funds by issuing bonds to the public.

Loan

The process of borrowing money and repaying it with interest.

Bank deposits

The money in your bank account.

Demand deposits

Checking account funds that can be accessed whenever needed.

Bond prices and interest rates

They have an inverse relationship.

Nominal interest rate

The stated interest rate before adjustments for inflation.

Real interest rate

The interest rate adjusted for inflation.

Inflation

The rate at which the general level of prices for goods and services rises.

Positive real interest rates

Indicate that nominal interest rates are higher than inflation rates.

Negative real interest rates

Indicate that nominal interest rates are lower than inflation rates.

Functions of money

Money serves as a medium of exchange, a unit of account, and a store of value.

Fiat Money

Paper and coin money that has no intrinsic value and is backed by government trust.

Commodity Money

Money that has intrinsic value and can be used for alternative purposes.

Money supply

The quantity of money in circulation as measured by the Federal Reserve, labeled as M1 and M2.

Liquidity measure

How easily an asset can be converted to cash.

M1

The most liquid money definition, including cash, coins, checking deposits, and traveler's checks.

M2

Includes M1 along with less liquid components such as savings deposits.

Monetary base

The physical money in circulation and the reserves held by banks.

Fractional reserve banking

A system where only a fraction of the total money deposited is held in reserve.

Reserve ratio (rr)

The fraction of a bank’s total deposits kept on reserve.

Excess reserves

Cash reserves held by banks above the minimum reserve requirement.

T-account

A tabular representation of a bank’s assets and liabilities.

Money multiplier

Measures the maximum amount of new checking deposits that can be created from excess reserves.

Transaction demand

The amount of money held for the purpose of transactions.

Asset demand

The amount of money held as an asset.

Total demand for money

The sum of transaction demand and asset demand for money.

Price Level

The average of current prices across the entire spectrum of goods and services produced in the economy.

Open market operations

The buying and selling of government securities by the Fed to control the money supply.

Federal funds rate

The interest rate charged on overnight loans between banks.

Discount rate

The interest rate charged to commercial banks for loans received from the Fed.

Required reserve ratio

The minimum amount of reserves a bank must hold against deposits.

Demand for loanable funds

The quantity of credit demanded by borrowers at every real interest rate.

Supply of loanable funds

The quantity of credit provided by lenders at every real interest rate.

Loanable funds market

Where borrowers and lenders come together to negotiate loans.

Monetary Policy

The processes by which the central bank controls the money supply and interest rates.

Expansionary monetary policy

Designed to increase aggregate demand by lowering interest rates.

Contractionary monetary policy

Aimed at reducing inflation by increasing interest rates.

Money market equilibrium

Occurs when the quantity of money demanded equals the quantity of money supplied in the money market.

What is monetary policy?

Monetary policy is the process by which a central bank manages the money supply and interest rates to influence economic activity.

What are the two main types of monetary policy?

The two main types are expansionary monetary policy, which aims to increase the money supply, and contractionary monetary policy, which aims to decrease it.

What is the loanable funds market?

The loanable funds market is where savers supply funds for loans to borrowers, determining the interest rates based on supply and demand.

How does the interest rate affect the loanable funds market?

Higher interest rates discourage borrowing and encourage saving, while lower interest rates encourage borrowing and discourage saving.

What role does the central bank play in the loanable funds market?

The central bank influences the loanable funds market by setting interest rates through monetary policy, affecting the supply of money available for loans.

What is the Fisher effect?

The Fisher effect is the theory that real interest rates are equal to nominal interest rates minus the expected inflation rate.