Unit 4 Ap econ

What is an Interest Rate?

The cost of borrowing money or the return on lending money, typically expressed as a percentage of the principal over a period of time.

What is the Savings-Investment Spending Identity?

States that total savings in the economy must equal total investment spending. National \ Savings + Capital \ Inflow = Investment \ Spending

What is a Budget Surplus?

When a government's tax revenue exceeds its spending over a given period.

What is a Budget Deficit?

When a government's spending exceeds its tax revenue over a given period.

What is an Interest Rate?

The cost of borrowing money or the return on lending money, typically expressed as a percentage of the principal over a period of time.

What is the Savings-Investment Spending Identity?

States that total savings in the economy must equal total investment spending. National \ Savings + Capital \ Inflow = Investment \ Spending

What is a Budget Surplus?

When a government's tax revenue exceeds its spending over a given period.

What is a Budget Deficit?

When a government's spending exceeds its tax revenue over a given period.

What is Budget Balance?

The difference between government tax revenue and government spending. It can be a surplus (revenue > spending), a deficit (spending > revenue), or zero (revenue = spending).

What are National Savings?

The sum of private savings and the government's budget balance. It represents the total amount of savings generated within a country.

What is Capital Inflow?

The net inflow of funds into a country from international capital markets, equivalent to the net purchase of domestic assets by foreigners.

What is Wealth?

The total value of accumulated assets minus liabilities.

What is a Financial Asset?

A paper claim that entitles the buyer to future income from the seller (e.g., a stock, bond, or loan).

What is a Physical Asset?

A tangible object that can be used to generate future income (e.g., real estate, machinery, gold).

What is a Liability?

A requirement to pay income in the future (e.g., a loan or mortgage).

What are Transaction Costs?

The expenses of negotiating and executing a deal.

What is Financial Risk?

Uncertainty about future outcomes that involve financial gains or losses.

What is Diversification?

Investing in several different assets with unrelated, or independent, risks to reduce overall risk.

What does it mean for an asset to be Liquid?

An asset is liquid if it can be easily converted into cash with little or no loss of value.

What does it mean for an asset to be Illiquid?

An asset is illiquid if it cannot be easily converted into cash without a substantial loss of value.

What is a Loan?

A sum of money provided to a borrower that must be repaid, typically with interest, over a specified period.

What is Default?

The failure to make payments on a loan according to the specified terms.

What are Loan-Backed Securities?

Assets created by pooling individual loans and selling shares in that pool. These shares entitle their holder to an income stream generated by the payments on the underlying loans.

What is a Financial Intermediary?

An institution that transforms funds from individuals into financial assets. Examples include banks, mutual funds, pension funds, and life insurance companies.

What is a Mutual Fund?

A financial intermediary that creates a stock portfolio and then resells shares of this portfolio to individual investors.

What is a Pension Fund?

A type of mutual fund that holds assets in order to provide retirement income for its members.

What is a Life Insurance Company?

A financial intermediary that sells policies guaranteeing a payment to a policyholder's beneficiaries when the policyholder dies.

What is a Bank Deposit?

Money placed into a bank account, typically earning interest, which represents a liability for the bank and an asset for the depositor.

What is a Bank?

A financial intermediary that provides liquid assets in the form of deposits to lenders and uses those funds to finance illiquid investments or loans for borrowers.

What is Money?

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

What is Currency in Circulation?

Cash held by the public (outside of banks).

What are Checkable Bank Deposits?

Bank accounts on which people can write checks.

What is Money Supply?

The total quantity of money in the economy. Often measured as M1 (currency in circulation + checkable bank deposits) or M2 (M1 + near-moneys).

What is a Medium of Exchange?

An asset that individuals use to trade for goods and services rather than for consumption.

What is a Store of Value?

An asset that holds purchasing power over time.

What is a Unit of Account?

A measure used to set prices and make economic calculations.

What is Commodity Money?

Money that has intrinsic value in other uses (e.g., gold or silver used as currency, which also has value as a metal).

What is 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 valuable goods (e.g., paper currency redeemable for a fixed amount of gold).

What is Fiat Money?

Money whose value derives entirely from its official status as a means of payment, typically declared by government decree (e.g., U.S. dollar bills).

What is a Monetary Aggregate?

An overall measure of the money supply; common aggregates include M1 and M2.

What are Near-moneys?

Financial assets that can't be directly used as a medium of exchange but can be readily converted into cash or checkable bank deposits (e.g., savings accounts, money market funds).

What is Present Value?

The current worth of a future sum of money or stream of cash flows given a specified rate of return (or discount rate).

What is Net Present Value?

The present value of all cash inflows minus the present value of all cash outflows associated with a project or investment. A positive NPV generally indicates a profitable investment.

What are Bank Reserves?

Currency held by banks in their vaults plus their deposits at the central bank (e.g., the Federal Reserve).

What is a T-account?

A simplified balance sheet used by banks that shows the changes in a bank's assets (on the left) and liabilities (on the right).

What is the Reserve Ratio?

The fraction of bank deposits that a bank holds as reserves.

What is the Required Reserve Ratio?

The smallest fraction of deposits that the Federal Reserve (or central bank) allows banks to hold as reserves.

What is a Bank Run?

A phenomenon in which many bank depositors try to withdraw their funds simultaneously due to fears of bank failure.

What is Deposit Insurance?

A guarantee that a bank's depositors will be paid even if the bank cannot come up with the funds, up to a maximum amount per account, provided by a government agency (e.g., FDIC in the U.S.).

What are Reserve Requirements?

Regulations set by the central bank on the minimum fraction of deposits that banks must hold as reserves.

What is the Discount Window?

An arrangement by which the Federal Reserve stands ready to lend money to banks in need of reserves.

What are Excess Reserves?

A bank's reserves over and above its required reserves.

What is the Monetary Base?

The sum of currency in circulation and bank reserves. It is controlled by the central bank.

What is the Money Multiplier?

The ratio of the money supply to the monetary base; it indicates the total number of dollars created in the money supply by each dollar in the monetary base (Money \ Multiplier = 1 / Required \ Reserve \ Ratio).

What is a Central Bank?

An institution that oversees and regulates the banking system and controls the monetary base (e.g., the Federal Reserve in the U.S. or the European Central Bank).

What is a Commercial Bank?

A type of bank that accepts deposits from the public and makes loans to individuals and businesses.

What is an Investment Bank?

A financial institution that assists corporations and governments in raising capital by underwriting and acting as the agent in the issuance of securities.

What is a Savings and Loan (thrift)?

Financial institutions that traditionally specialized in accepting savings deposits and making mortgage loans.

What is Leverage?

The use of borrowed money to finance investments, which magnifies potential gains but also potential losses.

What is the Balance Sheet Effect?

The reduction in a firm's net worth due to falling asset prices, which can make the firm financially precarious and lead to deleveraging.

What is the Vicious Cycle of Deleveraging?

The process through which a financial crisis accelerates: asset sales by financial firms to cover losses drive down asset prices, forcing further asset sales, creating a downward spiral.

What is Subprime Lending?

Lending to borrowers with lower credit ratings (and thus higher risk of default), often at higher interest rates due to the increased risk.

What is Securitization?

The process of pooling various types of contractual debts (like mortgages, auto loans, or credit card debt) and selling their related cash flows to third-party investors as securities.

What is the Federal Funds Market?

A financial market that allows banks that fall short of reserve requirements to borrow funds (federal funds) from banks with excess reserves for short periods, usually overnight.

What is the Federal Funds Rate?

The interest rate at which banks lend reserves to each other in the federal funds market.

What is the Discount Rate?

The interest rate the Federal Reserve (or central bank) charges on loans to banks through the discount window.

What is an Open-market Operation?

A purchase or sale of government debt (Treasury bills) by the Federal Reserve, which is the primary tool of monetary policy to influence the money supply and interest rates.

What are Short-term Interest Rates?

Interest rates on financial assets that mature within a relatively short period, typically less than a year.

What are Long-term Interest Rates?

Interest rates on financial assets that mature a number of years in the future (e.g., 10-year Treasury bonds).

What is the Money Demand Curve?

A graphical representation showing the relationship between the quantity of money demanded and the interest rate, typically downward-sloping.

What is the Liquidity Preference Model of the Interest Rate?

A model that determines the equilibrium interest rate in the money market by the supply and demand for money, explaining how changes in money supply or demand affect interest rates.

What is the Money Supply Curve?

A graphical representation showing the relationship between the quantity of money supplied and the interest rate. It is a vertical line because the money supply is determined by the central bank and is independent of the interest rate.

What is the Loanable Funds Market?

A hypothetical market that brings together savers (suppliers of loanable funds) and borrowers (demanders of loanable funds) to determine the equilibrium interest rate and the quantity of funds exchanged.

What is Rate of Return?

The percentage gain or loss on an investment over a period of time, typically expressed as an annual percentage.

What is Crowding Out?

Occurs when increased government borrowing raises interest rates, thereby reducing (or 'crowding out') private investment spending and consumption.

What is the Fisher Effect?

States that an increase in expected future inflation drives up the nominal interest rate, leaving the real interest rate unchanged. The formula is: Nominal \ Interest \ Rate = Real \ Interest \ Rate + Expected \ Inflation