Mankiw, Cha. 13 - Saving, Investment, and the Financial System

the financial system

the group of institutions in the economy that help to match one person’s saving with another person’s investment.

financial markets

financial institutions through which savers can directly provide funds to borrowers.

the bond market and the stock market

The two most important financial markets!

bond

a certificate of indebtedness

date of maturity

the time at which a loan will be repaid

principal

the amount borrowed

1). term,

2) credit risk,

3). tax treatment,

4). inflation protection.

four significant varying characteristics of bonds:

term

the length of time until a bond matures

perpetuities

bonds that never mature

NO!

Does the principal of a perpetuity ever need to be repaid?

credit risk

the probability that the borrower will fail to pay some of the interest or principal

default

failure to pay some of the interest or principal

high-yield bonds

(aka “junk bonds”); pay high interest rates because they are issued by financially shaky corporations.

tax treatment

the way the tax laws treat the interest earned on a bond.

municipal bonds

bonds issued by state and local governments; the interest earned on these bonds is not eligible for federal income tax, and sometime not eligible for state and local taxes.

inflation protection

index the payments of interest and principal to a measure of inflation so that the lender gets proportionate money back.

stock

a claim to partial ownership in a firm

equity finance

the sale of stock to raise money

debt finance

the sale of bonds to raise money

stock index

computed as an average of a group of stock prices

financial intermediaries

financial institutions through which savers can indirectly provide funds to borrowers

1). banks,

2). mutual funds.

two of the most important financial intermediaries

primary: to take in deposits from people who want to save and use these deposits to make loans to people who want to borrow.

secondary: to facilitate the exchange of goods and services.

What is the primary job of banks and what is the secondary job of banks?

medium of exchange

a special asset that people can use to engage in transactions.

store of value

create by bonds and stocks as a measure of the wealth that people have accumulated in past saving.

mutual fund

an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds.

index funds

buy all the stocks in a stock index; generally, perform better than mutual funds.

accounting

refers to the way in which various numbers are defined and added up.

identity

an equation that must be true because of the way the variables in the equation are defined.

closed economy

an economy that does not interact with other economies.

open economies

actual (real-life) economies interact with other economies around the world.

national saving (aka, just “saving”)

the total income in the economy that remains after paying for consumption and government purchases.

1). S = Y - C - G,

2). S = (Y - T - C) + (T - G).

*Y = GDP; C = consumption; G = government spending; T = taxes minus transfer payments.

the two formulas for national saving (S) -

private saving

the income that households have left after paying for taxes and consumption.

private saving = Y - T - C.

formula for private saving -

public saving

the tax revenue that the government has left after paying for its spending

public saving = T - G.

formula for public saving -

budget surplus

an excess of tax revenue over government spending

budget deficit

a shortfall of tax revenue from government spending

saving must equal investment.

For the economy as a whole, saving must equal ___.

market for loanable funds

the market in which those who want to save supply funds and those who want to borrow to invest demand funds.

the interest rate

What may be viewed as the “price” of a loan?

crowding out

a decrease in investment that results from government borrowing.

insolvency

the state of a company’s liabilities exceeding the value of its assets.