Financial Sector

financial sector

is a network of institutions that link borrowers and lenders. this includes banks, mutual funds, pension funds, and other financial intermediaries.

assest

anything tangible or intangible that has value

interest rate

the amount a lender charges borrowers for borrowing money. it is the price of a loan

interest-bearing assests

assests that earn interest over time (ex: bonds)

personal finance

the management of your individual or household money— including earning, budgeting, saving, investing, and planning for future financial goals

what will cause an increase in investments?

low interest rates

liquidity

the ease with which an assest can be converted to a medium of exchange. in general, the higher the liquidity, the lower the rate of return

bonds

loans, or IOUs, that represent debt that the government, businesses, or individual must repay to the lender. The bond holder has no ownership of the company and is payed interest

stocks

represent ownership of a corporation and the stockholder is often entitled to a portion of the profit paid out as dividends

are stocks and bonds inversely related?

yes

real interest rate

the percentage increase in purchasing power that a borrower pays

nominal interest rate

the percentage increase in money that the borrower pays

real interest rate formula

nominal interest rate - expected inflation

nominal interest rate formula

real interest rate + expected inflation

furture value formula

$X in N Years = $X (1+ir)^N

present value

the current worth of some furture amount of money

barter system

involves trading goods and services directly with no money exchanged

double coincidence of wants

each trader had to have something the other wanted

money

anything that is generally accepted as payment for goods and services

wealth

the total collection of assets

income

a flow of earnings per unit of time

commodity money

something the performs the function of money and has intrinsic value

fiat money

something that serves as money but has no other value or uses

medium of exchange

money can easliy be used to buy goods and services with no complications of the barter system

a unit of account (measure of value)

money measures the value of all goods and services

a store of value

money allows you to store purchasing power for the future

generally accepted

buyers and sellers have confidence that is legal tender

scarce

money must not be easily reproduced

portable and dividable

money must be easily transported and divided

purchasing power

money is the amount of goods and services a unit of money can buy. inflation decreases purchasing power

what is M1

• currency in circulation

• checkable bank deposits (checking accounts)

• savings and deposits (money market accounts)

what is M2

• M1

• time deposits (CDs)

• Money market funds

fractional reserve banking

occurs when banks hold aportion of deposits to cover potential withdrawals and then loans the rest of the money out

money multiplier

1/reserve requirement

demand deposit

money deposited in a commerical bank in a checking account

required reserves

the percent that banks must hold by law

excess reserves

the amount that the bank can loan out

balance sheet

a record of a banks assets, liabities, and net worth

Are demand deposits an asset or a liability for the bank? for the depositer?

liability, asset

economic demand

not the same as merely wanting something. remember that “money” in this model refers to M1 money, which includes cash and money in checking accounts

transaction demand for money

people hold money for everyday transactions

asset demand for money

people hold money since it is less risky than other assets

opportunity cost

holding money in your pocket or checking account: the interest you could be earning from other financial assets like stocks, bonds, and real estate

Is there an inverse relationship between stocks and bonds?

yes

money demand shifters

• price level

• change in income

• change in technology

money supply

set by the central bank and is independent from the interest rate

federal reserve

a nonpartisan government office that adjust the money supply to influence the economy. This is called monetary policy

increasing money supply

• decrease interest rates

• increase investment

• increase AD

decreasing money supply

• increase interest rates

• decrease investment

• decrease AD

federal reserves job

to regulate banks and make sure people have faith in our financial system

shifters in money supply

• reserve ratio

• discount rate

• open market operations

fractional reserve banking

if you have a bank account, your money is not all held in reserve. only a reserved percent of your money is held in reserve. the rest of your money has been loaned out

who sets the reserve requirement?

the Fed

reserve requirement

is the percent of deposits that banks must hold in reserve

discount rate

is the interest rate that the central bank charges commercial banks

What could the central bank do to increase the money supply?

decrease the discount rate, buy government bonds

What could the central bank do to decrease the money supply?

increase the discount rate, sell government bonds

open market operations

is when the central bank buys or sells government bonds

BIG

buying bonds increases money supply

SELL

selling bonds decreases money supply

federal funds rate

the interest rate that banks charge one another for one day loans of reserve

what would the feds do to increase money supply?

• decrease interest rates

• increase investment

• increase AD

• increase price level and GDP

why would the feds ever slow down the economy?

to fight inflation

interest on reserves

the interest rate that the federal reserve pays commercial banks to hold reserves

administered rates

interest rates set by the fed rather than determined in a market

Is there an inverse relationship between federal funds rate and the quantity of reserves demanded?

yes

to decrease rates with ample reserves, the central bank can?

decrease interest on reserves and the discount rate

to increase ample reserves, the central bank can?

increase interest rates and the discount rate

loanable funds market

shows the supply and demand of loans and shows the equalilibrum real interest rate

private savings

the amount that households save instead of consume

public saving

the amount the government saves instead of spends

national savings

public + private savings will shift the supply of loanable funds

capital inflow

the amount of money entering the country

capital outflow

the amount of money leaving the country

Net capital inflow

inflow - outflow

private investment

borrowing by businesses and comsumers

government borrowing

deficit spending when government spending is greater than tax revenue

Loanable funds market demand shifters

• changes in borrowing by consumers

• changes in borrowing by businesses(investment spending)

• changes in borrowing by the government

loanable funds market supply shifters

• changes in private saving behavior

• changes in public saving

• changes in foreign investment

what creates demand for loanable funds?

borrowing is the demand of loanable funds