3/10 Chap 13 (Borrowers & Savers) Lecture

Overview of Upcoming Examination

  • Next Exam: April 7 (Monday)
    • Chapters Covered: Chapters 11 and 12
    • Preparation: Suggested practice on Chapter 11 questions

Exam Grading Criteria

  • Specificity in Answers:

    • Must answer questions directly without unnecessary information ("beating about the bush").
    • No points for excessive fluff in responses.

  • Quantitative Questions:

    • Correct numerical answers may receive partial credit if methods are unclear.
    • A correct answer earns half a point; remaining points awarded for clarity in method.

Financial System: Savings, Investment, and Institutions

Introduction to Financial System

  • The financial system comprises institutions that mobilize savings from savers (suppliers of funds) and channel them to investors (demanders of funds).

Types of Financial Systems

  • Components: Two main parts - Financial Markets and Financial Intermediaries.
  • Financial Markets:
    • Direct interaction between savers and investors.
    • Types of Markets:
    • Bond Market
    • Stock Market

Financial Market: Overview

  • Bond Market:
    • Definition: A bond is a certificate that signifies a loan from the bondholder to the issuer (could be a corporation or government).
    • Colloquial Definition: Often referred to as an "IOU" (I owe you).
    • Examples:
    • Treasury bonds issued by the U.S. Government
    • Corporate bonds issued by companies like AT&T
    • Bonds for projects like the Silver Line Metro in Virginia
    • Characteristics of Bonds:
    • Interest Rate: Pre-determined, payable over maturity.
    • Credit Risk: Risk of default; varies by issuer (e.g., U.S. has low credit risk).
    • Tax Treatment: Most interest earned is taxable; municipal bonds may have tax advantages.
    • Types:
    • Short-term (3 years), Long-term (10 years, 30 years), Perpetuity (never matures)
    • Junk bonds have high risk and high interest rates.

Stock Market

  • Definition: Represents ownership in a company.
  • When one buys a stock, they purchase part ownership of the company (Example: 1 share of 100 total shares equals 1% ownership).
  • Higher potential returns but also higher risks as stockholders are paid after creditors.
  • Stock Prices Determination:
    • Governed by supply and demand; market expectations of future profitability influence prices.
    • Limited supply in primary market, traded in secondary market.
  • Significant Indices:
    • Dow Jones Industrial Average: Comprises 30 top U.S. companies; established in 1896.
    • Standard and Poor 500: Comprises 500 major companies, provides a broader market view.

Financial Intermediaries

Overview of Intermediary Institutions

  • Distinction: Indirect route through which savers provide funds to investors.

Example Institutions

  • Banks:
    • Collect deposits from savers and lend to investors.
    • Pay interest (r) to savers while charging a higher interest (I) to borrowers.
    • Difference (I - r) funds shareholder dividends and operational costs.
    • Offer checks as a means of transaction and ease of access to funds.
  • Mutual Funds:
    • Sell shares; they pool resources to invest in various assets using professional managers.
    • Typically charge fees based on the amount invested (0.25% to 2%).
    • Provide benefits to small investors who cannot afford direct financial management.
  • Comparison of Mutual Funds and Index Funds:
    • Mutual Funds: Active management, higher costs due to trading and management fees.
    • Index Funds: Passive management, lower costs, diversifying investments in entire indices without active trading.

Conclusion

  • Final Notes: Rely heavily on PowerPoint slides for understanding material and preparing for exams. Emphasis on learning from past mistakes in grading.
  • Understanding the mechanisms and roles within financial systems is essential as they reflect broader economic principles and impacts.