ch11 concise

Financial Markets and International Capital Flows

• Role of Financial Intermediaries

  • Facilitate allocation of savings to productive investments.

  • Commercial banks assess borrower risk and pool savings to make loans.

• Savings and Investments

  • Investments are subject to value fluctuations.

  • Banks provide interest on deposits and help allocate savings efficiently.

• Bonds

  • A bond is a promise to repay debt with specified principal and interest payments.

  • Key terms: principal amount, maturation date, coupon payments, coupon rate.

  • term: 30days to 30years; longer term, higher coupon rate

  • higher risk, higher coupon rate

  • Municipal bonds free from federal taxes

  • lower taxes, lower coupon rates

  • second-hand bond — Inversely related bond prices and market interest rates.

  • can be sold before maturation date — Market value = $ (depends on coupon rate and int. rate)

• Stocks

  • Represents ownership in a firm; stockholders receive dividends and potential capital gains( stock price increase).

  • value of stock = expected price + dividend

  • (stock price)(1+int rate) = value of stock

  • higher value if:

    • dividend higher

    • expected price higher

    • int. rate lower

    • risk lower

  • risk premium = rate of return - safe investment rate

  • Stock values reflect demand and are impacted by dividends and interest rates.

• Bond and Stock Markets

  • Channel funds from savers to borrowers, providing opportunities for capital investment.

  • They facilitate risk sharing and diversification across investments.

  • diversification = spreading wealth over variety of investments to reduce risk

  • Mutual fund = sell

• International Capital Flows

  • Involves purchase/sale of assets across borders; includes capital inflows and outflows.

  • Capital inflows occur when foreign entities invest in domestic assets.

  • Higher domestic interest rates = greater capital inflow

• Trade Balance

  • Defined as net exports (NX); surplus (exports > imports) (capital outflows)and deficit (imports > exports)(capital inflows).

  • NX + KI =0

  • 

• Savings and National Investment

  • Saving + capital inflows = investment in new capital goods

  • S + KI = I .

  • 

  • Low national savings leads to trade deficits due to higher imports outpacing exports. S - I = NX

  • low savings implies high spending

    • more spent on imports

    • high domestic spending leaves less available for export

    • high imports and low exports

  • trade deficit country receives capital inflows

    • lack sufficient saving to finance domestic investment

    • int rate rise and attract capital inflows

• US Trade Deficit Trends

  • Persistent deficits since the 1970s related to low national savings rates and high consumption.

  • Trade balance can be maintained if the economy continues to grow.