Chapter 8.docx

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14 Apr 2012
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Chapter 8: Saving, Investment, and the Financial System
Financial system: those institutions in the economy that help to match one person’s saving with
another person’s investment
Financial Institutions in the Canadian Economy
Broadest level, financial system moves money from savers (spend less than they earn) to
borrowers (people who spend more than they earn)
Office of the Superintendent of Financial Institutions (OSFI) primary regulator of federally
regulated banks, insurance companies, and pension plans in Canada
Financial Market
Financial Markets: institutions through which a person who wants to save can directly supply
funds to a person who wants to borrow
The Bond Market
Bond: a certificate of indebtedness that specifies the obligations of the borrower to the holder
of the bond (IOU)
o Date of Maturity: time at which the loan will be repaid
o Rate of interest that will be paid periodically until the loan matures
o Principle: the amount borrowed
o Term: length of time until the bond matures
Perpetuity: bond that never matures, pays interest forever, but bond is never repaid
Long term bonds are risker than short term bonds because holders of long term bonds have to
wait longer for repayment of principle
o Long term bonds usually pay higher interest rates than short term bonds
Credit risk: the probability that the borrower will fail to pay some of the interest or principal
o Failure to pay is default
o When perceived probability of default is high, demand higher interest rate to
compensate
Provincial bonds considered greater credit risk than the federal gov’t b/c prov economics tend
to be less diverse than the national economy , tax revs are more volatile
Corporate bonds tend to pay higher rates of interest than provincial bonds because corporate
revenues are likely to be more volatile than provincial tax rev
Junk bonds: higher interest rates than bonds issued by more secure corporations and by gov’t.
Issued by financially shaking companies
The Stock Market
Stock: represents ownership in a firm, a claim to the profits that the firm makes
Equity finance: sale of stock to raise money
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Debt finance: the sale of bonds
Shares, mean you’re a part owner
Bondholders paid before stockholders
Stocks offer have higher risk and potentially higher return
Prices of which shares trade on stock exchanges are determined by the supply and demand for
the stock in in these companies
Stock index: computed average of a group of stock prices
Financial Intermediaries
Financial intermediaries: financial institutions through which savers can indirectly provide funds
to borrowers
Intermediary, means that they are standing between savers and borrowers
Banks
Primary job, take in deposits form people who want to save and use these deposits from people
who want to save and use these deposits to make loans to people
Banks also facilitate purchases of goods and services by allowing people to write cheques
against their deposits
Medium of exchange: item that people can easily use to engage in transactions
Stocks and bonds like bank deposits are a possible store of value
Mutual Funds
Mutual fund: institution that sells shares to the public and uses the proceeds to buy a selection,
or portfolio of various types of stocks, bonds, or both stocks and bonds
Allow people with small amounts of money to diversify
Mutual funds give ordinary people access to the skills of professional money managers
Index funds: buy all the stocks in a given stock index
o Perform better on average than mutual funds
o B/c they keep costs low by buying and selling very rarely and by having to pay the
salaries of the professional money managers
Summing Up
Financial institutions serve the same goal, directing the resources of savers into the hands of
borrowers
Saving and Investment in the National Income Accounts
Saving and investment are important determinants of long-run growth in GDP and living
standards
Accounting: how various numbers are defined and added up
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