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Chapter 8

Principles of Macro [Mankiw, Kneebone, McKenzie] - Chapter 8 Notes

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ECON 2020U
Peter Cheung

ECON2020_Chapter 8 Notes ~~~ SAVING, INVESTMENT, AND THE FINANCIA L SYSTEM ~~~ - Financial System > the group of institutions in the economy that help to matc h one person's saving with another person's investment ~!~ Financial Institutions and the Canadian Economy ~!~ - the purpose of the financial system is to move the money that some peo ple want to save into the hands of other people who want to borrow ~!~ Financial Markets ~!~ - Financial markets > the institutions through which a person who wants to save can directly supply funds to a person who wants to borrow - Two most important financial markets in Canadian economy are s tocks and bonds THE BOND MARKET - Bond > a certificate of indebtedness - Selling bonds to raise money is called debt finance - Date of maturity > the time by which the loan taken out (bond) will be repaid - A buyer can hold a bond until the date of maturity or sell it to someone else - The government usually issues bonds to build schools, fund the militar y, build infrastructure, etc. - Two characteristcs are important in a bond: - Term > the length of time until the bond matures - Perpetuity > a bond that never matures, but rather pay s interest for eternity, never repaying the principal - Credit Risk > the probability that the borrower will fail to p ay some of the interest or principal -If an institution fails to pay interest or repay a bond , they are said to be in default - Bonds which are sold with a long term and a high credit risk p ay out the highest interest - These bonds sold from shaky corporations are called ju nk bonds THE STOCK MARKET - Stock > a claim to partial ownership in a firm - Selling stocks to raise money is called equity finance - Stocks are paid after bonds because a bond is not ownership in the com pany; rather, it is funding the company at a price of interest - Because stocks are a claim to partial ownership, the owners mu st first pay out to their financers, then pocket any profit - Stocks are inherently risky compared to bonds and generally have the p otential to pay out much higher - The prices at which stocks buy and sell are dependant on the desire of traders to hold the stock - If there is little faith in a stock, the prices will fall (lik e supply and demand) - Stock index > an average of a group of stock prices based on the stock prices of 30 major US companies ~!~ Financial Intermediaries ~!~ - Financial intermediaries > financial institutions through which savers can indirectly provide funds to borrowersBANKS - Small companies do not sell stocks of their company on the TSX or NASD AQ, but go to a local bank for a loan instead - It is hard to gain interest in a small company to sell stocks, but it is easy to get a loan from a bank - The primary job of banks in to take in money that people want to save and use it to fund other people who want to borrow MUTUAL FUNDS - Mutual fund > an institution that sells shares to the public and uses te proceeds to buy a portfolio of stocks and bonds - Portfolio > an arrangement of several stocks and bonds purchased all t ogether as a package - this allows for people with small amounts of money to diversif y - 'Don't put all your eggs in one basket' - Mutual funds also give ordinary people access to the skills of profess ional money managers because the people themselves don't assemble these portfoli os - Index funds > mutual funds that purchase all of the stock in a certain index ~!~ Saving and Investment in the National Income Accounts ~!~ SOME IMPORANT IDENTITIES Y = C + I + G + NX - GDP Identity where Y is GDP, C = Consumption, I = Investment, G = Gove rnment expenditure, NX = Net Export (Export-Import) For closed economy: Y = C + I + G - Closed economy GDP where Y is GDP, C = Consumption, I = Investment, G = Government expenditure National Saving > the total income in the economy that remains after pay ing for consumption and governm
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