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Chapter 23

Econ 1010 chapter 23

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York University
ECON 1000
Rebecca Jubis

Econ 2010 chapter 23 - Financial institutions and financial markets, the market describes how the firms are financed and the financial structures that sustains the economy. o Finance and money – finance describes the activity of providing the funds that finance expenditures on capital. Examines how households manage their financial resources and cope with risks. Money is what we use to pay for goods and services and factors of production and to make financial transactions. We examine its presence and how individuals and banks manages it. o Physical capital and financial capital – physical capital is the tools instruments, machines, buildings, and other items that have been produced in the pat and that are used today to produce goods and services. Such as inventory, raw material, semi finished goods, etc. capital means physical capital. The firm uses financial capital to purchase physical capital. o Capital and investment – quantity of capital changes due to investment and depreciation  Investment increases the quantity of capital and depreciation decrease it. The amount spent on new capital is called gross investment. The change in the value of capital is called net investment. Net investment equals gross investment minus depreciation. o Wealth is the value of all the things that people own. This is different from income, which is the amount earned during a given period from supplying the service of the resources they own. Savings is the amount of income that is not paid in taxes or spent on consumption goods and services. Savings increase wealth and wealth also increases when market value of assets rises, called capital gains and decreases called capital losses. National wealth equals income minus consumption expenditure. - Market for financial capital o Loan markets – loans are made to firms and individuals to help them finance personal expenditures and adapt to financial problems. A mortgage is a legal contract that gives ownership of a home to the lender in the event that the borrower fails to meet the agreed loan payments. o Bond market – is a promise to make specified payments on specified dates. The bonds are traded on bond markets and is a method of borrowing financial capital from the public. Mortgage backed security which entitles its holder to the income from a package of mortgages. Money is lent to individuals and the payments are drawn from the repayments of the mortgages. o Stock markets – a stock is a certificate of ownership and claim to the firm’s profits. Bond owners do not own a part of the firm. A stock market is a financial market in which shares of stocks of corporations are traded. - Financial institutions – is a firm that operates on both sides of the market for financial capital. It is a borrower in one market and a lender in another. They link the demand and supply for financial needs. o Banks – banks accept deposits and use the funds to buy government bonds and other securities to make loans, they control more than 70 percent of the total Canadian financial service sector. o Trust and loan companies - very similar to banks and make loans, also administer estates, trusts, and pension plans. o Credit unions and Caises populaires – banks that are owned and controlled by depositors and borrowers, regulated by provincial rules, and operate only in the provincial boundaries. The firm is large in number but small in size. o Pension funds – firms that receive pension contribtutions of firms and workers. They invest the deposits to make profit and use it to pay pension benefits. o Insurance companies – provide risk sharing services. They are paid premiums in exchange for protection and assurance in the case of misfortunes for individuals and firms. There are a large insurance network and earn 70% of their income outside Canada. - Solvency and Liquidity – a financial institution’s net worth is the total market value of what it has lent minus the market value of what is has borrowed. If the net worth is positive then it is solvent and if its negative its insolvent and goes out of business. The owners of an insolvent business usually the stock holders bear the losses when the asets are sold and debts paid. To reduce risk, a minimum amount of their lending must be backed by their net worth. A firm is illiquid if it has made long term loans with borrowed funds and is faced with a sudden demand to repay more of what it has borrowed than its available cash. - Interest rates and Asset prices – stocks, bonds, loans are collectively called financial assets. The interest rate is expressed as a percentage of the price of the asset. If the asset price rises, other things remaining the same, the interest rate falls. Conversely if the asset price falls, the interest rate rises. The market for loanable funds is the aggregate of all the individual financial markets. - Funds that finance investments o Household savings o Government budger surplus o Borrowing from the rest of the world Y is household income, C is spent on consumption goods and services, S is saved, paid in net taxes T. o Net taxes are the taxes paid to government minus the cash transfers received from the government. Such as social insurance and unemployment benefits. Income is equal to the sum of consumption on expenditure savings and net taxes Y = C + S + T. I = S + (T – G) + (M – X). the government surplus is outlined by T – G, and borrowing from the rest of the world is (M-X). if a T > G government contributes to the finance investment and if T
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