MacroEconomics Ch 26.docx

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University of California - Irvine
Mu- Chun Chen

Ch. 26: Saving, Investment, and the Financial System - Financial system: group of institutions in the economy that help to match average person’s savings with another’s investments I. Financial Institutions in the U.S. Economy A. Financial Market - Financial institutions in which savers can directly provide funds to borrowers - Bond Market o Certificate of indebtedness (IOU) I. Date of maturity, interest rate, can resell bonds to others II. Intel sell bonds to get $$$ III. Bonds differ from 3 characteristics:  Bond’s Term: Long-term bond risker than short-term 1. Get higher interest rates  Credit Risk: Probability borrowers will fail to pay some of the interest/principal: eventual repayment of amount borrowed 1. Junk bonds: very high interest rates  Tax Treatment: Way tax laws treat the interest earned on bonds 1. Municipal bonds: Bond owners not required to pay fed income tax on interest income (Bond of state/gov) - Stock Market o Claim to partial ownership of a firm o Sale of stock to raise $ = Equity Finance o Sale bonds = Debt Finance o Stocks offer higher risk & high return to holders o Prices of shares trade in stock exchange determined by supply and demand o Stock Index: Computed average of group of stock prices I. Stand. & Poor’s 500 Index B. Financial Intermediaries - Financial institutions in which savers can indirectly provide funds to borrowers 1. Banks o Small grocer gets loan from bank o Facilitate purchases of g&s (checks) o Creates med. of exchange: easily used to engage in transactions o Stock & bond = Store of Value 2. Mutual Funds o Institution that sells shares to public & uses proceeds to buy portfolio of stocks & bonds o If value of portfolio rises then shareholders benefi o Don’t put all money in 1 stock (risky), DIVERSIFY! o Gives people access to skills of professional money managers ALL OF THESE INSTITUTIONS DIRECT RESOURCES OF SAVERS INTO HANDS OF THE BORROWERS!! II. Saving & Investment in the National Income Accounts - Accounting: How various #s are defined and added up
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