Economics Chapter 24 Savings, investment and the financial system
The financial system – the group of institutions in the economy that help to match one
person’s saving with another person’s investment.
This chapter:
- Variety of institutions that make up the financial system
- The relationship between the financial system and some key marcoeconomic variables
- Develop a model of the supply and demand for funds in financial markets
Financial institutions in the economy
There are 2 categories of financial institutions:
- Financial markets
- Financial intermediaries
Financial markets – financial institutions through which savers can directly provide funds to
borrowers.
The 2 most important financial markets in advanced economies are:
- Bond market
- Stock market
The bond market
A company can sell bonds when it needs money. A bond is a certificate of indebtedness.
- It identifies the time at which the loan will be repaid – date of maturity
- It states the rate of interest that will be paid periodically – called the coupon
- The buyer gives his money to the company in exchange for this promise of interest and
eventual repayment of the amount borrowed – called the principal
2 characteristics of bonds:
- A bond’s term – the length of time until the bond matures.
Some bonds have short terms, while other have terms as long as 30 years.
A bond that never matures is called a perpetuity.
Long bonds are riskier than short bonds, because holders of long-term bonds have to
wait longer for repayment of the principal. If a holder needs his money earlier than the
distant date of maturity, he has no choice but to sell the bond to someone else, perhaps
at a reduced price.
To compensate for this risk, long-term bonds usually pay higher interest rates.
- A bond’s credit risk – the probability that the borrower will fail to pay some of the
interest or principal.
Such a failure to pay is called a default.
Borrowers can default on their loans by declaring bankruptcy.
The financial system – the group of institutions in the economy that help to match one
person’s saving with another person’s investment.
This chapter:
- Variety of institutions that make up the financial system
- The relationship between the financial system and some key marcoeconomic variables
- Develop a model of the supply and demand for funds in financial markets
Financial institutions in the economy
There are 2 categories of financial institutions:
- Financial markets
- Financial intermediaries
Financial markets – financial institutions through which savers can directly provide funds to
borrowers.
The 2 most important financial markets in advanced economies are:
- Bond market
- Stock market
The bond market
A company can sell bonds when it needs money. A bond is a certificate of indebtedness.
- It identifies the time at which the loan will be repaid – date of maturity
- It states the rate of interest that will be paid periodically – called the coupon
- The buyer gives his money to the company in exchange for this promise of interest and
eventual repayment of the amount borrowed – called the principal
2 characteristics of bonds:
- A bond’s term – the length of time until the bond matures.
Some bonds have short terms, while other have terms as long as 30 years.
A bond that never matures is called a perpetuity.
Long bonds are riskier than short bonds, because holders of long-term bonds have to
wait longer for repayment of the principal. If a holder needs his money earlier than the
distant date of maturity, he has no choice but to sell the bond to someone else, perhaps
at a reduced price.
To compensate for this risk, long-term bonds usually pay higher interest rates.
- A bond’s credit risk – the probability that the borrower will fail to pay some of the
interest or principal.
Such a failure to pay is called a default.
Borrowers can default on their loans by declaring bankruptcy.
