Chapter 7
financial institution
a firm that operates on both sides of the markets for financial capital: It borrows in one market and lends in another.
Bonds issued by _____ are traded in the bond market.
firms and governments
nominal interest rate
the number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent.
A government budget deficit ______ the real interest rate because ______.
raises; the demand for loanable funds increases
The demand for loanable funds increases and the supply of loanable funds decreases.
As a result, the equilibrium real interest rate rises and the equilibrium quantity of loanable funds increases, decreases, or remains the same.
The demand for loanable funds increases and the supply of loanable funds increases.
As a result, the equilibrium real interest rate rises, falls, or remains the same and the equilibrium quantity of loanable funds increases.
Explain the flows of funds that finance business investment.
Funds from household saving, the government budget surplus, and the rest of the world flow through financial markets and institutions to firms who borrow the funds for investment.
State the financial decision rule
If the net present value is positive, take the action. If the net present value is negative, do not take the action.
Describe the relationship between the price of a treasury bond and its interest rate.
The interest rate is a percentage of the price of the Treasury bond.
Define and distinguish between future value and present value.
The present value of a future dollar is the amount that will grow to be as large as that future value when the interest that it will earn is considered.
Explain why the real interest rate is the opportunity cost of loanable funds.
The real interest rate is the opportunity cost of loanable funds because the real interest paid on borrowed funds is the opportunity cost of borrowing and the real interest rate forgone is the opportunity cost of not saving or not lending those funds
credit risk (default risk)
The risk that a borrower, also known as a creditor, might not repay a loan
gross investment
The total amount spent on new capital goods.
Explain how this increase in expected profit influence First Call's demand for loanable funds.
This increase in expected profit increase the demand for loanable funds and brings a rightward shift of the demand for loanable funds curve.
U.S. household income has grown considerably since 1984.
U.S. saving has decreased; because wealth has increased due to capital gains
Explain the relationship between asset prices and the interest rate.
When the price of an asset rises, the interest rate falls, everything else remaining the same.
bond
a promise to pay specified sums of money on specified dates.
A type of _____ is a mortgage-backed security, which entitles _____ to the income from a package of mortgages.
a bond; its holder
The financial institutions that the G-20 might require to hold more capital are ______. The "capital" referred to in the news clip is ______.
banks and insurance companies; the institutions' own funds
net investment
change in the quantity of capital - equals gross investment minus depreciation.
Firms make investment decisions by _______.
comparing the expected profit with the real interest rate and making the investment if the project has a positive net present value
Households preferred to buy corporate equities rather than bonds because ______.
corporate equities deliver capital gains, which increases wealth
The requirement to hold more capital can make financial institutions safer because by holding more capital, a financial institution ______.
decreases its risk of insolvency
stock market
financial market in which shares of stocks of corporations are traded.
The supply of loanable funds changes when _______.
disposable income, expected future income, wealth, or default risk change
The demand for loanable funds changes when ______ changes.
expected profit
The _______, the greater is the amount that a household decides to save.
greater a household's disposable income and the smaller a household's expected future income
real interest rate
he nominal interest rate adjusted to remove the effects of inflation on the buying power of money.
The demand for loanable funds is determined by ______.
he real interest rate and expected profit
The interest rate moves inversely to price because _______.
if the price of a Treasury bond rises, other things remaining the same, the interest rate falls because the interest payment is a smaller percentage of the Treasury bond price
A government budget deficit _______ loanable funds.
increases the demand for
A government budget surplus _______ loanable funds.
increases the supply of
mortgage
legal contract that gives ownership of a home to the lender in the event that the borrower fails to meet the agreed loan payments
The three main types of markets for financial capital are _______.
loan markets, bond markets, and stock markets
A government budget surplus _______ the real interest rate, decreases ______.
lowers; private saving, and increases investment
A government budget deficit _______ the real interest rate, increases ______.
raises; private saving, and decreases investment
The supply of loanable funds is determined by the _________.
saving decisions of households, which are influenced by the real interest rate, disposable income, expected future income, wealth, and default risk
financial capital
the funds that firms use to buy physical capital and that households use to buy a home or to invest in human capital.
According to the Ricardo-Barro effect, when a government budget deficit occurs today, ______.
saving increases, the supply of loanable funds increases, and the real interest rate does not change
loanable funds market
the aggregate of all the individual financial markets.
Saving
the amount of income that is not paid in net taxes or spent on consumption goods and services.
Federal Reserve
the central bank of the United States, a public authority whose main role is the regulation of banks and money.
Financial capital
the funds that firms use to buy physical capital
demand for loanable funds
the relationship between the quantity of loanable funds demanded and the real interest rate when all other influences on borrowing plans remain the same.
supply of loanable funds
the relationship between the quantity of loanable funds supplied and the real interest rate when all other influences on lending plans remain the same.
crowding-out effect
the tendency for a government budget deficit to raise the real interest rate and decrease investment
Net worth
the total market value of what a financial institution has lent minus the market value of what it has borrowed.
Wealth
the value of all the things that people own.
net present value
the value today of all the future flows of money that arise from a financial decision minus the initial cost of the decision.
Physical capital
the tools, instruments, machines, buildings, and other items that have been produced in the past and that are used today to produce goods and services;
A stock is a certificate of _____ and claim to the _____ that a firm makes.
ownership; profits