MODULE 22

Physical Asset

A claim on a tangible object that gives the owner the right to dispose of the object as he or she wishes

Bank Deposit

A claim on the bank, which is obliged to give you your cash if and when you demand it

Mutual Fund

A financial intermediary that creates a stock portfolio by buying and holding shares in a company and then selling shares of the stock portfolio to individual investors

Bank

A financial intermediary that provides liquid financial assets in the form of deposits to lenders and uses their funds to finance borrowers' investment spending on illiquid assets

Diversified Portfolio

A group of stocks in which risks are unrelated to, or offset, one another

Wealth

A household's value of its accumulated savings

Loan

A lending agreement between an individual lender and an individual borrower

Financial Asset

A paper claim that entitles the buyer to future income from the seller

Stock

A share in the ownership of a company

Bond Rating Agencies

Bond purchasers can acquire free information free of charge on the quality of the bond issuer such, such as the bond issuers credit history, from bond rating agencies rather than having to incur the expense of investigating it themselves.

Mortgage-Backed Securities

Created by pooling thousands of individual home mortgage loans and selling shares to investors

Outflows

Domestic savings that finance investment spending in another country

What relationship would you expect to find between the level of development of a country's financial system and its level of economic development? Explain in terms of the country's levels of savings and investment spending.

Economic development and growth are the result of among other factors, investment spending on physical capital. Since investment spending is equal to savings, the greater the amount saved, the higher investment spending will be, and so the higher growth and economic development will be. So the existence of institutions that facilitate savings will help a country with financial system that provides low transaction costs, opportunities for diversification of risk, and high liquidity to its savers will experience faster growth and economic development than a country that doesn't.

Inflow

Foreign savings that finance investment spending in the country

Budget Deficit

Government spending exceeds tax revenue; a negative budget surplus

Budget Surplus

If government collects more tax revenue than it spends

Three important problems facing borrowers and lenders

transaction costs, financial risk, desire for liquidity

Illiquid

An asset is illiquid if it cannot be quickly converted into cash without much loss of value

Liquid

An asset is liquid if it can be quickly converted into cash without much loss of value.

Diversification

An individual can engage in diversification by investing in several different assets with unrelated risks.

Financial Indeterminancy

An institution that transforms funds gathered from many individuals into financial assets

Loan-Backed Securities

Assets created by pooling individual loans and selling shares in that pool (a process called securitization)

The Most Important Types of Financial Indeterminancy

Mutual Funds, Pension Funds, Life Insurance Companies, and Banks

Pension Funds

Nonprofit institutions that collect the savings of their members and invest those funds in a wide variety of assets, providing their members with income when the retire.

Human Capital

One of the two instrumental sources of economic growth; increases in the skills and knowledge of the workforce. Largely provided from the government through public education.

Physical Capital

One of the two sources of instrumental economic growth; increases in capital - goods used to make other goods. Is mainly created through private investment spending.

Bond

Promise to pay a fix sum of interest each year and to repay the principal -- the value stated on the face of the bond -- to the owner of the bond. A financial asset from the owner's point of view and a liability from its issuers point of view.

Liability

Requirement to money in the future

Savings-Investment Spending Identity

Savings are investment spending are always equal for the economy as a whole

Life Insurance Companies

Sells policies that guarantee a payment to a policyholder's beneficiaries when the policyholder die

Four Kinds of Financial Assets

Stocks, bonds, loans, and bank deposits

Budget Balence

The difference between tax revenue and government spending; refers to both a budget surplus and a budget deficit

Transaction Costs

The expenses of actually putting together and executing a deal

List and describe the four most important types of financial intermediaries

The four most important type of financial intermediaries are mutual funds, pension funds, life insurance companies, and banks. Mutual funds are a financial intermediary that creates a stock portfolio by buying and holding shares in a company and then selling shares of the stock portfolio to individual investors. Mutual funds are a way for individuals who don't have a large amount of money to invest to solve the problem of achieving diversification without higher transaction costs. A pension fund is a nonprofit institution that invests the savings of members and provides them with income when they retire. A life insurance company sells policies that guarantee payment to a policyholder's beneficiaries when the policyholder dies, enabling policyholders to cushion their beneficiaries from financial hardships from their death. A bank provides liquid assets in the form of bank deposits to lenders and uses those funds to finance borrowers investment spending on liquid assets.

National Cost

The interest that must eventually be paid to the foreigner

Capital Inflow

The net effect of international inflows and outflows of funds on the total savings available for investment spending in any given country. Is equal to the total inflow of foreign funds minus the total outflow of domestic funds to other countries.

Interest Rate

The price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year.

Default

The risk that the bond issuer might fail to make payments as specified by the bond contract

Identify and describe the three tasks of a well-functioning financial system

The three tasks of a financial system are to reduce transaction costs, financial risk, and provide liquidity. A well functioning financial system facilitates investment spending by allowing companies to borrow large sums of money without incurring large transaction costs. A well functioning financial system helps people reduce their exposure to risk, so that they are more willing to engage in investment spending in the face of uncertainty in the economy. A well functioning financial system allows the fast, low cost conversion of assets into cash.

Decreasing which of the following is a task of the financial system? i. transaction costs ii. risks iii. liquidity

Transaction costs and risks

Financial Risk

Uncertainty about future outcomes the involve financials losses and gains

Depositers

When you put your money in a bank, you are essentially becoming a lender by lending the bank your money

A financial intermediary that provides liquid financial assets in the form of deposits to lenders and uses their funds to finance borrowers' investment spending on illiquid assets is called... a.) mutual fund b.) bank c.) corporation d.) pension fund e.) life insurance company

b.) bank

A nonprofit institution collects the savings of its members and invests those funds in a wide variety of assets in order to provide its members with income after retirement. This describes a a.) mutual fund b.) bank c.)savings and loan d.) pension fund e.) life insurance company

d.) pension fund

National Savings

equal to the sum of private savings and the budget balance; the total amount of savings generated within the economy

Which of the following is not a type of financial asset? a.) bonds b.) stocks c.) bank deposits d.) loans e.) houses

houses