4.1 macro

There are three important problems facing borrowers and lenders:

1. transaction Costs 2. Financial Risk 3. Liquidity The goal is to reduce these problems in a cost-effective way in order to incentivize savers and borrowers to make mutually beneficial trades.

Banks

A bank is a financial intermediary that provides liquid assets in the form of bank deposits to lenders. A bank deposit gives a depositor a claim on a bank, which is obliged to give you cash.

Bonds

A bond is an interest-bearing asset. (The seller of the bond promises to pay a fixed sum of interest each year and to repay the principal-- the value stated on the face of the bond.) Unlike a loan, bond-rating agencies provide a grade as to the risk level of the bond. Bonds are also easy to resell. INVERSE : When interest rates rise, the price of previously issued bonds fall to become more competitive. When interest rates fall, the price of previously issued bonds increases.

financial asset

A financial asset is a nonphysical asset that entitles the buyer to future income from the seller. Ex: when a saver loans funds to a company

Financial Intermediaries

A financial intermediary is an institution that transforms funds gathered from individuals into financial assets

loan

A loan is a lending agreement between an individual lender and an individual borrower. use: Most people enter into loans to finance the purchase of a car or a house. Loans can present transaction costs associated with identifying qualified buyers. To minimize these costs, large borrowers (such as the government or major corporations) often take a more streamlined approach: they sell or issue bonds.

Mutual Funds

A mutual fund is a financial intermediary that creates a stock portfolio by buying and holding shares in companies and then selling shares of the stock portfolio.

stock

A stock is a share in the ownership of a company. Not all companies sell stock. Privately held companies are owned by an individual or a few partners and get to keep all of the profit. Selling stock diffuses the risk across many individuals and gives shareholders an opportunity to possibly earn a higher rate of return over time. However, bonds are a promise and stocks are a hope. If a company were to fail, bondholders would be paid back first. BUY LOW SELL HIGH

A. Explain how each of the following will affect the rate of return on financial aspect. ii. high risk i. increased equity B.describe the level of risk and liquidity associated with holding cash as a financial aspect

A. Higher risk will increase the rate of return on a financial asset. For two otherwise identical assets, the one with greater risk must have a higher rate of return in order for buyers to be willing to purchase it. Buyers will only accept higher risk if there is potential for greater return. : All other things equal, a less liquid asset will have a higher rate of return. : Buyers will only purchase the less liquid asset if the rate of return offered is higher because they are giving up easier access to cash if they need to convert the asset to cash in the future. B. Cash carries less risk because it will not lose its value. Cash is the most liquid asset since it does not need to be converted into cash.

illiquid

An asset is illiquid if it cannot be quickly converted to cash without much loss of value. Ex: buying a house

liquid

An asset is liquid if it can be quickly converted to cash without much loss of value. Ex: buying a stock

There are four types of financial assets:

Loans Bonds stocks bank deposits

what is an asset?

Financial markets are where households invest their current savings and their accumulated savings, or wealth, by purchasing financial assets. In general, an asset is something of value.

bonds are

IOUs issued by the barrower a financial asset for bond owner a liability for the bond owner easy to resell

interest rate

The interest rate is the amount paid to borrow money.

transaction costs

Transaction costs are the expenses of putting together and executing a deal. Arranging a loan requires time and money. Instead of coordinating the borrowing of money from many individuals, banks can pool together large sums of money for lending.

what is a task of the financial system?

decreasing financial risks

physical asset

is a tangible object that the owner has the right to use or dispose of as they wish. Ex: title to a car

Financial risk

is uncertainty about future outcomes that involve financial losses or gains. Financial risk is a problem because the future is uncertain. A well-functioning financial system helps people reduce their exposure to risk. Diversification-- investing in several assets with unrelated, or independent risks-- is a way to lower overall risk.

an asset that can quickly be turned into cash

liquid

a financial intermediary that creates a stock profile by buying and holding shares in company and then selling shares in the stock portfolio to private investor is?

mutual fund

stocks are

repersent ownership of buisness havve a higher historical rate of return than bonds are examples of an equity are used by buisness owners to reduce risk

certificate of deposit (CD

= pays a higher interest rate than a checking account. But, if you need to withdraw your money before a certain amount of time, you'll pay a penalty.

explain the interest rate between the interest rate in economy and price of previously issues bonds?

The price of a previously issued (preexisting) bond is inversely related to the interest rate in the economy. When the interest rate increases, preexisting bond prices fall because bond buyers could purchase a new bond paying the higher interest rate. Bond buyers would not buy a preexisting bond unless the price of that bond decreases (to make up for the difference between the interest rates on new and preexisting bonds). Conversely, when the interest rate falls, preexisting bond prices rise because bond buyers can only purchase new bonds paying lower interest rates. Bond owners can raise the price of preexisting bonds paying higher interest rates.

The Opportunity Cost of Cash

There is an opportunity cost to holding cash: your money earns no interest.

Suppose you get a loan from a bank to buy a car. The loan is an example of a ?

financial asset. The loan has also created a liability. The loan is a financial asset from the bank's point of view, but a liability from your point of view because of the requirement for you to pay back the loan (plus interest) in the future.

what is not a type of a financial asset?

house