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