Economics summary chapter 24 Saving, investment and the financial system
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Course
Economics
Institution
Avans Hogeschool (Avans)
Book
Economics
Summary of chapter 24 of the book Economics. Written by N. Gregory Mankiw and Mark P. Taylor, 3rd edition. Written for IBMS students of Avans or for the course Economics. ISBN 9781408093795.
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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.
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