Saving, Investment, and the Financial System Chapter 26 Copyright © 2001 by Harcourt, Inc All rights reserved Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777 The Financial System ◆ ◆ ◆ The financial system consists of institutions that help to match one person’s saving with another person’s investment It moves the economy’s scarce resources from savers to borrowers The financial system is made up of institutions(Markets and Intermediaries) Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Financial Institutions in the U.S Economy ◆ Financial Markets Stock Market ◆ Bond Market ◆ ◆ Financial Intermediaries Banks ◆ Mutual Funds ◆ Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Other Financial Institutions ◆ Credit unions ◆ Pension funds ◆ Insurance companies ◆ Loan sharks Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Bond Market A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond IOU Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Characteristics of a Bond ◆ ◆ ◆ Term: The length of time until the bond matures Credit Risk: The probability that the borrower will fail to pay some of the interest or principal Tax Treatment: The way in which the tax laws treat the interest on the bond ◆ Municipal bonds are federal tax exempt Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Stock Market Basics ◆ What is Stock? ➤A stock is a tradable security that a firm issues to certify that the stockholder owns a share of the firm ➤Figure 19.1 shows an example of a stock certificate Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Stock Market ◆ ◆ Stock represents ownership in a firm and is therefore, a claim to the profits that the firm makes The sale of stock to raise money is called equity financing ◆ Compared to bonds, stocks offer both higher risk and potentially higher returns Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Stock Market The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Stock Market Most newspaper stock tables provide the following information: ◆ Price (of a share) ◆ Volume (number of shares sold) ◆ Dividend (profits paid to stockholders) ◆ Price-earnings ratio Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Stock Market Basics ◆ Reading the Stock Market Report ➤Figure 19.2 in the textbook shows a part of a page from of the Wall Street Journal Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Market for Loanable Funds Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Market for Loanable Funds Interest Rate Supply 5% Demand $1,200 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Loanable Funds (in billions of dollars) Government Policies That Affect Saving and Investment ◆ Taxes and saving ◆ Taxes and investment ◆ Government budget deficits Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc An Increase in the Supply of Loanable Funds Interest Rate Supply, S1 S2 Tax incentives for saving increase the supply of loanable funds % 4% Demand .which reduces the equilibrium interest rate $1,200 Loanable Funds $1,600 (in billions of dollars) .and raises the equilibrium quantity of loanable funds Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc An Increase in the Demand for Loanable Funds Interest Rate 6% 5% .which raises the equilibrium interest rate Supply An investment tax credit increases the demand for loanable funds D2 Demand, D1 $1,400 $1,200 Loanable Funds (in billions of dollars) .and raises the equilibrium quantity of loanable funds Government Budget Deficits and Surpluses ◆ When the government spends more than it receives in tax revenues, the short fall is called the budget deficit ➤ ◆ For 2003, the budget deficit is $307 billion The accumulation of past budget deficits is called the government debt ➤ For 2003, the total debt is 6.7 trillion Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Government Budget Deficits and Surpluses Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms ◆ This fall in investment is referred to as crowding out ◆ ◆ The deficit borrowing crowds out private borrowers who are trying to finance investments Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Effect of a Government Budget Deficit Interest Rate S2 6% 5% .which raises the equilibrium interest rate $800 $1,200 .and reduces the equilibrium quantity of loanable funds Supply, S1 A budget deficit decreases the supply of loanable funds Demand Loanable Funds (in billions of dollars) [...]... 2 .which raises the equilibrium interest rate 0 Supply 1 An investment tax credit increases the demand for loanable funds D2 Demand, D1 $1,400 $1,200 Loanable Funds (in billions of dollars) 3 .and raises the equilibrium quantity of loanable funds Government Budget Deficits and Surpluses ◆ When the government spends more than it receives in tax revenues, the short fall is called the budget deficit... in the Supply of Loanable Funds Interest Rate Supply, S1 S2 1 Tax incentives for saving increase the supply of loanable funds 5 % 4% Demand 2 .which reduces the equilibrium interest rate 0 $1,200 Loanable Funds $1,600 (in billions of dollars) 3 .and raises the equilibrium quantity of loanable funds Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc An Increase in the Demand... Market Basics ◆ Reading the Stock Market Report ➤Figure 19.2 in the textbook shows a part of a page from of the Wall Street Journal Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Market for Loanable Funds Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption Harcourt, Inc items and derived items copyright... 2003, the budget deficit is $307 billion The accumulation of past budget deficits is called the government debt ➤ For 2003, the total debt is 6.7 trillion Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Government Budget Deficits and Surpluses Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and. .. Funds Interest Rate Supply 5% Demand 0 $1,200 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Loanable Funds (in billions of dollars) Government Policies That Affect Saving and Investment ◆ Taxes and saving ◆ Taxes and investment ◆ Government budget deficits Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc items and derived items copyright ©... crowding out ◆ ◆ The deficit borrowing crowds out private borrowers who are trying to finance investments Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Effect of a Government Budget Deficit Interest Rate S2 6% 5% 2 .which raises the equilibrium interest rate $800 $1,200 0 3 .and reduces the equilibrium... Deficit Interest Rate S2 6% 5% 2 .which raises the equilibrium interest rate $800 $1,200 0 3 .and reduces the equilibrium quantity of loanable funds Supply, S1 1 A budget deficit decreases the supply of loanable funds Demand Loanable Funds (in billions of dollars)