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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 thework should be mailed to:
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The Financial System
The financial system consists ofinstitutions that help to match oneperson’s saving with another person’sinvestment.
It moves the economy’s scarce resourcesfrom savers to borrowers.
The financial system is made up ofinstitutions(Markets and Intermediaries)
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Financial Institutionsin the U.S. Economy
Financial Markets Stock Market
Bond Market
Financial Intermediaries Banks
Mutual Funds
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Other Financial Institutions
Credit unions
Pension funds
Insurance companies
Loan sharks
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The Bond Market
A bond is a certificateof indebtedness thatspecifies obligations ofthe borrower to theholder of the bond.
IOU
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Characteristics of a Bond
Term: The length of time until the bondmatures.
Credit Risk: The probability that theborrower will fail to pay some of theinterest or principal.
Tax Treatment: The way in which thetax laws treat the interest on the bond. Municipal bonds are federal tax exempt.
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Stock Market BasicsStock Market Basics
What is Stock?A stock is a
tradable securitythat a firm issues tocertify that thestockholder owns ashare of the firm.
Figure 19.1 showsan example of astock certificate.
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Stock represents ownership in a firm andis therefore, a claim to the profits that thefirm makes.
The sale of stock to raise money is calledequity financing. Compared to bonds, stocks offer both higher
risk and potentially higher returns.
The Stock Market
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The Stock Market
The most important stock exchanges inthe United States are the New YorkStock Exchange, the American StockExchange, and NASDAQ.
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The Stock Market
Most newspaper stock tables provide thefollowing information:
Price (of a share)
Volume (number of shares sold)
Dividend (profits paid to stockholders)
Price-earnings ratio
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Stock Market BasicsStock Market Basics
Reading the Stock Market ReportFigure 19.2 in the textbook shows a part of a page
from of the Wall Street Journal.
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The Market for Loanable Funds
Loanable funds refers to all incomethat people have chosen to save andlend out, rather than use for theirown consumption.
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Loanable Funds (inbillions of dollars)
0
InterestRate
Demand
Supply
5%
$1,200
Market for Loanable Funds...
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Government Policies That AffectSaving and Investment
Taxes and saving
Taxes and investment
Government budget deficits
S2
1. Tax incentives forsaving increase thesupply of loanablefunds...
An Increase in the Supply of LoanableFunds...
Loanable Funds (in billions of dollars)
0
InterestRate
5%
Supply, S1
$1,200
Demand
$1,600
3. ...and raises the equilibrium quantity of loanable funds.
4%
2. ...whichreduces theequilibriuminterest rate...
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An Increase in the Demand forLoanable Funds...
Loanable Funds(in billions of dollars)
0
InterestRate
5%
$1,200
Supply
Demand, D1
1. An investment taxcredit increases thedemand for loanablefunds...
D2
6%
2. ...whichraises theequilibriuminterest rate...
$1,4003. ...and raises the equilibriumquantity of loanable funds.
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Government Budget Deficits andSurpluses
When the government spends more than itreceives in tax revenues, the short fall is calledthe budget deficit. For 2003, the budget deficit is $307 billion
The accumulation of past budget deficits iscalled the government debt. For 2003, the total debt is 6.7 trillion.
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Government Budget Deficits andSurpluses
Government borrowing to finance itsbudget deficit reduces the supply ofloanable funds available to financeinvestment by households and firms.
This fall in investment is referred to ascrowding out. The deficit borrowing crowds out private
borrowers who are trying to financeinvestments.
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S2
1. A budget deficitdecreases thesupply of loanablefunds...
The Effect of a Government BudgetDeficit...
Loanable Funds(in billions of dollars)
0
InterestRate
$1,200
Supply, S1
Demand
5%
$8003. ...and reduces the equilibriumquantity of loanable funds.
2. ...whichraises theequilibriuminterest rate...
6%
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