Market for Loanable FundsFinancial InstrumentsMarket for Loanable FundsFinancial Instruments.......Savings and InvestmentElias YannopoulosSeptember 14, 2012Elias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..ConceptsCapital goods - goods used to produce other goods andservicesEx: Factories, machines that build carsInvestment - Spending on capital goodsSpending to increase future productionWithout investment there is no future productionRemember depreciationEvery dollar borrowed requires a dollar savedElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..TerminologyMarket for Loanable Funds has different terminology butfunctions similar to other marketsGood - Savings/loansPrice - Interest rateBuyers/Demanders - BorrowersSellers/suppliers - Savers/lendersElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..Supply of Loanable FundsInterest rate - Reward for savingRemember Law of Supply - ↑ P ⇒↑ QsFor loanable funds ↑ interest rate ⇒↑ savingsTime Preference - Goods and services are more valuable thesooner they are deliveredTime preference means that individuals prefer money today tomoney tomorrow, therefore lenders want compensationIn general people prefer smooth consumption patternsBorrow early in life and save while working for retirementElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..Demand for Loanable FundsInterest rate - Cost of BorrowingFirms borrow ⇔ expected return on investment > cost of aloanRemember Law of Demand - ↑ P ⇒↓ QdFor loanable funds ↑ interest rate ⇒↓ investmentWhen capital is more productive, loan demand increases at allinterest ratesNew technology ⇒ greater returns to investment ⇒ increasedemand for loansInvestor confidence - A firm’s expectations about futureeconomic activityEquilibrium graph - Savings = InvestmentElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..BondsBonds - loan contracts, function like IOUsThree key pieces of informationName of the BorrowerDate of maturityValue at maturity - Face ValueBond price - the amount paid to own the bondBond price and the Face value together set the interest rateBond price and the interest rate move in opposite directionsEx: $10,000 bondDefault Risk - How likely is the borrower to not repay?Ratings agencies - Assign grades to indicate default riskElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..Other Financial InstrumentsStocks - Ownership share of a corporationPrice of a stock is the price of a shareHow much you own depends on the total number of sharesU. S. Treasury bonds - Bonds used to fund national debtVery low default riskUsed in monetary policy by the FedHome mortgages - Loan contract for buying a homeConstant payments - formula is complicatedDifficult to rateElias Yannopoulos Savings and InvestmentMarket for Loanable FundsFinancial Instruments..Finance ConceptsSecondary Markets - Markets for the resale of financialinstrumentsLenders may not want to hold till maturityThe resale option for lenders makes it more valuableEasier for borrowers to find lenders because the don’t have toagree on the length of the loanSecuritization - Creation of a financial asset by combiningother financial assetsEx: Mortgage-backed Securities (MBS)Elias Yannopoulos Savings and
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