Economic growth enhancement…Saving and investmentFund productive projectsAllocation of saving in free markets by a decentralized financial system, in command systems by a centralized bureaucracyImproving Allocation of SavingFree market financesBanks, bond and stock marketsInformation to saversWays to use funds that are productiveHelp savers share the risksImproves allocation to risky but productive projectsMisallocate resources if a “bubble” occursCommand economyMisallocates resourcesUses non-economic reasons to make allocation decisionsPolitical favoritism influences decisionsDifficult to obtain informationExpertise is lacking to allocate efficientlyThe Banking System- Loan MarketsFinanical intermediariesExtend credit to borrowers using funds raised from saversCommercial Banks, credit unions, insurance companiesBring together savers and borrowersGather important infoReduce costs of gathering infoDirect saving = productive projectsBorrowers- access to creditFinancial Markets- collections of households, firms, gov’t, banks, other financial instituoons that lend and borrow4 groups = Bond, stock, short-term securities, loansGlobal Financial Markets- Lenders seek highest real interest rate, borrowers seek lowest interest rate in a single global financial marketBond- promise to pay specified sums of money on specified datesA debt for the issuerLegal promise to pay back a loan plus interestUsed by firms, gov’t to raise fundsCoupon Rate- Interest rate promised when a bond is issuedTerm of bond- length of time before debt is fully repaidMaturity- time which the bondholders are supposed to be repaidCredit risk- risk that borrower will not repay the loanHigh- Yield “junk bonds”- debt of higher credit risk firms that pay high interest rates to compensate for the higher risk of defaultPeople holding bonds do not have to keep them until maturity, can be sold in bond-market (organized market run by professional bond traders.Price of a bond- market value of a particular bond at any point, inverse relationship exists between price of a bond and interest rate on a bondBond Market- Bonds issued by firms and gov’ts are tradedStock – Ownership and claim to profits that a firm makesStock Market- financial market where shares of companies stocks are tradedShort-term securities- include commercial bills and treasury bills. Promises by large firms and gov’t to pay agreed sum no longer than one year in the futureLoans Markets- Banks and other financial intuitions lower cost of financing firms capital expenditures by accepting short term deposits and making longer-term loansEcon test 2 notes 02/27/2012Economic growth enhancement…-Saving and investment-Fund productive projects oAllocation of saving in free markets by a decentralized financial system, in command systems by a centralized bureaucracy Improving Allocation of Saving-Free market finances oBanks, bond and stock markets -Information to savers oWays to use funds that are productive -Help savers share the risks oImproves allocation to risky but productive projects-Misallocate resources if a “bubble” occurs-Command economyoMisallocates resourcesUses non-economic reasons to make allocation decisionsPolitical favoritism influences decisions Difficult to obtain informationExpertise is lacking to allocate efficiently The Banking System- Loan Markets -Finanical intermediariesoExtend credit to borrowers using funds raised from saversCommercial Banks, credit unions, insurance companies Bring together savers and borrowers oGather important info oReduce costs of gathering infooDirect saving = productive projects oBorrowers- access to credit Financial Markets- collections of households, firms, gov’t, banks, other financial instituoons that lend and borrow -4 groups = Bond, stock, short-term securities, loansGlobal Financial Markets- Lenders seek highest real interest rate, borrowers seek lowest interest rate in a single global financial marketBond- promise to pay specified sums of money on specified dates -A debt for the issuer -Legal promise to pay back a loan plus interest-Used by firms, gov’t to raise fundsCoupon Rate- Interest rate promised when a bond is issued Term of bond- length of time before debt is fully repaidMaturity- time which the bondholders are supposed to be repaidCredit risk- risk that borrower will not repay the loan High- Yield “junk bonds”- debt of higher credit risk firms that pay high interest rates to compensate for the higher risk of default-People holding bonds do not have to keep them until maturity, can be sold in bond-market (organized market run by professionalbond traders. Price of a bond- market value of a particular bond at any point, inverse relationship exists between price of a bond and interest rate on a bond Bond Market- Bonds issued by firms and gov’ts are traded Stock – Ownership and claim to profits that a firm makesStock Market- financial market where shares of companies stocks are tradedShort-term securities- include commercial bills and treasury bills. Promises by large firms and gov’t to pay agreed sum no longer than one yearin the futureLoans Markets- Banks and other financial intuitions lower cost of financing firms capital expenditures by accepting short term deposits and making longer-term loans