- The next midterm will be on Monday. The room assignments were sent out in an email.- *The title for the diagram drawn at the end of the last lecture is Financial Intermediation- connecting savers and investorso This is very important to give us opportunities to get money we need now (for getting aneducation, buying a home, etc.)- What the financial system does (continued)o Reduces risk (compared to an individual lending money)o Provides liquidity (access to money you don’t actually have now)- Assets and liabilitieso Asset: something of value you own E.g. a house, car investments (retirement fund, insurance, savings account, mutual fund, checking account, etc.), furniture, jewelry, etc.o Liability: something of value you owe E.g. a mortgage, a car loan, etc.o It all depends on perspective: E.g. A car loan can be a liability or an asset- it is a liability to the borrower, and an asset to the lender E.g. A checking account is an asset to the lender, and a liability to the borrower (the bank)o Types of assets Loans Bonds (IOUs, you can sell them to others) Loan-backed securities- Securitization: assets created by pooling individual loans and selling shares in that pool- E.g. there is a company with $1 million available to finance mortgageso A traditional mortgage of $200,000 value can be lent out to be paid back in the next 30 yearso This would mean you could lend out 5 total mortgageso This is risky because you have to guess what a good interest ratefor the next 30 years will beo If the lender gave out one mortgage, and then sold that mortgage to someone else, the lender has his $1 million again. This means there is no limitation of mortgages the lender can lend out if he sells them. It is an easy way to make money, but is not very ethical because the lender ends up giving out a lot of risky mortgages. - Tranche: a “slice” of combined mortgageso E.g. you can sell someone all of the first year payments of securitized mortgages- If the system fails it is hard to clean upo Oil spill analogy: if the oil spill is small, you can boom it off (enclose it) easily, but if it is large it is much harder to clean upo A failed system that is spread all over the world is very hard to clean up- Rating agencies rate the risk of these financial assets. Before the economic crisis they got paid off to give good ratings to risky mortgages.- The system falls apart when people can’t pay their loans back or when people realize there is a disconnect from the real value of assets. Stocks: buying a share (a piece of ownership) in a company- Return to the circular flow diagram ideao Total spending (in $) = total income (in $) = total production (in $) Spending: GDP = C + I + G + (X – M) Income: GDP = wages + interest + rent + profit Production: GDP = ∑i=1nPiQio In a more complicated world Households: can do the following with income:- Spend it C- Save it (includes investment) Sp = private saving- Pay taxes T – TR = taxes – transfers = net taxeso Transfers represent the money you get back from the government (such as welfare, social security, etc.)- Spending can be done by o Households Co Businesses Io Government G- Y = C + Sp + (T – TR)- Or Sp = Y – C – (T –
View Full Document
Unlocking...