Chapter 13 Saving, Investment, and the Financial System.ppt

Chapter 13 Saving, Investment, and the Financial System Financial Institutions in the Canadian Economy Saving and Investment in the National Income Accounts The Market for Loanable Funds The Financial system consists of those institutions in the economy that help to match one person’s saving with another person’s investment. Financial institutions in the Canadian Economy At the broadest level, the financial system moves the economy’s scarce resources from savers ( people who spend less than they earn) to borrowers ( people who spend more than they earn). Savers save for various reasons: children’s education fund, retirement fund, etc. Savers supply their money to the financial system with the expectation that they will get it back with interest at a later date. Borrowers demand money from the financial system with the knowledge that they will be required to pay it back with interest at a later date. Financial institutions can be grouped into two categories: financial markets and financial intermediaries. Financial markets: are the institutions through which a person who wants to save can directly supply funds to a person who wants to borrow. Two most important financial markets: the bond market and the stock market. The Bond Market: A bond is a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond. Put simply, a bond is an IOU. Characteristics of a bond: Term: the length of time until maturity. Short terms: a few months Long terms: up to 30 years. The British government has even issued a bond that never matures, called a perpetuity. This bond pays interest forever, but the principal is never repaid. Long term bonds are riskier than short term bonds because holders of long term bonds have to wait longer for repayment of principal. To compensate for this risk, long-term bonds usually pay higher interest rates than short-term bonds. Credit Risk: the probability that the borrower will fail to pay some of the interest or