Econ – Chapter 13 – Outline #1Econ – Chapter 13 – Outline #1

I. Savings and Financial System I. Savings and Financial System = = An economic system must be An economic system must be able to produce capital if it is to able to produce capital if it is to satisfy the wants and needs of its satisfy the wants and needs of its people. To produce capital, people. To produce capital, people must be willing to save, people must be willing to save, which releases resources for use which releases resources for use elsewhere. elsewhere.

+ + Savings to an Economist = Savings to an Economist =

Means the absence of spending, Means the absence of spending, while savings refers to the other while savings refers to the other dollars that become available in dollars that become available in the absence of consumptionthe absence of consumption

A. Saving and Capital Formation A. Saving and Capital Formation = = when people save, they make funds when people save, they make funds available to others. When businesses available to others. When businesses borrow these savings, new goods and borrow these savings, new goods and services are created, new plants and services are created, new plants and equipment are produced, and new equipment are produced, and new jobs become available. Saving makes jobs become available. Saving makes economic growth possible.economic growth possible.

1. Example – Entrepreneurs 1. Example – Entrepreneurs who borrow =who borrow =

Borrow to start a business Borrow to start a business immediatelyimmediately

if others have been saving in a bank, if others have been saving in a bank, then the bank has the funds for the then the bank has the funds for the entrepreneur to borrowentrepreneur to borrow

if people have been spending their if people have been spending their income, then the bank may not be income, then the bank may not be able to make the loanable to make the loan

a. a. When people save, they are When people save, they are abstaining from consumption, abstaining from consumption, which frees resources for others to which frees resources for others to borrow and use. These resources borrow and use. These resources also make investments possible.also make investments possible.

B. Financial Assets and the B. Financial Assets and the Financial System Financial System – for people to – for people to use the savings of others, the use the savings of others, the economic must have a financial economic must have a financial system, or a way to transfer system, or a way to transfer savers’ dollars to investor.savers’ dollars to investor.

1. How do people save?1. How do people save?

put the money in a savings account, put the money in a savings account, commercial bank, or a thrift commercial bank, or a thrift (independent savings and loan (independent savings and loan associations, high risk, but high associations, high risk, but high interest paid)interest paid)

purchase a certificate of deposit at a purchase a certificate of deposit at a depository institutiondepository institution

purchase a government or corporate purchase a government or corporate bondbond

a. Financial Assets =a. Financial Assets =

Receipts of deposits (paper trail)Receipts of deposits (paper trail)

claims on the property and the income claims on the property and the income of the borrowerof the borrower

the receipts are assets because they the receipts are assets because they are property that has valueare property that has value

specify the amount loaned and the specify the amount loaned and the terms at which the loan was madeterms at which the loan was made

1). 1). If the borrower defaults, the If the borrower defaults, the lender can use the financial asset lender can use the financial asset as proof in court that the funds as proof in court that the funds were borrowed and that were borrowed and that repayment is expected. repayment is expected.

2). 2). When funds are lent from one When funds are lent from one individual or business to another, a individual or business to another, a financial asset is generated. financial asset is generated.

2. The Financial System2. The Financial System

a. The Main Components of the a. The Main Components of the Financial System =Financial System =

11stst component, the funds that the component, the funds that the saver transferred to the borrowersaver transferred to the borrower

22ndnd, the financial assets or receipts , the financial assets or receipts that certify the loans were madethat certify the loans were made

savers, borrows, and institutions, savers, borrows, and institutions, that bring surplus funds and that bring surplus funds and financial assets togetherfinancial assets together

b. b. Any sector of the economy can Any sector of the economy can provide savings, but the most provide savings, but the most important sectors areimportant sectors are the the household and businesses. State household and businesses. State and local governments provide and local governments provide some savings, but they are not some savings, but they are not borrowers of funds.borrowers of funds.

c. Financial intermediaries =c. Financial intermediaries =

Financial institution that pool funds Financial institution that pool funds and lend them to othersand lend them to others

include the depository institutions, include the depository institutions, life insurance companies, pension life insurance companies, pension funds, and other groups that funds, and other groups that channel savings from savers to channel savings from savers to borrowersborrowers

d. Borrowers =d. Borrowers =

Generate financials assets when they borrow Generate financials assets when they borrow fundsfunds

corporation borrows directly from savers or corporation borrows directly from savers or indirectly from savers through financial indirectly from savers through financial intermediariesintermediaries

the corporation will issue a bond or other the corporation will issue a bond or other financial asset to the lenderfinancial asset to the lender

when the government borrows, they issue when the government borrows, they issue bonds and / or other financial assets to the bonds and / or other financial assets to the lenderlender

e. e. Almost everyone participates in Almost everyone participates in the financial system. The smooth the financial system. The smooth flow of funds through the system flow of funds through the system helps ensure that savers will have helps ensure that savers will have an outlet for their savings. an outlet for their savings. Borrowers, in turn, will have a Borrowers, in turn, will have a source of financial capital.source of financial capital.

3. Investments =3. Investments =

Many businesses and individuals Many businesses and individuals watch for profitable investment watch for profitable investment opportunitiesopportunities

looking for financial assetslooking for financial assets

Such as: corporate bonds, Such as: corporate bonds, government bonds, certificates of government bonds, certificates of deposit, and even saving accountsdeposit, and even saving accounts

in which they can investin which they can invest

C. Nonbank Financial C. Nonbank Financial Intermediaries = Intermediaries = Savings banks, Savings banks, credit unions, commercial banks, credit unions, commercial banks, and savings associations obtain and savings associations obtain fund when their customers and / or fund when their customers and / or members make regular deposits. members make regular deposits.

+ Nonbank Financial + Nonbank Financial Institutions =Institutions =

Group obtains funds in a different Group obtains funds in a different manner, and includes finance manner, and includes finance companies, life insurance companies, life insurance companies, pension funds, and companies, pension funds, and real estate investment trustsreal estate investment trusts

1. Finance Companies =1. Finance Companies =

Make loans directly to consumers Make loans directly to consumers and specializes in buying and specializes in buying installment contracts from installment contracts from merchants who sell goods on merchants who sell goods on creditcredit

a. a. Many merchants cannot afford Many merchants cannot afford to wait years for their customers to to wait years for their customers to pay off high cost items on the pay off high cost items on the installment plan. The merchants installment plan. The merchants sell the customer’s installment sell the customer’s installment contract to a finance company for contract to a finance company for a lump sum.a lump sum.

b. Utilizing a finance company =b. Utilizing a finance company =

Enables the merchant to advertise Enables the merchant to advertise instant credit or easy terms without instant credit or easy terms without actually carrying the loan full termactually carrying the loan full term

absorbing losses for an unpaid absorbing losses for an unpaid accountaccount

taking customers to court for taking customers to court for nonpayment of the loannonpayment of the loan

c. Consumer Loans =c. Consumer Loans =

Generally check a consumer’s credit Generally check a consumer’s credit rating and will make a loan only if the rating and will make a loan only if the individual qualifiesindividual qualifies

some loans are made to some loans are made to high riskhigh risk individuals, they tend to pay more for individuals, they tend to pay more for the funds they borrowthe funds they borrow

finance companies charge more than finance companies charge more than commercial banks do for loanscommercial banks do for loans

d. Bill Consolidation Loan =d. Bill Consolidation Loan =

A loan consumers use to pay off A loan consumers use to pay off all other billsall other bills

the consumer agrees to repay the the consumer agrees to repay the finance company over a period of finance company over a period of on or more yearson or more years

2. Life Insurance Companies = 2. Life Insurance Companies = life insurance companies collect life insurance companies collect their funds in order to provide their funds in order to provide financial protection for the financial protection for the survivors of the insured, collecting survivors of the insured, collecting a large sum of cash. a large sum of cash.

a). Premium =a). Premium =

The price paid for the life The price paid for the life insurance policyinsurance policy

it must be paid at specific times for it must be paid at specific times for the length of the protectionthe length of the protection

b). b). Insurance companies tend to Insurance companies tend to lend their surplus funds to others, lend their surplus funds to others, making loans to banks in the form making loans to banks in the form of large certificates of deposit. of large certificates of deposit. They may negotiate other They may negotiate other arrangements with smaller arrangements with smaller consumer finance companies.consumer finance companies.

3. Mutual Funds = 3. Mutual Funds =

A company that sells stock in itself A company that sells stock in itself to individual investors and then to individual investors and then invests the money it receives in invests the money it receives in stock and bonds issued by other stock and bonds issued by other corporationscorporations

a. a. Mutual fund stockholders Mutual fund stockholders receive dividends earned from the receive dividends earned from the mutual fund’s investments. They mutual fund’s investments. They many also sell their mutual fund many also sell their mutual fund shares for profit, just like other shares for profit, just like other stocks.stocks.

b. Mutual funds allow =b. Mutual funds allow =

People to play the market without People to play the market without risking all they have in one or a risking all they have in one or a few companiesfew companies

c. Size of the funds =c. Size of the funds =

The size of the mutual fund allows for The size of the mutual fund allows for the hiring of a staff of experts to the hiring of a staff of experts to analyze the securities market before analyze the securities market before buying and selling securitiesbuying and selling securities

allows for the purchase of different allows for the purchase of different stocks and bonds and to build up a stocks and bonds and to build up a more diversified portfolio (hold several more diversified portfolio (hold several investments, to protect from risk). If investments, to protect from risk). If the value of one investment falls the value of one investment falls sharply, the affect will be minimal.sharply, the affect will be minimal.

4. Pension Funds4. Pension Funds

a. pension =a. pension =

A regular allowance intended to A regular allowance intended to provide income security to provide income security to someone who has worked a someone who has worked a certain number of years, reached certain number of years, reached a certain age, or suffered a certain a certain age, or suffered a certain type of injurytype of injury

b. pension funds =b. pension funds =

A fund set up to collect income A fund set up to collect income and disburse payments to those and disburse payments to those person eligible for retirement, old person eligible for retirement, old age, or disability benefits.age, or disability benefits.

c. private pension funds =c. private pension funds =

Employers regularly withhold a Employers regularly withhold a percentage of workers’ salaries to percentage of workers’ salaries to deposit in the funddeposit in the fund

during the 30 – 40 year lag between during the 30 – 40 year lag between the time the savings are deposited the time the savings are deposited and the time the workers generally and the time the workers generally use them, the money is invested in use them, the money is invested in corporate stocks and bondscorporate stocks and bonds

d. government pension funds =d. government pension funds =

Similar to private fundsSimilar to private funds

the government makes regular the government makes regular contributions to the fund that will contributions to the fund that will pay benefits laterpay benefits later

Real Estate Investment Trust = Real Estate Investment Trust =

A company organized chiefly to A company organized chiefly to make loans to construction make loans to construction companies that build homescompanies that build homes

provide billions annually for home provide billions annually for home constructionconstruction

a. REITs borrowing =a. REITs borrowing =

Borrow most of their funds from Borrow most of their funds from banks and get their income from banks and get their income from the rents and mortgage payments the rents and mortgage payments of the people who use their moneyof the people who use their money

the income is use to pay interest the income is use to pay interest on the money they borrowedon the money they borrowed