Section 1: Savings and the Financial System CH.12 Financial markets Section 1: Savings and the Financial System

Objectives Why saving is important for capital formation How the financial system works to transfer funds from savers to borrowers the role of the non depository financial institutions in the financial system

Savings means absence of spending Savings refers to dollars that become available When people abstain from consumption There are only two things you can do with your income-spend it or save it

Saving and Capital Formation When people save they make funds available Businesses borrow these funds and can produce new plants and equipment, goods, services, and create jobs “For investment to take place, someone must save”

Financial assets and the financial system A financial system is a network of savers ,investors and financial institutions

Financial Assets Certificate of deposit-reciept for an interest bearing loan to a bank,or a governemnt or corporate bond Financial assets-claims on the property and the income of the borrower

The Circular Flow of Funds Any sector can of the economy can provide savings but households and businesses are the most important Any sector can borrow but governments and businesses are the biggest borrowers Everyone participates and benefits from the financial system Savers have an outlet for their savings and borrowers have a source of capital

Non Bank Financial Intermediaries These are nondepository institutions that channel savings to borrowers Examples are finance companies;life insurance companies,pension funds and real estate investment trusts

Financial Intermediaries Financial institutions that lend the funds that savers provide to borrowers Examples are depository institutions,life insurance companies, and pension funds

Finance companies A finance company is a firm that specializes in making loans directly to consumers and in buying installment contracts from merchants who sell goods on credit (BrandsMart) The retailer can’t afford to wait for the payment for its inventory; instead it sells the contract to a finance company for a lump sum (Brandsmart to GEMoney)

Some finance companies loan directly to consumers, but charge higher interest because of the risk involved (easier credit has a price!) Still others offer bill consolidation loans

Life Insurance Companies A life insurance company provides financial protection for survivors of the insured individual(deceased) It does this by collecting premiums—the price for the coverage paid in installments(monthly quarterly, or annually) Since they accrue excess funds(they only pay out occasionally) they loan this to money to others

Mutual Funds A mutual fund is a company that sells stock in itself to investors then takes that money and invests it in stocks and bonds The money they make is then paid as dividends to investors The company acts as a manager for the investors money providing expertise and a diversified portfolio

Net Asset Value(NAV) This is the net value of the fund divided by the number of shares issued by the mutual fund and is the market value of the mutual fund share

Pension Funds A pension is a fund to provide financial security to individuals who qualify for retirement from a company or government A pension fund is the instrument set up to collect funds (state, city ,county,federal, private company) and then disperses these as mandated The general fund is invested in order to make money(benefits may be costly, i.e. health)

Real Estate Investment Trusts A real estate investment trust (REIT) is a company that exists to make its money from loans to construction companies that build homes.