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1 Chapter 13 Saving, Investment, and the Financial System
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2 Outline Coordination of savings and investment by the economy Working of the financial system and its constitution Develop a model of supply and demand for funds Impact of government policies on interest rate
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3 Financial System in Canada Financial system is a group of institutions in the economy that help to match one person’s saving with another person’s investment. It is made up of a number of financial institutions. Broadly of two types Financial markets Financial Intermediaries
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4 Financial Markets Financial markets are institutions through which savers can directly provide funds to borrowers The bond market The stock market The bond is a certificate of indebtedness and has two important characteristics Term of the bond (date of maturity) Credit risk- probability of default by the borrower Tax assessment: Interest rate on most bonds is subject to a tax
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5 Financial Markets The stock market: Stock is a claim to partial ownership of firm and issue of stock is done through sale of shares to the public Equity finance versus debt finance The prices at which shares trade on stock exchange are determined by the supply and demand for the stock in the company Equity premium- bonus paid by the market to shareholders Stock index is the average of a group of stock prices
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6 Financial Intermediaries Financial intermediaries are financial institutions through which savers ca indirectly provide funds to borrowers Banks Mutual funds Banks help create a special asset (cheques against deposits) that functions as a medium of exchange
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7 Financial Intermediaries Mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds The shareholder of the mutual fund accepts the risks and returns associated with the mutual fund Helps small savers to diversify risk
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8 Reading the Newspaper’s stock tables
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9 Reading an online Quote
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10 S and I in the National Income Accounts S and I are important determinants of LR growth in GDP and standards of living of a nation Recall: Y = C + I + G + NX Assume a closed economy There are two components to national saving: Public saving Private saving
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11 S and I in the National Income Accounts For the economy as a whole, saving must be equal to investment The concept and calculation of Present Value
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12 The Market For Loanable Funds Financial markets co-ordinate the economy’s saving and investment in the Loanable Funds Market Saving represents the supply of loanable funds Investment represents demand for loanable funds The supply and demand for loanable funds depends on the real interest rate Equilibrium determines the real interest rate in the economy
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13 Government Policy and Economy’s Saving and Investment Policies that influence the loanable funds market: Tax incentives and Saving Tax incentives that encourage savings would result in lower interest rates and greater investment Tax credits and Investment Tax credits that encourage investment would result in higher interest rates and greater saving Government Budget Deficits/Surpluses
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14 Government Policy and Economy’s Saving and Investment Government Budget Deficits Impacts adversely on national saving Government borrowing crowds out private investment Budget deficits and vicious circle Budget surplus and virtuous circle Accumulation of government debt in Canada Policies undertaken by the federal and provincial governments
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16 FEDERAL GOVT: BUDGET SURPLUS and BUDGET DEFICIT
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17 PROVINCIAL GOVT: BUDGET SURPLUS and BUDGET DEFICIT
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18 Savings and Investment in Canada as % of GDP 1961-2001
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