Savings, Investment and the
Financial System
The SavingsInvestment Spending Identity
Let’s go over this together…
The Financial System
Let’s go over this together…
Types of Financial Assets
• There are officially only four, but I want to
address loan-backed securities (with loans) –
as these played an important role in the 2008
recession
Types of Financial Assets
1. Loans are an agreement between a lender and
borrower.
They create funding for the borrower (who is a
seller in this transaction) and income for the
lender (buyer).
The buyer gives the seller the right to use the
money, which is repaid with interest.
These provide funds that fit the borrower’s needs
and ability to repay, but are not ideal for large
borrowers.
Types of Financial Assets
• Loan-backed securities are pools of individual loans sold
as shares.
Their intent was to reduce risk for lenders, since it was less
likely that all (or most) of the borrowers would default.
These securities were sold on the financial market as
bundles of debt divided into small pieces and sold as an
investment. Buyers were buying interest on the loan, not
the loan itself.
These were intended to be well-diversified to reduce risk,
since the underlying loans have a variety of different risks
(mortgages, credit cards, student loans, etc.), but proved
risky because the quality and quantity of risk was hidden.
Types of Financial Assets
2. Stocks are shares of ownership in a publicly-traded
company.
Their purpose is to reduce risk for the business owner, as they
do not have to finance business needs from their own
savings.
Stocks are sold to finance business expansion, with
shareholders (buyers) profiting in two ways: They receive
shares of business profit (called dividends) as well as
benefiting from growing resale value on the stock market.
Stocks tend to have a higher rate of return than other
investments, and they have high liquidity – but owning
stock is riskier than many other investments, as these are
not debts that companies have to pay if they fail.
Types of Financial Assets
3. Bonds are a debt/promise to pay that is sold on the bond
market.
Like loans, they create funding for the borrower (seller) and
income for the lender (buyer).
The seller promises to repay a fixed amount of interest each
year and to repay the principal on a set date. To raise
needed money, a seller issues a number of bonds with a
given interest rate and maturity date. Seller also benefits
from growing resale value on the bond market.
Bond-rating agencies assess risk, which helps to set the
interest rate. Bonds are also very liquid, but they have a
lower rate of return than some other investments.
Types of Financial Assets
4. Bank deposits are a transaction in which money
deposited is, in fact, a loan to a bank in exchange for a
record of that deposit that allows you to draw on that
money in the future.
Bank deposits provide the funds for banks to lend.
The depositor has the right to access funds at any time,
but banks can use this money to finance loans.
These are the most liquid of financial assets, and they are
insured by the federal government to $250,000 – but
they also have the lowest rate of return.
Types of Financial Intermediaries
1. Mutual funds are diversified stock portfolios sold as
shares.
Mutual funds allow small investors to hold stock in a
variety of companies.
Mutual fund companies purchase a large stock portfolio
and sell shares of the portfolio (with specialized
options).
These allow buyers to avoid transaction fees for each
purchase, benefit from the expertise of fund
managers, and better assess risk. Overall, mutual
funds have a lower rate of return than stocks and can
charge high management fees.
Types of Financial Intermediaries
2. Pension funds are nonprofit organizations that
collect savings of members and invest them.
Pension funds provide retirement income for
members.
Pension funds purchase a large stock portfolio and
divide it among members based on their
savings.
These have the same advantages/disadvantages as
mutual funds.
Types of Financial Intermediaries
3. Life insurance companies collect premiums
(payments) and invest them.
Buyers who pay premiums are guaranteed that the
insurance company will provide an income to
their beneficiaries.
Premiums received are invested to provide profit
for the insurance company.
Life insurance is considered a safe investment, but
you have little liquidity (very limited access to
your money) during your lifetime – and there is
a very low rate of return.
Types of Financial Intermediaries
4. Banks provide assets to borrowers and
depositors.
See notes on bank deposits