Name: ________________________________________________________________________________
CHAPTER 26 – Saving, Investment, and the Financial System
Activator
1. What would be the disadvantage of putting your savings under your mattress? ______________________________
______________________________________________________________________________________________
2. List some places that you could invest your money that might cause it to gain interest/grow.___________________
______________________________________________________________________________________________
Chapter 26 – Saving, Investment, and the Financial System
 Financial System – a group of institutions that turn ____________________________________________________
 Financial Markets – institutions through which savers can _______________________________________________
 Saving – the absence of _________________________
 Savings – dollars that become available to ____________________________________________________________
The Bond Market
 Bond – IOU, certificate of _____________________________ that specifies the obligations of the
________________________________ to the _______________________________________________
 Corporate, _________________________, U.S. _________________________
 Debt finance – sale of bonds __________________________________________________
 Principal – initial ___________________________________, $1000
 Date of maturity – time at which the __________________________________________________, 10-2030
 Term – length of time ______________________________________, 30 years
 Interest – rate at which the __________________________________________________, 6%
 Credit risk – the ____________________ or loss by an investor arising from a
__________________________________________________ some interest or _________________________
 Junk bonds – bonds offered by _________________________, _________________________corporations
 Default – failure to __________________________________________________
 Tax treatment – the way tax laws treat the ___________________________________________________________
 The interest on most bonds is considered _____________________________________________
 Municipal bonds – bonds offered by ___________________________________________________________; bond
holders are ___________________________________________________________ on interest
 Federal bonds – U.S. Treasury bonds are exempt from ____________________________________
The Stock Market
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Stock – partial ______________________________ of a firm through the purchase of a ______________________
 Disney, ______________________________, Babies ‘r Us, etc.
 1 share of a company, company has 1,000,000 shares, you own 1/1,000,000 of the business
Equity finance – sale of stocks to raise money; right to __________________________________________________
Difference between Stocks and Bonds
 Owner of shares in a company is a ______________________________________________________________
 Owner of bonds is a _________________________________________________________________________
 Stockholders enjoy benefits of _________________________while bondholders receive __________________
___________________________________________________________
 Bondholders ___________________________________________________________before stockholders if
the company is in _________________________________
 Stocks have a higher ___________________ than bonds, but a potentially higher __________________
Stock Exchanges
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Stock Exchanges – places where __________________________________________meet to trade stocks
 Perfectly competitive market – ____________________________________, prices are based solely on
______________________________________________________________________________________
New York Stock Exchange (NYSE) - a stock exchange located at __________________________________________,
New York City, USA. It is the world's _____________________________________________
National Association of Securities Dealers Automated Quotation System (NASDAQ) - the largest
___________________________________________________________ trading market in the United States
 Bidding system – brokers bid up the price of a share of stock through _________________________________
 Price of shares based on the following:
 _____________________________________
 _____________________________________
 _____________________________________
Intermediaries
 Financial Intermediaries – entity that channel ______________________ from people who have
___________________________ (______________________) to those who do
__________________________________________________________________ (______________________).
 Banks – takes deposits from ______________________ and loan to ______________________
 Mutual Funds – sell ______________; pool money from investors into a ___________________________________
(stocks, ______________________, __________________________, etc.)
Saving & Investment in National Income Accounts
 Gross domestic product (GDP)
 Total income = ___________________________
 Y = ____ +____ + ____ + ____
 Y = gross domestic product GDP
 C = consumption
 G = government purchases
 NX = net exports
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Closed economy – one that does ___________________________________________________________________
 NX = ____
 Y = ____ + ____ + ____
Open economy - interact with other ______________________________________________________
National saving (saving), S – total ________________________ in the economy that remains after paying for
_____________________________ and ______________________________ purchases
 ____ – ____ – ____ = I; S = ____ – ____ – ____
 ____ = ____
T = taxes minus _________________________________ (amount it pays back to _________________,
_________________________ and _____________________)
 National Saving, S = ____ – ____ – ____
Private saving – amount of ____________________ that households have left after paying for
_________________and _________________
 Y – ____ – ____
Public saving – tax __________________ that the government has left after paying for its _____________________
 T–G
Budget surplus – income in ____________________________________ over government spending; occurs when
the government _____________________________________________________________
 ____ – ____> 0
Budget deficit – shortfall of ____________________________________ from government spending; occurs when
the ________________________________________________________________
 ____ – ____< 0
The Market for Loanable Funds
 Market for loanable funds – market for those who want to ____________________________________and those
who want to ________________________________________________________________________
 Loanable funds – all ____________________ people have chosen to ____________________________________
rather than use for ________________________________
 Assumes a closed economy and only one market for loanable funds
 Market for loanable funds is governed by ____________________________________
 Source of the supply of loanable funds is __________________________
 Source of the demand for loanable funds is __________________________
 Price of a loan = _____________________________
 Borrowers ____________________________________
 Lenders receive a ____________________________________

Supply and demand of loanable funds
 Demand curve – ____________________________________
 As interest rates rise _________________________________________________
 Supply curve - ____________________________________
 As interest rate rises _________________________________________________
The Loanable Funds Model
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The interest rate in the economy adjusts to balance the supply and demand for loanable funds.
The supply of loanable funds comes from national saving, including both private saving and public saving. The
demand for loanable funds comes from firms and households that want to borrow for purposes of investment.
Here the equilibrium interest rate is labeled ir, and quantity of loanable funds are supplied and demanded q.
Application – Loanable Funds Graphing
Using a properly labeled graph, illustrate each of the following scenarios:
1. Suppose the economy is in a recession and the demand for loanable funds decreases.
2. Suppose the economy is in a recession and the government injects funds into the market.
3. Suppose the government implements a tax credit for consumers in the housing market which stimulates demand.
4. Suppose the government runs a budget deficit and increases their reliance on loanable funds (closed economy).
Chapter 26 Homework, pgs. 586 - 593
Answer the following questions based on the reading:
1. How do American families compare to other countries when it comes to saving? ____________________________
______________________________________________________________________________________________
2. What principles of economics relate to Americans' saving habits? _________________________________________
3. How does the U.S. federal government discourage saving? ______________________________________________
4. Describe the example provided in the book regarding a 25 year old investing in a bond.
______________________________________________________________________________________________
______________________________________________________________________________________________
5. What example is provided as a way to improve saving in the U.S.? ________________________________________
______________________________________________________________________________________________
6. What curve would this policy affect; Which way would the curve shift? ____________________________________
7. How would this affect both the quantity of loanable funds and the interest rates?
______________________________________________________________________________________________
8. What does an investment tax credit refer to? _________________________________________________________
9. Which curve would it affect; which way would it shift? __________________________________________________
10. How would an investment tax credit affect the interest rate and the loanable funds?
______________________________________________________________________________________________
11. How does a budget deficit affect the supply for loanable funds; which way does the curve shift?
______________________________________________________________________________________________
12. What does crowding out refer to? __________________________________________________________________
13. Why does increased borrowing by the government shift the supply curve and not the demand curve?
______________________________________________________________________________________________
14. Describe what a declining debt-GDP ratio , and a rising debt-GDP ratio indicates as it relates to indebtedness.
______________________________________________________________________________________________
15. How does war affect the debt to GDP ratio? __________________________________________________________
______________________________________________________________________________________________
16. Describe the two reasons that debt financing is an appropriate policy. _____________________________________
______________________________________________________________________________________________
17. How was government debt affected as a result of the Ronald Reagan administration? ________________________
______________________________________________________________________________________________
18. What was a primary goal of the Clinton administration? ________________________________________________
______________________________________________________________________________________________