GN-b Macroeconomics

3 Savings & Investments
The financial system consists of institutions, such as banks, insurance
markets, bond markets, and stock markets, that help transfer funds between
savers and investors. When you open a savings account, you play an
important role in our economy. Your savings will be borrowed and invested
by businesses and the government. The new products created by these
investments help to fuel the nation’s economy.
This section corresponds to Chapter 11: Sections 1 & 2.
50. Identify what constitutes the financial system and describe financial
51. Explain how economists categorize various markets where financial
assets are sold.
52. Explain how risk and return are related.
L. Savings and Investment
o Savings—income not used for consumption
o Investment—use of income now in a way that provides a
future benefit
o economic investment—money lent to businesses
o personal investment—individuals putting savings into financial
o Financial system—transfers funds between savers and
o Mutual fund—pools individuals’ money to buy range of
financial assets; investors own shares of entire fund.
A. The Financial System—bringing savers and investment together.
1. People and businesses save funds in various ways, including
savings accounts, CDs, corporate and/or government bonds, and
stocks. The person who receives these funds is the borrower,
who issues written confirmation to the savers. This written
confirmation is a financial asset—★
2. Savers and borrowers come together on a financial market;
they may exchange assets directly—for instance when a person
buys corporate bonds or shares of stock. More commonly, people
use a financial intermediary who collects funds from savers and
invests in financial assets.
B. Financial Intermediaries
1. Includes banks, S&Ls, credit unions, also finance companies,
pension funds, and life insurance companies.
2. Banking Financial Intermediaries provide checking, savings,
money market deposit accounts, and CDs. Depositors earn
interest, and the federal government insures deposits up to
$100,000. The banks make loans—to make a profit, they charge
higher interest than they pay their depositors. Since banking
deregulation in the early 2000s, ★
3. Nonbank Financial Intermediaries are finance companies that
make small loans to households and small businesses.
a. Mutual funds let individuals own many assets with fund
managers making the decisions of which assets.
b. Similarly, pension funds invest employees’ money, so
the investors will have more at retirement.
c. Life insurance companies invest income in financial
assets; it lets people save by building cash values and
protect them against loss.
LI. Financial Asset Markets are categorized according to time and
o Capital market—for buying and selling long-term financial
o Money market—for buying and selling short-term financial
o Primary market—for financial assets that original buyer must
o Secondary market—where financial assets are resold
A. Factor 1: Time—there are two time-sensitive markets
1. Capital markets—assets held for over a year. ★
2. Money markets—loans made for less than a year. The include
short-term CDs and Treasury bills.
B. Factor 2: Resalability—there are two markets based on whether it
can be resold.
1. Primary markets—financial assets can be redeemed only by
original buyer. They include savings bonds, small denomination
CDs. The term “primary market” also refers to the market where
2. Secondary markets—resale markets; offer liquidity to
investors. They include stocks and bonds.
LII. Investing in a Market Economy
o Risk—possibility for loss on an investment
o Return—profit or loss on an investment. It refers to interest
paid on savings or increase in value of stock.
o Diversification—investing in different financial assets. Its
purpose is to maximize returns, minimize risk.
A. Why are you investing?
1. Investment Objectives: The individual investor must first
determine own investment objective—the goal that the investor
uses to decide if an investment is appropriate. Two issues play a
major role in determining which investment works best to reach
the objectives:
2. When the money will be needed: If it is a short-term goal may
mean that investors want low-risk and liquid investments. If a
long-term goal, then investors may tie up their money in longterm deposits or they ★
3. Available income: will the investor’s income change in the
future? Is this an emergency fund? Is this extra income after
paying expenses?
4. Other issues:
a. Investors should first pay off debts.
b. Investments may bring tax concerns.
c. Savings for emergencies should be liquid.
d. Long-term investments are good for retirement and
college savings.
e. Investors may choose CDs to coincide with timing of
savings goals.
B. Risk and Return
1. What Kind of Risk Are You Willing to Take?
a. ★
b. No-risk investments: insured savings and CDs, U.S.
government bonds. But safe investments still have risk—
the interest rate may not keep up with inflation.
c. The return on riskier investments depends on how
profitable company is. Bonds are less risky than stocks, as
bondholders paid off first if the company has financial
2. What Kind of Return Do You Want?
a. ★
b. Stocks, bonds have no guaranteed rates; stocks have
higher rates of return over time.
c. If investing over long period, investors can risk some
losses in stock some years. But if the investor has less
time and money, they may want safer investment.
d. Diversification gives investors a better chance of
offsetting a loss with a gain.