Unit 6: Saving, Investment, and the Financial System
How savers and borrowers find each other through banks, bonds, and stocks, and the loanable funds market that sets the one price connecting them all.
9 topics · 35 questions
Each topic is a path, not a menu: work down it in order and every question builds on the one above. Click any of them to watch the answer draw itself.
Financial Institutions: Banks, Bonds, and Stocks
- How it worksHow do banks, the bond market, and the stock market each move funds from savers to borrowers in a different way?
- Common mistakeWhy isn't buying a share of stock the same kind of claim on a company as buying its bond?
- Going furtherWhat happens to a company's options for raising money once it is large enough to sell stock to the public?
Your turn1 of 2
An investor buys a company's bond, while another investor buys that same company's stock. If the company goes bankrupt, how does each investor's claim on the company differ?Bond Prices and Interest Rates
- How it worksHow does the price of a fixed-payment bond move in the opposite direction from the interest rate?
- Worked exampleFind the yield on a bond that pays 60 dollars a year and currently sells for 1000 dollars.
- Worked exampleFind the new price of that same bond once interest rates rise and buyers demand a yield of 8 percent instead.
- Common mistakeWhy isn't a bond's face value the same thing as what the bond is currently worth on the market?
Your turn1 of 2
Find the yield on a bond that pays 75 dollars a year and currently sells for 1060 dollars.The Time Value of Money and Present Value
- How it worksHow does discounting a future payment by an interest rate turn it into a present value you can compare to cash in hand today?
- Worked exampleFind the present value of 1210 dollars received two years from now at an interest rate of 10 percent.
- Common mistakeWhy isn't comparing two payments at different points in time as simple as comparing their raw dollar amounts?
- Going furtherWhat happens to the present value of a fixed future payment as the interest rate used to discount it rises?
Your turn1 of 2
Find the present value of 1636 dollars received two years from now at an interest rate of 9 percent.Compounding and Future Value
- How it worksHow does compound interest earn interest on top of interest already earned in every prior year?
- Worked exampleFind the future value of 5000 dollars invested for 3 years at an annual interest rate of 6 percent.
- Common mistakeWhy isn't compound interest over 20 years just 20 times the interest earned in a single year?
Your turn1 of 2
Find the future value of 6179 dollars invested for 5 years at an annual interest rate of 8 percent.Risk, Diversification, and the Tradeoff with Return
- How it worksHow does spreading savings across many different stocks cancel out risk that is specific to any one company?
- Common mistakeWhy doesn't diversification protect a portfolio from a risk that hits every company in the economy at once?
- Going furtherWhat happens to the risk of a portfolio as it grows from holding one stock to holding hundreds?
- Ties togetherHow does the risk-return tradeoff explain why government bonds pay less than the stock market on average?
Your turn1 of 2
A portfolio's risk falls as more stocks are added, but never below the level of risk common to the entire market. If total risk starts at 26 percent and idiosyncratic, diversifiable risk accounts for 12 percentage points of it, how much systematic, market-wide risk remains?National Saving and the Saving-Investment Identity
- How it worksHow do private saving and public saving add together into the national saving that funds investment?
- Worked exampleFind national saving when private saving is 2.8 trillion dollars and the government runs a 700 billion dollar deficit.
- Common mistakeWhy isn't public saving simply the government's total tax revenue for the year?
- Going furtherWhat happens to the saving-investment identity once a closed economy opens itself up to foreign capital?
Your turn1 of 2
Find national saving, in billion dollars, when private saving is 2987 billion dollars and the government runs a 724 billion dollar deficit.The Market for Loanable Funds
- How it worksHow does the real interest rate rise or fall until the quantity of loanable funds supplied matches the quantity demanded?
- Worked exampleFind the equilibrium real interest rate when saving is S equals 400 plus 30 times r and investment is I equals 900 minus 20 times r.
- Common mistakeWhy isn't the loanable funds market the same graph as the market that sets the nominal interest rate?
- Going furtherWhat happens to the real interest rate once a country opens its loanable funds market to foreign savers?
- Ties togetherHow does a shift in the loanable funds market show up later as a shift in the production function's capital stock?
Your turn1 of 2
Find the equilibrium real interest rate when saving is S = 439 plus 33 times r and investment is I = 1080 minus 19 times r.What Shifts Loanable Funds Supply and Demand
- How it worksWalk me through an investment tax credit shifting the demand for loanable funds right and lifting the real rate.
- Going furtherWhat happens to the loanable funds market when households suddenly decide to save a much larger share of income?
- Common mistakeWhy doesn't more national saving always translate into more investment and faster growth?
Your turn1 of 2
A government introduces a new investment tax credit, making it cheaper for businesses to invest in new equipment. What happens in the market for loanable funds?Government Borrowing and Crowding Out
- How it worksWalk me through a budget deficit shifting the demand for loanable funds right and pushing up the real interest rate.
- Worked exampleFind the change in private investment when the real interest rate rises from 3 to 5 percent and investment is I equals 900 minus 40 times r.
- Common mistakeWhy doesn't crowding out cancel out the entire effect of a government's extra borrowing?
- Going furtherWhat happens to crowding out when an economy has plenty of idle savings and few firms wanting to borrow?
- Ties togetherHow does crowding out link a government's budget deficit to a slower-growing capital stock a decade later?
Your turn1 of 2
Find the change in private investment when the real interest rate rises from 4 to 5.2 percent and investment is I = 1009 minus 39 times r.