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Saving, Investment, And The Financial System

1223 words - 5 pages

Chapter twenty-six examines how the financial system in America works and analyzes its macroeconomic role. I plan to structure my summary similar to the way chapter twenty-six does. First by talking about different financial institutions and how they work in the U.S. economy. Then by breaking down saving and investment in the national income accounts. Lastly I will explain how government policies affect society’s allocation of resources by manipulating the interest rate.
The first thing chapter twenty-six does is explain what a financial system is and why they are needed. A financial system is defined in the book as a group of institutions in the economy that help to match one person’s ...view middle of the document...

The longer the term of the bond, the higher the interest rate and the more return the holder will receive for the bond. This is simply because more time is more high risk and time is money. If the holder of a bond needs a payment before the date of maturity then he has to sell his bond to a different holder. Borrowers also can default on their loans by declaring bankruptcy. In this case the holder of the bond is now holding a bond that is worthless. Borrowers that have a higher risk to default on their loans have to pay a higher interest rate. The higher the risk, the higher the return is for the holder of the bond if the borrower does not default on the loan. U.S. government bonds are low-risk and a safe way to save money. However, low-risk means lower interest rates and smaller returns. The last important characteristic of a bond is its tax treatment. Most bonds require the holder to pay a portion of interest in income taxes. However, with municipal bonds, the bond holder is not required to pay taxes with a portion of interest. These bonds are issued by local and state government and have lower returns than bonds issued by the federal government or corporations since they have a tax advantage. Buying stock is another way to save money. Stock represents ownership in a firm. Selling stock allows firms to raise money. The sale of stock to raise money is known as equity finance. The more stock purchased in firm, the greater claim to profits an individual has. Buying stock in a prosperous business can lead to a large claim of profits. Stock indexes are watched closely as indicators to see how profitable certain stock will be in the future.
Other types of financial institutions in the U.S. economy are financial intermediaries. Financial intermediaries allow savers to be able to indirectly provide funds to borrowers. This allows borrowers who would struggle to raise money by selling stock or bonds a better route to obtain more funding. The two main financial intermediaries are banks and mutual funds. Banks pay interest to people who deposit their money and charge slightly higher interest to people who need to borrow. Banks are also important because they provide a different medium of exchange other than money with assets such as checks and debit cards. Mutual funds sell shares to the public and uses the money to buy a selection of different bonds and stocks. The shareholder accepts all risk of the selection he or she purchases. Obviously if the value of the portfolio increases, the shareholder benefits. The best thing about mutual funds is that they allow people with small amounts of money to spread out their holdings. This gives holders an advantage because the...

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