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Chapter 13Chapter 13Saving, Investment, and the Saving, Investment, and the

Financial SystemFinancial System

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OutlineOutline

Coordination of savings and investment Coordination of savings and investment by the economyby the economy

Working of the financial system and its Working of the financial system and its constitutionconstitution

Develop a model of supply and Develop a model of supply and demand for fundsdemand for funds

Impact of government policies on Impact of government policies on interest rate interest rate

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Financial System in Canada Financial System in Canada

Financial systemFinancial system is a group of is a group of institutions in the economy that help to institutions in the economy that help to match one person’s saving with match one person’s saving with another person’s investment. another person’s investment.

It is made up of a number of financial It is made up of a number of financial institutions. Broadly of two typesinstitutions. Broadly of two types Financial markets Financial markets Financial Intermediaries Financial Intermediaries

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Financial Markets Financial Markets Financial markets are institutions through Financial markets are institutions through

which savers can directly provide funds to which savers can directly provide funds to borrowersborrowers The bond marketThe bond market The stock market The stock market

The bond is a certificate of indebtedness and The bond is a certificate of indebtedness and has two important characteristics has two important characteristics Term of the bond (date of maturity)Term of the bond (date of maturity) Credit risk- probability of default by the borrower Credit risk- probability of default by the borrower Tax assessment: Interest rate on most bonds is Tax assessment: Interest rate on most bonds is

subject to a tax subject to a tax

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Financial Markets Financial Markets The stock market: Stock is a claim to partial The stock market: Stock is a claim to partial

ownership of firm and issue of stock is done ownership of firm and issue of stock is done through sale of shares to the publicthrough sale of shares to the public

Equity finance versus debt finance Equity finance versus debt finance The prices at which shares trade on stock The prices at which shares trade on stock

exchange are determined by the supply and exchange are determined by the supply and demand for the stock in the companydemand for the stock in the company

Equity premium- bonus paid by the market Equity premium- bonus paid by the market to shareholders to shareholders

Stock index is the average of a group of Stock index is the average of a group of stock pricesstock prices

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Financial Intermediaries Financial Intermediaries

Financial intermediaries are financial Financial intermediaries are financial institutions through which savers ca institutions through which savers ca indirectly provide funds to borrowers indirectly provide funds to borrowers Banks Banks Mutual fundsMutual funds

Banks help create a special asset Banks help create a special asset (cheques against deposits) that functions (cheques against deposits) that functions as a medium of exchange as a medium of exchange

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Financial Intermediaries Financial Intermediaries

Mutual fund is an institution that sells Mutual fund is an institution that sells shares to the public and uses the shares to the public and uses the proceeds to buy a portfolio of stocks and proceeds to buy a portfolio of stocks and bonds bonds

The shareholder of the mutual fund The shareholder of the mutual fund accepts the risks and returns associated accepts the risks and returns associated with the mutual fundwith the mutual fund Helps small savers to diversify risk Helps small savers to diversify risk

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Reading the Newspaper’s stock Reading the Newspaper’s stock tables tables

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Reading an online Quote Reading an online Quote

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S and I in the National Income S and I in the National Income Accounts Accounts

S and I are important determinants of LR S and I are important determinants of LR growth in GDP and standards of living of growth in GDP and standards of living of a nationa nation

Recall: Y = C + I + G + NXRecall: Y = C + I + G + NX Assume a closed economyAssume a closed economy There are two components to national There are two components to national

saving: saving: Public saving Public saving Private savingPrivate saving

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S and I in the National Income S and I in the National Income Accounts Accounts

For the economy as a whole, saving must For the economy as a whole, saving must be equal to investmentbe equal to investment

The concept and calculation of Present The concept and calculation of Present ValueValue

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The Market For Loanable FundsThe Market For Loanable Funds

Financial markets co-ordinate the Financial markets co-ordinate the economy’s saving and investment in the economy’s saving and investment in the Loanable Funds MarketLoanable Funds Market

Saving represents the supply of loanable Saving represents the supply of loanable fundsfunds

Investment represents demand for Investment represents demand for loanable fundsloanable funds

The supply and demand for loanable The supply and demand for loanable funds depends on the real interest rate funds depends on the real interest rate

Equilibrium determines the real interest Equilibrium determines the real interest rate in the economyrate in the economy

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Government Policy and Economy’s Government Policy and Economy’s Saving and InvestmentSaving and Investment

Policies that influence the loanable funds Policies that influence the loanable funds market:market: Tax incentives and SavingTax incentives and Saving

Tax incentives that encourage savings would Tax incentives that encourage savings would result in lower interest rates and greater investment result in lower interest rates and greater investment

Tax credits and InvestmentTax credits and InvestmentTax credits that encourage investment would result Tax credits that encourage investment would result

in higher interest rates and greater savingin higher interest rates and greater saving

Government Budget Deficits/SurplusesGovernment Budget Deficits/Surpluses

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Government Policy and Economy’s Government Policy and Economy’s Saving and InvestmentSaving and Investment

Government Budget DeficitsGovernment Budget Deficits Impacts adversely on national savingImpacts adversely on national saving Government borrowing Government borrowing crowdscrowds out private out private

investment investment Budget deficits and vicious circle Budget deficits and vicious circle Budget surplus and virtuous circleBudget surplus and virtuous circle

Accumulation of government debt in Canada Accumulation of government debt in Canada Policies undertaken by the federal and provincial Policies undertaken by the federal and provincial

governments governments

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FEDERAL GOVT: BUDGET SURPLUS and BUDGET DEFICIT

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PROVINCIAL GOVT: BUDGET SURPLUS and BUDGET DEFICIT

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Savings and Investment in Canada as % of GDP 1961-2001