FINANCIAL SYSTEM ADVANTAGES TOOLS OF FINANCE

Definition 1. Less risk Definition

- A collection of economic 2. Portfolio diversification - Finance is the field that studies
organizations that assist in 3. Fixed income decision making
matching one person’s 4. Better interest income PRESENT VALUE OF MONEY
savings with another’s DISADVANTAGES Definition
investment 1. Risk of default - Present Value of a Future Sum
- Banks, insurance companies, 2. Opportunity costs o The amount of money
stock exchanges today that would be
FINANCIAL INSTITUTIONS STOCK MARKET needed using
Definition Definition prevailing interest
- Coordinate the actions of - Where stocks are bought and rates to o produce a
savers and borrowers in the sold to investors given future amount
financial system - Sells a minority part of their of money
o Financial markets- ownership Related Concept
allow savers to - PSE (Philippine Stock - Future Value of a Sum
provide funds directly Exchange) previously Manila o Amount the sum will
to borrowers SE be worth at a given
o Financial STOCKS future date, when
intermediaries- - Shares of ownership of a allowed to earn
allow savers to company (become a interest at the
provide funds to shareholder/stockholder) prevailing rate
borrowers indirectly - A document that reflects a CONCEPTS
FINANCIAL MARKETS claim to a portion of a 1. Receiving a given sum of
Definition company’s ownership (share money in the present is
- Allow savers to provide funds of profits) preferred to receiving the
to borrowers directly - Sale of stock = equity same sum in the future
- Direct financing financing 2. Helps explain why investment
BOND MARKET PROS falls when interest rates rises
Definition 1. Capital growth/ price 3. x/(1+r)N (x=amounts to be
- A certificate of indebtedness appreciation received in N years)
(proof that its issuer 2. Dividend income BRIEF EXPLANATION
[government or private corpo] 3. Rights of being a company’s - PV > Principal = Good deal
has borrowed money from you part-owner - PV < Principal = Bad deal
and will pay you what you are CONS When the present value (PV) of the
owed plus periodic interest 1. Higher risk of loss future cash flows ($200 in 10 years) is
payments over the period 2. Lack of control $112, it means that $112 today is
indicated) 3. Liquidity risk equivalent to $200 in 10 years,
CHARACTERISTICS 4. Costs considering the time value of money.
➢ Long-term = high interest FORMULA
𝑭𝑽
rates FINANCIAL INTERMEDIARIES 𝑷𝑽 = (𝟏+𝒓)𝑵
➢ Credit risk – likelihood that the Definition FV- Future Value
borrower may be unable to - Savers supply funds indirectly r= rate
make interest payments or to borrowers N= time
repay principal (bankruptcy) - An intermediary between two BASIC CALCULATOR HOW TO USE
➢ Tax status differs between parties in a transaction 1 + r → ÷ (twice) → = (press = depending on
bonds and other investments BANK N)
TYPES OF BONDS - Take deposits from people
FUTURE VALUE OF MONEY
1. Government Bonds who want to save and use the
Definition
- or sovereign bonds deposits to make loans to
- Amount of money in the future
- a form of bond people who want to borrow
that an amount of money
issued by a - Pay depositors interest on their
today will yield
government to deposits and charge
FORMULA
support public borrowers slightly higher 𝑷𝑽
𝑭𝑽 = (𝟏+𝒓)𝒏
spending interest on their loans
2. Corporate Bonds MUTUAL FUNDS BASIC CALCULATOR HOW TO USE
- issued by private - Sells shares to the public and r ×(twice) → = (n-1 [if n=1, do not press
corpo uses proceeds to buy a =]) → × FV
portfolio
COMPOUNDING - Are the key to economic it takes for policies to
Definition development work
- Accumulation of a sum of LABOR ii. Has negligible effect on
money where the interest - A particularly valuable aggregate demand
earned on the sum earns resource until 6 months after
additional interest TYPES OF UNEMPLOYMENT change is made
FORMULA (I HAVE NO IDEA) 1. Open Unemployment iii. Works with lag because
a. Work not available of the long process that
but is willing to work govern changes in
2. Underemployment spending
THE RULE OF 70 a. Works more than 8 iv. Inadvertently
Definition hours exacerbate rather than
- If a variable grows at a rate of 3. Structural Unemployment mitigate the magnitude
x percent per year, that a. Caused by changes of fluctuations
variable will double in about in the structure of an 2. SHOULD MONETARY POLICY BE
70/x years economy MADE BY RULE RATHER THAN
MANAGING RISK 4. Frictional/Transitional DISCRETION
Definition Unemployment a. SHOULD BE MADE BY RULE
- Rational response to risk a. Move from one job to i. Can suffer from
another job with incompetence and
RISK AVERSION same skills abuse of power
Definition 5. Cyclical Unemployment ii. Central banks ally
- A concept in economics and a. Caused by themselves with
finance that refers to the downswings of the politicians
preference of individuals to business cycle iii. discrepancy between
avoid uncertainty or potential 6. Disguised/Hidden what policymakers say
loses when making investment Unemployment they will do and what
decisions a. People seem to be they actually do (time
UTILITY FUNCTION employed but in inconsistency of policy)
Satisfaction → consumers receive → productivity terms iv. people are skeptical
consuming a good they are not when central banks
7. Natural Rate of Unemployment announce their
UNEMPLOYMENT a. Minimum percentage intentions to reduce the
Definition of the labor force that rate of inflation
- A person is unemployed if they is unemployed v. limit incompetence,
are not working but is abuse power, time
available for work 5 DEBATES inconsistency
- A loss of output as well as 1. SHOULD MONETARY AND b. SHOULD NOT BE
personal hardship for those FISCAL POLICYMAKERS TRY TO i. Discretionary is flexible
who are out of work STABILIZE THE ECONOMY ii. Limit the ability of
TWO CATEGORIES a. STABILIZE policymakers to
1. Long-run problem i. Inherently unstable and respond to changes
a. Natural rate of left on its own to iii. Problems with
unemployment refers fluctuate discretion and abuse of
to the amount of ii. Can manage power are largely
unemployment that aggregate demand to hypothetical
the economy offset instability and iv. Importance of political
normally experiences fluctuations thereby business cycle is far
2. Short-run problem production and from clear
a. Cyclical employment 3. SHOULD THE CENTRAL BANK
unemployment refers iii. No reason for society to AIM FOR ZERO INFLATION
to the year-to-year suffer through the a. SHOULD AIM
fluctuations in booms and busts of the i. Inflation cnfers no
unemployment business cycle benefit to society
around its natural b. NOT STABILIZE ii. A policy with temporary
rate i. Affects economy with costs and permanent
long and unpredictable benefits
lags between the need iii. After disinflationary
HUMAN RESOURCES to act and the time that recession, the benefits
 of zero inflation would iv. Tax system
persist discourages saving in
b. SHOULD NOT AIM many ways
i. Unattainable and v. Consequences of
involves output, high capital income
unemployment, and tax policies are
social costs reduced saving,
ii. Can reduce many of capital accumulation,
the costs of inflation low labor productivity,
without actually economic growth
reducing inflation vi. Alternative to current
4. SHOULD FISCAL tax policies is a
POLICYMAKERS REDUCE THE consumption tax
GOVERNMENT DEBT vii. A household pays
a. SHOULD BALANCE taxes based on what
BUDGET it spends not on what
i. Imposse an it earns
unjustifiable burden b. SHOULDN NOT BE
on future generations REFORMED
by raising taxes i. Primarily benefit the
ii. Debts and wealthy
accumulated interest ii. Reducing the tax
come due, future burden on the
taxpayers face a wealthy lead to a less
difficult choice egalitarian society
iii. Shifts cost of current iii. Force the
government benefits government to raise
to future generations, the tax burden on the
bias against future poor
taxpayers iv. Eliminating the
b. SHOULD NOT BALANCE government budget
i. Deficit is often deficit would provide
exaggerated a more direct and
ii. Transfer of debt to equitable way to
the future may be increase national
justified saving
iii. Government debt can
increase to rise
because population
growth and progress
5. SHOULD THE TAX LAWS BE
REFORMED TO ENCOURAGE
SAVING
a. SHOULD BE REFORMED
i. Saving rate is a key
determinant of its
long-run economic
prosperity
ii. Nation’s productive
capability is
determined largely by
how much it saves
and invests in the
future
iii. High saving rate =
more resources are
available for
investment