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Types of financial institutions

Financial markets

Financial intermediaries



Financial markets

institutions through which savers can directly provide funds to borrowers

Bond market

Stock market (ASX)


Financial intermediaries

institutions through which savers can indirectly provide funds to borrowers

Managed funds



Credit unions
Pension (superannuation) funds
Insurance companies


Financial markets: the bond market

A bond is a certificate of indebtedness (IOU) that specifies obligations of the borrower to the holder of the bond


Characteristics of a bond


Credit risk

Tax treatment


Bond term

The length of time until maturity.


Bond credit risk

The probability that the borrower will fail to pay some of the interest or principal.


Bond tax treatment

The way in which the tax laws treat the interest on the bond.
In Australia interest earned on bonds is taxed as any other form of income. In the U.S. municipal bonds are federal tax exempt.


Financial markets: the stock market

A share is a claim to partial ownership in a firm.
The sale of stock to raise money is called equity financing.


What is the most important stock exchange in Australia?

the Australian Stock Exchange (ASX).


What information do most newspaper stock tables provide?

Price (of a share)

Volume (number of shares sold)

Dividend (profits paid to stockholders)

Price-earnings ratio


Financial intermediaries: indirect borrowing


take deposits from people who want to save and use the deposits to make loans to people who want to borrow.
pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans


Financial intermediaries

Banks help create a medium of exchange by allowing people to write cheques against their deposits or use credit cards
A medium of exchange is an item that people can easily use to engage in transactions.
This facilitates the purchases of goods and services.


What do managed funds allow

They allow people with small amounts of money to easily diversify their portfolio


Recall the GDP formula

Recall that GDP is both total income in an economy and total expenditure on the economy’s output of goods and services:

Y = C + I + G + NX


Recall the GDP formula as a closed economy

Assume a closed economy – one that does not engage in international trade (imports and exports are zero):

Y = C + I + G


National saving or just saving (S)

Now, subtract C and G from both sides of the closed economy GDP equation:
Y – C – G = I

The left side of the equation is the total income in the economy after paying for consumption and government purchases.

This is referred to as National saving, or just saving (S).

Substituting S for Y - C - G, the equation can be written as:
S = I


Does savings equal investments

This equation states that savings equals investment. Is it always true?
Important macroeconomic distinction between them that differs from our common usage of the term investment
Is buying shares/bonds an investment?


National saving, or saving, is equal to:

S = I
S = Y – C – G
S = (Y – T – C) + (T – G)


National Saving Consists of

Private and Public Components


Private saving

Private saving is the amount of income that households have left after paying their taxes and paying for their consumption.
Private saving = (Y – T – C)


Public saving

Public saving is the amount of tax revenue that the government has left after paying for its spending.
Public saving = (T – G)


Budget Surplus and Deficit

If T > G, the government runs a budget surplus because it receives more money than it spends.
The surplus of T − G represents public saving.
If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue


The market for loanable funds

Financial markets ‘coordinate’ the economy’s saving and investment in the market for loanable funds.
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds


Loanable funds

Loanable funds refer to all income that people have chosen to save and lend out, rather than use for their own consumption


the supply of loanable funds

The supply of loanable funds comes from people who have extra income they want to save and lend out.


The demand for loanable funds

The demand for loanable funds comes from households and firms that wish to borrow to make investments.


Interest rate

The interest rate is the price of the loan.
It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving.



Interest represents a payment in the future for a transfer of money in the past.