Chapter 3

Savings-Investment Process
and Financial Assets

© 2008 John Wiley and Sons

 Chapter Outcomes
● Briefly describe the objectives of national
economic policy
● Identify and briefly describe the major
components of the gross domestic
product
● Identify the major policy maker groups
and briefly describe their primary
responsibilities
● Discuss the three ways money is
transferred from savers to businesses

2
 Chapter Outcomes
(Continued)
● Identify the major sources of savings in
the United States
● Identify and describe the factors that
affect savings
● Discuss what is meant by real assets
versus financial assets

3
 Chapter Outcomes
(Concluded)

● Identify major financial instruments that

have maturities of up to one year
● Identify major financial instruments and
securities that have very long or no
maturities
● Describe the four types of financial
markets

4
 National Economic Policy
Objectives
● Economic Growth
function of increasing stock of productive
resources (labor force and stock of capital)
and improved technology and skills
● High Employment
● Price Stability
occurs when an increase in the price of
goods or services is not offset by an
increase in quality
● Balance in International Transactions

5
 Gross Domestic Product (GDP)
and Capital Formation

● GROSS DOMESTIC PRODUCT:

Measures the output of goods and
services in an economy
● CAPITAL FORMATION:
Process of constructing real property,
manufacturing producers’ durable
equipment, and increasing business
inventories

6
 Gross Domestic Product (GDP)
Components
GDP is composed of:
● Personal Consumption Expenditures

● Government Expenditures including

Gross Investment
● Gross Private Domestic Investment
● Net Exports of Goods and Services

7
 Gross Domestic Product (GDP)
Components (continued)
● EQUATION:
GDP = PCE + GE + GPDI + NE
● PERSONAL CONSUMPTION
EXPENDITURES (PCE):
Expenditures by individuals for durable
goods, nondurable goods, and services
● GOVERNMENT EXPENDITURES (GE):
Purchases of goods and services by the
government
8
 Gross Domestic Product (GDP)
Components (continued)
● EQUATION:
GDP = PCE + GE + GPDI + NE
● GROSS PRIVATE DOMESTIC
INVESTMENTS (GPDI):
Investments in residential & nonresidential
structures, producers’ durable equipment,
& business inventories
● NET EXPORTS (NE):
Exports minus imports of goods & services
9
 Four Policy Maker Groups

● FEDERAL RESERVE SYSTEM

-Sets Monetary Policy
● THE PRESIDENT
-Helps set Fiscal Policy
● CONGRESS
-Helps set Fiscal Policy
● U.S. TREASURY
-Conducts Debt Management Policy
10
 Policy Makers in the European
Economic Union
● Members of the European Union (EU):
signed the Maastricht Treaty in 1991
● Objective: converge economies, fix
exchange rates, & introduce the euro
(1999)
● European Monetary Union (EMU): twelve
members of the EU that adopted the euro
as their common currency
● European Central Bank (ECB) focuses on
maintaining price stability while each
member country is responsible for its own
fiscal policy
11
 Government Influence on the
Economy
● FISCAL POLICY:
Government influences economic
activity through taxation and
expenditure plans
● FUNDRAISING ACTIVITIES:
Government raises funds to pay for
its activities by: levying taxes,
borrowing, or printing money for its
own use 12
Transferring Savings into Investments

● Savings-Investment Process:
involves the direct or indirect
transfer of individual savings to
business firms in exchange for their
securities

13
 Savings-Investment Process
Direct Transfers:
Savers Money Business
Firm Securities

Indirect Transfers:
Savers Money InvestmentBusiness
Money

Securities Banking Firm Securities

Firm

Savers Money Financial Business

Money
Intermed’s
Intermediary Firm’s
Firm
Securities Securities

14
 Historical Role and Creation
of Savings

● Foreign investors initially purchased large

amounts of the securities sold by
government & private promoters to
develop the U.S.
● The American family later took over the
function of providing savings for the
capital formation process

15
 Creation of Savings

● U.S. Financial System’s Three Basic

Economic Units:
--individuals
--business firms (including financial
institutions)
--governments (federal, state, and local)
● Savings:
Income that is not consumed but is held in
the form of cash and other financial assets

16
 Creation of Savings (Continued)

● Savings Surplus:
Occurs when current income exceeds
investment in real assets
● Savings Deficit:
Occurs when investment in real assets
exceeds current income
● Importance of Individuals:
Individuals represent an important savings
surplus economic unit
17
 Major Sources of Savings

● Personal Savings:
Personal Saving = Personal Income –
Personal Current Taxes – Personal
Outlays
● Corporate Savings:
Undistributed Profits = Profits After Taxes
– Dividends

18
 Two Types of Personal Savings

● VOLUNTARY SAVINGS:
Financial assets set aside for future use
● CONTRACTUAL SAVINGS:
Savings accumulated on a regular
schedule by prior agreement (e.g.,
reserves in insurance and pension plans)

19
 Personal Savings in the U.S.
● PERSONAL SAVINGS DEFINITION:
Personal income
Less: taxes and other payments
Equals: disposable personal income
Less: personal outlays
Equals: personal savings
● SAVINGS RATE DEFINITION:
Savings Rate = (Personal Savings)/
(Disposable Personal Income)

20
Historical Personal Savings Rates

● 1960 5.8%
● 1965 7.0
● 1970 8.1
● 1975 9.2
● 1980 7.1
● 1985 4.5
● 1990 4.3
● 1995 4.8
● 2000 1.0
● 2003 2.1
● 2006 -1.0

21
 Types of Personal Savings

● Cash balances
● Time and savings deposits
● Insurance reserves and pension
funds
● Securities

22
 Corporate Savings in the U.S.
● UNDISTRIBUTED PROFITS DEFINITION:
Profits before taxes
Less: tax liabilities
Equals: profits after taxes
Less: dividends
Equals: undistributed profits
● RETENTION RATE DEFINITION:
Retention Rate = (Undistributed
Profits)/(Profits After Taxes)

23
 Factors Affecting Savings

● Levels of income
● Economic expectations
● Cyclical Influences (economic
cycles)
● Life stage of the individual saver
or corporation

24
Life Stages of the Individual Saver
and the Corporation
● Individual Saver
--Formative/education developing
--Career starting/family creating
--Wealth building
--Retirement enjoying
● Corporation
--Start-up stage
--Survival stage
--Rapid growth stage
--Maturity stage
25
 Types of Assets
● REAL ASSETS:
Physical assets that provide value or
wealth to their owners
● FINANCIAL ASSETS:
Contractual assets often backed by real
assets that provide value or wealth to their
owners
● INDIVIDUAL NET WORTH:
An individual’s money, real assets, and
other financial assets less the individual’s
debt obligation
26
 Types of Financial Instruments
with Maturities Up to 1 Year
Instrument: Issuer:
● Treasury bills U.S. government
● Negotiable certifi- Commercial banks
cates of deposit (CDs)
● Commercial paper Corporations
● Bankers’ acceptances Commercial banks
● Eurodollar deposits Commercial banks

27
 Short-term (Maturities Up to 1 Year)
Financial Instruments

● Treasury bill:
Short-term debt obligation issued by the
U.S. federal government
● Negotiable certificate of deposit (CD):
Short-term debt instrument issued by
depository institutions that can be traded in
secondary markets

28
 Short-term (Maturities Up to 1 Year)
Financial Instruments (Cont’d)
● Commercial paper:
Short-term unsecured promissory note
issued by a corporation with high-quality
credit
● Bankers’ acceptance:
Promise of future payment for credit
pur-chases by a firm and guaranteed by a
bank
● Eurodollar deposit:
Funds placed in a foreign bank that remain
29
denominated in U.S. dollars
Types of Financial Instruments or
Securities with Long-term or No
Maturities
Instrument/Security: Issuer:
● Mortgages Fin. intermediaries
● Treasury bonds U.S. government
● Municipal bonds State/local gov’ts.
● Corporate bonds Corporations
● Corporate stocks Corporations

30
Long-term (No Maturities or Up to 30
Years) Financial Instruments or
Securities
● Mortgage:
Loan against which a borrower pledges
real property as collateral for the loan
● Treasury bond:
Long-term debt instrument issued by the
U.S. federal government
● Municipal bond:
Long-term debt instrument issued by a
state or local government
31
Long-term (No Maturities or Up to 30
Years) Financial Instruments or
Securities (Cont’d)

● Corporate bond:
Debt instrument issued by a corporation
to raise long-term funds
● Common stock:
Ownership interest in a corporation

32
 Types of Financial Markets:
General
● PRIMARY MARKETS:
Markets in which financial instruments
and securities are initially offered or sold
with the proceeds going to the issuer
● SECONDARY MARKETS:
Markets in which previously issued or
“seasoned” instruments or securities are
traded

33
 Types of Financial Markets:
General (Cont’d)

● MONEY MARKETS:
Where debt instruments of one year or
less are traded
● CAPITAL MARKETS:
Markets for debt securities with maturities
longer than one year, and corporate
stocks

34
Four Specific Types of Financial
Markets
● SECURITIES MARKETS:
Physical locations or electron forums
where debt and equity securities are
sold and traded
● MORTGAGE MARKETS:
Where mortgage loans, backed by real
property are originated and sometimes
traded

35
Four Specific Types of Financial
Markets (Cont’d)
● DERIVATIVES MARKETS:
Facilitate purchase and sale of
derivative securities, which are financial
contracts that derive their values from
underlying securities
● CURRENCY EXCHANGE MARKETS:
Electronic markets in which financial
intermediaries buy and sell various
currencies on behalf of businesses and
other clients
36
 Web Links

● www.stls.frb.org
● www.federalreserve.gov

37