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By the end of this section, you will be able to:
  • Show the relationship between savers, banks, and borrowers
  • Calculate bond yield
  • Contrast bonds, stocks, mutual funds, and assets
  • Explain the tradeoffs between return and risk

The ways in which firms would prefer to raise funds are only half the story of financial markets. The other half is what those households and individuals who supply funds desire, and how they perceive the available choices. The focus of our discussion now shifts from firms on the demand side of financial capital markets to households on the supply side of those markets. The mechanisms for saving available to households can be divided into several categories: deposits in bank accounts; bonds; stocks; money market mutual funds; stock and bond mutual funds; and housing and other tangible assets like owning gold. Each of these investments needs to be analyzed in terms of three factors: (1) the expected rate of return it will pay; (2) the risk that the return will be much lower or higher than expected; and (3) the liquidity    of the investment, which refers to how easily money or financial assets can be exchanged for a good or service. We will do this analysis as we discuss each of these investments in the sections below. First, however, we need to understand the difference between expected rate of return, risk, and actual rate of return.

Expected rate of return, risk, and actual rate of return

The expected rate of return    refers to how much a project or an investment is expected to return to the investor, either in future interest payments, capital gains, or increased profitability. It is usually the average return over a period of time, usually in years or even decades. Risk measures the uncertainty of that project’s profitability. There are several types of risk, including default risk and interest rate risk. Default risk, as its name suggests, is the risk that the borrower fails to pay back the bond. Interest rate risk is the danger that you might buy a long term bond at a 6% interest rate right before market rates suddenly raise, so had you waited, you could have gotten a similar bond that paid 9%. A high-risk investment is one for which a wide range of potential payoffs is reasonably probable. A low-risk investment will have actual returns that are fairly close to its expected rate of return year after year. A high-risk investment will have actual returns that are much higher than the expected rate of return in some months or years and much lower in other months or years. The actual rate of return    refers to the total rate of return, including capital gains and interest paid on an investment at the end of a period of time.

Bank accounts

An intermediary is one who stands between two other parties; for example, a person who arranges a blind date between two other people is one kind of intermediary. In financial capital markets, banks are an example of a financial intermediary    —that is, an institution that operates between a saver who deposits funds in a bank and a borrower who receives a loan from that bank. When a bank serves as a financial intermediary, unlike the situation with a couple on a blind date, the saver and the borrower never meet. In fact, it is not even possible to make direct connections between those who deposit funds in banks and those who borrow from banks, because all funds deposited end up in one big pool, which is then loaned out.

Questions & Answers

identify and quantify five social costs and social benefits of building a school
Mokgobo Reply
identify and quantity five social costs and social benefits of building a hospital
is it true that the opportunity cost of unemployed labour is zero?
Wisdom Reply
give two forms of collusion
nondumiso Reply
1.Explicit Collusion: Also termed overt collusion, this occurs when two or more firms in the same industry formally agree to control the market .
2.Implicit Collusion: Also termed tacit collusion, this occurs when two or more firms in the same industry informally agree to control the market, often through nothing more than interdependent actions. A prime example of implicit collusion is price leadership .
explicit collusion: this occurs when two or more firms in the same industry legally agree to control the market
implicit collusion this occurs when two or more firms in the same industry illegally agree to control the market
what is responsible for investigating cases of collusion
reasons why a country maybe involved in international trade
Nde Reply
state five similarities and differences between money market and capital market
Victoria Reply
Give a Zimbabwean example of firms operating in an oligopoly market and illustrate using diagrams how a manager in such a market maximize profit
Pam Reply
what is an industry
EWAH Reply
An industry is the production of goods and related services within an economy
an industry is place where goods and services are produced for human consumption....
scarcity is the major course of economics problems. discuss
Abdulhameed Reply
please say about that it is interesting for us
what is economics
Michael Reply
economics is a social sciences that deals with the production distribution and consumption of goods and services produced.its study of behaviour between economic agents
what is the formula for elasticity of demand
change in demand/change in variable variable may be price, income,
seasonal unemployment
Enoch Reply
example agriculture
want and scarcity
why the average of revenue AR fun
What is monopoli
Gadrey Reply
What is monopoly
monipoly ..where one firm controls all the market
what is demand
Jafar Reply
demand is what one willing and enable to purchase at a given price over period of a time.
what is marginal revenue
distinguish between commercialization and industrialization
Alhassan Reply
why division of labour increase economy level of production
Henry Reply
what is opportunity coast
Henry Reply
a benefit profit or value of something that must be given up to acquire achieve something else

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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