7.1 Notes

7.1 Saving and Investing

Objectives
1. Understand how investing contributes to the free enterprise system.
2. Explain how the financial system brigs together savers and borrowers.
3. Describe how financial intermediaries link savers and borrowers.
4. Identify the trade-offs among risk, liquidity and return

If you go to school today, you give up your time now so that you will be prepared for a career in the future. If a firm builds a new plant, it spends money today for the sake of earning more money in the future. These actions represent investments.

Investment – The act of redirecting resources from being consumed today so that they may create benefits in the future.

Investment promotes economic growth
EX: You put money in bank, the bank lends it to a business, the business invests the money in a new plant, and the plant hires people and produces better products.

In order for investment to take place an economy must have a financial system.
Financial System – The system that allows the transfer of money between savers and borrowers.


Financial Intermediary – An institution that helps channel funds from savers to borrowers.

EX: Banks, saving & loan associations, credit unions, and mutual funds.

Mutual Fund – A fund that pools the savings of many individuals and invest this money in a variety of stocks, bonds and other assets.

Savers give their money to financial intermediaries, who give it to investors. Why don’t savers deal with investors directly? There are three reasons:

1. Diversification – Spreading out investments to reduce risk.

EX: Putting your money in a bank or a mutual fund allows you to pool your money with other people, which is then invested in a variety of places.



2. Financial intermediaries provide information to savers. For example, mutual fund managers are knowledgeable about how the stocks in their portfolios are performing.

Portfolio – A collection of financial assets.

Intermediaries also provide a prospectus to savers.

Prospectus – An investment report to potential investors.

And finally intermediaries provide liquidity.

3. Liquidity – The ease with which people can convert and asset into cash.

EX: You can sell your shares in a mutual fund easily but if you had invested in a piece of art, it might be hard to sell.


Investors must make choices between return on an investment, its risk and how liquid it is.

Return – The money an investor receives above and beyond the sum of money initially invested.