Chapter 7 Savings and Investment Process © 2011 John Wiley and Sons.
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Transcript of Chapter 7 Savings and Investment Process © 2011 John Wiley and Sons.
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Chapter 7
Savings and Investment Savings and Investment ProcessProcess
© 2011 John Wiley and Sons
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Chapter Outcomes
Identify and briefly describe the major components of the gross domestic product
Describe how the balance between exports and imports affects the gross domestic product
Describe recent developments in the aggregate level of personal and corporate savings
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Chapter Outcomes(Continued)
Describe the principal sources of federal government revenues and expenditures
Discuss the historical role of savings in the United States and how savings are created
Identify the major sources of savings in the United States
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Chapter Outcomes(Concluded)
Identify and describe the factors that affect savings
Describe the major capital market securities that facilitate the savings and investment process
Discuss the role of individuals in the recent financial crisis
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Gross Domestic Product (GDP) and Capital Formation
Gross Domestic Product:: Measures the output of goods and services in an economy over a specified time period
Capital Formation:: Process of constructing real property, manufacturing producers’ durable equipment, and increasing business inventories
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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
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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
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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
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Recent Gross Domestic Product (GDP) Amounts
($ Billions) 2006 2009 GDP $13,253.9 $14,258.7
PCE 9,270.8 10,092.6 GPDI 2,218.4 1,622.9 NE -761.8 -390.1 GE 2,526.4 2,933.3
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Link Between Saving and Investment
Gross Saving = Net Saving + Consumption of Fixed Capital
For 2008 (in $ Billions):
Net Saving = -$23.0
Consumption of Fixed Capital = $1,847.1
Gross Saving = $1,824.1
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Link Between Saving and Investment
Net Saving = Net Private Saving + Net Government Saving
For 2008 (in $ Billions):
Net Private Saving = $659.8
Net Government Saving = -$682.7
Net Saving (rounded) = -$23.0
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Link Between Saving and Investment
Consumption of Fixed Capital = Private + Government
For 2008 (in $ Billions):
Private = $1,536.2
Government = $310.9
Consumption of Fixed Capital = $1,847.1
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Federal Government Receipts and Expenditures
1970-1997:
Annual deficit budgets 1998-2001:
Annual surplus budgets 2002-Present:
Annual deficits with fiscal 2009 and 2010 deficits each exceeding $1.0 trillion [National Debt now exceeds $12 trillion]
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Federal Government Dollar:Fiscal Year 2008
Where It Comes From (Income):
--Personal Income Taxes (39%)
--Social Security and other Retirement Taxes (30%)
--Borrowing to Cover Deficit (15%)
--Corporate Income Taxes (10%)
--Excise, Estate, and other Taxes (6%)
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Federal Government Dollar:Fiscal Year 2008 (continued)
Where It Goes (Outlays): --Social Security, Medicare, and other
retirement (37%)
--National Defense, veterans, and Foreign Affairs (24%)
--Social Programs (including Medicaid)(20%)
--Physical , Human, and Community Development (9%)
--Net Interest on the Debt (8%)
--Law Enforcement and General Gov’t. (2%)
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Debt Financing
Budgetary Deficit: Occurs when expenditures are greater than revenues
Federal Statutory Debt Limits:
Limits on the federal debt set by Congress
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Historical Role of Savings in the United States
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
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Creation of Savings
Savings: Income that is not consumed but held in the form of cash and other financial assets
Savings Surplus: Occurs when current income exceeds investment in real assets
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Creation of Savings
Savings Deficit:
Occurs when investment in real assets exceeds current income
Undistributed Profits:
Proportion of after-tax profits retained by corporations
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Major Sources of Savings
Personal SavingPersonal Saving::
Savings of individuals equal to personal Savings of individuals equal to personal income less personal current taxes less income less personal current taxes less personal outlayspersonal outlays
Voluntary SavingsVoluntary Savings:: Savings held or set aside by choice for future use
Contractual SavingsContractual Savings:: Savings accumulated on a regular schedule by prior agreement
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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 DefinitionSavings Rate Definition:: Savings Rate = (Personal Savings)/ (Disposable Personal Income)
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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 2005 1.4
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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)
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Corporate Savings in the U.S.
Adjustments to Corporate Profits:Nonfinancial corporate profits before taxes are often shown after (1) inventory valuation and (2) capital consumption adjustments
(1) Records estimated changes in inventory values over time
(2) Reflects the “using up,” or depreciation, of plant and equipment assets used for business purposes
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Factors Affecting Savings
Levels of income Economic expectations Cyclical Influences (economic
cycles) Life stage of the individual saver
or corporation
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Life Stages of the Individual Saver
Individual Saver:--Formative/education developing--Career starting/family creating--Wealth building--Retirement enjoying
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Life Stages of the Corporation
Corporation:--Start-up stage--Survival stage--Rapid growth stage--Maturity stage
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Capital Market Securities
Capital Markets:
Markets where debt securities with maturities longer than one year and corporate stocks are issued or traded
Capital Market Securities:
Debt securities with maturities longer than one year and corporate stocks
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Major Capital Market Securities
Securities: Issuers: Mortgages Fin. intermediaries Treasury bonds U.S. government Municipal bonds State/local gov’ts. Corporate bonds Corporations Corporate stocks Corporations
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Major Capital Market Securities
Securities: Secondary Market:
Mortgages High activity Treasury bonds High activity Municipal bonds Moderate activity Corporate bonds Moderate activity Corporate stocks High activity
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Capital Market Securities Defined
Mortgage:Loan backed by real property in the form of buildings and houses
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
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Capital Market Securities Defined
Corporate bond:Debt instrument issued by a corporation to raise long-term funds
Common stock:Ownership interest in a corporation
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Derivative Security
Derivative Security:
Financial contract that derives its value from a bond, stock, or other asset
Use of Derivative Securities:
Corporations can use derivative securities to insure or hedge against various financial risks
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2007-09 Financial Crisis
Early Factors: 2000 -- Internet or “tech” bubble burst and
stock prices began declining rapidly 2001 -- Economic recession resulted
(exacerbated by the 9/11/2001 terrorist attacks)
2001-2002 – Monetary policy focused on providing liquidity and fiscal policy became stimulative resulting in low interest rates and economic growth
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2007-09 Financial Crisis
Borrowing-Related Cultural Shift: U.S. consumers moved from “save now,
buy later” to “spend now, pay later” with the result being increased mortgage loans and credit card borrowings
U.S. government officials encouraged wider home ownership and mortgage lenders offered adjustable-rate mortgages (ARMs) and even subprime mortgages to poorly qualified borrowers
The “housing price bubble” burst in mid-2006 and home owners began defaulting 35
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Web Links
www.bea.gov www.irs.gov www.stlouisfed.org www.federalreserve.gov