Financial Assets

#🏦 The Financial Sector: Your Guide to Money and Markets 🚀

Hey future AP Macro pro! Let's break down the financial sector. Think of it as the heart of the economy, where money flows between savers and borrowers. This guide will help you ace those exam questions!

#🎯 Key Concepts: Financial Assets and Their Characteristics

• Financial Assets: Things that hold value, like cash, stocks, and bonds.

• Liquidity 💧: How easily an asset can be converted into cash.

  • Cash: The most liquid asset.
  • Less Liquid Assets: CDs, real estate, and collectibles take longer to convert to cash.

• Rate of Return: The net gain or loss on an investment over time. Higher returns are generally preferred.

• Risk: The chance that an investment's actual outcome differs from the expected one. Risk tolerance varies among individuals.

#📜 Types of Financial Assets

#📈 Stocks: Ownership in a Company

• Definition: A security representing ownership in a company.

• Equity Financing: Companies sell stocks to raise capital, avoiding debt but sharing ownership.

Caption: The stock market facilitates the buying and selling of company shares, with prices fluctuating based on company performance and investor expectations.

• How it Works: Companies sell shares, and the public buys/sells them. Prices are determined by growth expectations.
• Profit: Shareholders profit by selling stocks at a higher price.

#📊 Bonds: Lending to Businesses or Governments

• Definition: An interest-bearing asset issued by businesses or governments.

• Debt Financing: Companies issue bonds to borrow money, promising to repay the principal plus interest.

Caption: Bonds represent a loan to a company or government, with the borrower promising to repay the principal plus interest over a set period.

• Opportunity Cost: Weigh the opportunity cost of holding money vs. buying bonds (potential interest).
• Advantages: Income through interest, return of principal, potential for profit by selling at higher prices.
• Disadvantages: Lower returns than stocks, risk of default, and potential decrease in value.

#💳 Loans: Borrowing Money

• Definition: Borrowing money and repaying it with interest.
• Credit Cards: A type of loan; the bank pays for your purchase, and you repay the bank later with interest.

#🏦 Bank Deposits: Your Checking Account

• Demand Deposits: Money in your checking account that you can access anytime.
• Debit Cards: Allow you to access your demand deposits without interest.

#📉 Bonds and Interest Rates: An Inverse Relationship

• Inverse Relationship: Bond prices and interest rates move in opposite directions.
• Falling Interest Rates: Bonds become more desirable, increasing their price.
• Rising Interest Rates: Bonds become less desirable, decreasing their price.

#💡 Final Exam Focus

• Key Topics: Liquidity, rate of return, risk, stocks, bonds, and the relationship between bond prices and interest rates.
• Common Question Types: MCQs on asset characteristics, FRQs on the impact of interest rate changes on bond prices, and scenarios involving different investment options.

#❓ Practice Questions

Practice Question

Multiple Choice Questions

1. Which of the following assets is generally considered the most liquid? (A) Real Estate (B) Stocks (C) Bonds (D) Cash

2. An increase in interest rates will most likely cause which of the following? (A) An increase in bond prices (B) A decrease in bond prices (C) No change in bond prices (D) An increase in the demand for bonds

Free Response Question

Assume the economy is currently in a recession. The central bank decides to lower the discount rate to stimulate the economy.

(a) Explain how lowering the discount rate will affect the money supply. (b) Explain how the change in the money supply will affect interest rates. (c) Using a graph of the bond market, show how the change in interest rates will affect bond prices. (d) How will the change in bond prices affect aggregate demand?

Answer Key

Multiple Choice

1. (D) Cash is the most liquid asset.
2. (B) An increase in interest rates decreases bond prices.

Free Response Question

(a) Lowering the discount rate increases the money supply because it encourages banks to borrow more from the central bank, increasing the reserves available for lending. (1 point) (b) An increase in the money supply leads to a decrease in interest rates due to the increased availability of loanable funds. (1 point) (c) The decrease in interest rates will cause an increase in demand for bonds, shifting the demand curve to the right. This will result in an increase in bond prices. (2 points for graph and explanation) (d) The increase in bond prices will lead to an increase in aggregate demand because lower interest rates encourage more investment and consumption. (1 point)

Alright, you've got this! Remember to stay calm, think through each question, and use these notes to guide you. You're ready to rock the AP Macro exam! 💪