Chapter 7 Savings and Investment Process © 2011 John Wiley and Sons

2 Chapter Outcomes n Identify and briefly describe the major components of the gross domestic product n Describe how the balance between exports and imports affects the gross domestic product n Describe recent developments in the aggregate level of personal and corporate savings

3 Chapter Outcomes (Continued) n Describe the principal sources of federal government revenues and expenditures n Discuss the historical role of savings in the United States and how savings are created n Identify the major sources of savings in the United States

4 Chapter Outcomes (Concluded) n Identify and describe the factors that affect savings n Describe the major capital market securities that facilitate the savings and investment process n Discuss the role of individuals in the recent financial crisis

5 Gross Domestic Product (GDP) and Capital Formation : n Gross Domestic Product: Measures the output of goods and services in an economy over a specified time period : n 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: n Personal Consumption Expenditures n Government Expenditures including Gross Investment n Gross Private Domestic Investment n Net Exports of Goods and Services

7 Gross Domestic Product (GDP) Components (continued) : n Equation: GDP = PCE + GE + GPDI + NE ): n Personal Consumption Expenditures (PCE): Expenditures by individuals for durable goods, nondurable goods, and services : n Government Expenditures (GE): Purchases of goods and services by the government

8 Gross Domestic Product (GDP) Components (continued) : n Equation: GDP = PCE + GE + GPDI + NE : n Gross Private Domestic Investments (GPDI): Investments in residential & nonresidential structures, producers’ durable equipment, & business inventories n Net Exports (NE): Exports minus imports of goods & services

Recent Gross Domestic Product (GDP) Amounts ($ Billions) n GDP $13,253.9$14,258.7 n PCE 9, ,092.6 n GPDI 2, ,622.9 n NE n GE 2, ,

10 Link Between Saving and Investment n Gross Saving = Net Saving + Consumption of Fixed Capital n For 2008 (in $ Billions): Net Saving = -$23.0 Consumption of Fixed Capital = $1,847.1 Gross Saving = $1,824.1

11 Link Between Saving and Investment n Net Saving = Net Private Saving + Net Government Saving n For 2008 (in $ Billions): Net Private Saving = $659.8 Net Government Saving = -$682.7 Net Saving (rounded) = -$23.0

12 Link Between Saving and Investment n Consumption of Fixed Capital = Private + Government n For 2008 (in $ Billions): Private = $1,536.2 Government = $310.9 Consumption of Fixed Capital = $1,847.1

Federal Government Receipts and Expenditures n : Annual deficit budgets n : Annual surplus budgets n 2002-Present: Annual deficits with fiscal 2009 and 2010 deficits each exceeding $1.0 trillion [National Debt now exceeds $12 trillion] 13

14 Federal Government Dollar: Fiscal Year 2008 n 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%)

15 Federal Government Dollar: Fiscal Year 2008 (continued) n 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%)

16 Debt Financing n Budgetary Deficit: Occurs when expenditures are greater than revenues n Federal Statutory Debt Limits: Limits on the federal debt set by Congress

17 Historical Role of Savings in the United States n Foreign investors initially purchased large amounts of the securities sold by government & private promoters to develop the U.S. n The American family later took over the function of providing savings for the capital formation process

18 Creation of Savings n Savings: Income that is not consumed but held in the form of cash and other financial assets n Savings Surplus: Occurs when current income exceeds investment in real assets

Creation of Savings n Savings Deficit: Occurs when investment in real assets exceeds current income n Undistributed Profits: Proportion of after-tax profits retained by corporations 19

20 Major Sources of Savings n Personal Saving: Savings of individuals equal to personal income less personal current taxes less personal outlays n Voluntary Savings: n Voluntary Savings: Savings held or set aside by choice for future use n Contractual Savings: n Contractual Savings: Savings accumulated on a regular schedule by prior agreement

21 Personal Savings in the U.S. : n Personal Savings Definition: Personal income Less: taxes and other payments Equals: disposable personal income Less: personal outlays Equals: personal savings n Savings Rate Definition: n Savings Rate Definition: Savings Rate = (Personal Savings)/ (Disposable Personal Income)

22 Historical Personal Savings Rates n % n n n n n n n n n

23 Corporate Savings in the U.S. n Undistributed Profits Definition: Profits before taxes Less: tax liabilities Equals: profits after taxes Less: dividends Equals: undistributed profits n Retention Rate Definition: Retention Rate = (Undistributed Profits)/(Profits After Taxes)

Corporate Savings in the U.S. n Adjustments to Corporate Profits: Nonfinancial corporate profits before taxes are often shown after (1) inventory valuation and (2) capital consumption adjustments n (1) Records estimated changes in inventory values over time n (2) Reflects the “using up,” or depreciation, of plant and equipment assets used for business purposes 24

25 Factors Affecting Savings n Levels of income n Economic expectations n Cyclical Influences (economic cycles) n Life stage of the individual saver or corporation

26 Life Stages of the Individual Saver nInIndividual Saver: --Formative/education developing --Career starting/family creating --Wealth building --Retirement enjoying

27 Life Stages of the Corporation nCnCorporation: --Start-up stage --Survival stage --Rapid growth stage --Maturity stage

Capital Market Securities n Capital Markets: Markets where debt securities with maturities longer than one year and corporate stocks are issued or traded n Capital Market Securities: Debt securities with maturities longer than one year and corporate stocks 28

29 Major Capital Market Securities Securities: Issuers: n Mortgages Fin. intermediaries n Treasury bonds U.S. government n Municipal bonds State/local gov’ts. n Corporate bonds Corporations n Corporate stocks Corporations

30 Major Capital Market Securities Securities: Secondary Market: n Mortgages High activity n Treasury bonds High activity n Municipal bonds Moderate activity n Corporate bonds Moderate activity n Corporate stocks High activity

31 Capital Market Securities Defined n Mortgage: Loan backed by real property in the form of buildings and houses n Treasury bond: Long-term debt instrument issued by the U.S. federal government n Municipal bond: Long-term debt instrument issued by a state or local government

32 Capital Market Securities Defined n Corporate bond: Debt instrument issued by a corporation to raise long-term funds n Common stock: Ownership interest in a corporation

Derivative Security n Derivative Security: Financial contract that derives its value from a bond, stock, or other asset n Use of Derivative Securities: Corporations can use derivative securities to insure or hedge against various financial risks 33

Financial Crisis Early Factors: n Internet or “tech” bubble burst and stock prices began declining rapidly n Economic recession resulted (exacerbated by the 9/11/2001 terrorist attacks) n – Monetary policy focused on providing liquidity and fiscal policy became stimulative resulting in low interest rates and economic growth 34

Financial Crisis Borrowing-Related Cultural Shift: n 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 n U.S. government officials encouraged wider home ownership and mortgage lenders offered adjustable-rate mortgages (ARMs) and even subprime mortgages to poorly qualified borrowers n The “housing price bubble” burst in mid and home owners began defaulting 35

36 Web Links n n n n