Chapter 21: Financial Markets, Saving and Investment
prefer holding common stock over holding preferred stock or bonds in the corporation.
2. Two good examples of the principal-agent problem in corporations are to discuss how effectively
3. Emphasize that stock prices change when expectations change, rather than waiting until an event
4. You might extend the discussion of reinvestment discussion to the tax treatment of capital gains
(higher taxation of capital gains discourages reinvestment), since reinvestment pays off to investors
through stock price appreciation.
5. A good illustration of whether one can consistently pick winners is why get rich quick schemes fail.
6. Note the connection between the idea that stock prices are a random walk and index funds and
mutual funds.
7. You may find it worthwhile to delve more deeply into the information available on the financial pages
than the text does, if your class shows a particular interest in those issues.
8. Emphasize that while a price/earnings ratio tells you some information about different firms, unless
9. When discussing financing a corporation, it can be worth emphasizing that different forms of financial
claims (stocks, bonds, etc.) allow people to specialize in the risks they are willing to bear (and monitor).
10. This is a good time to re-emphasize the crucial importance of understanding the underlying incentive
stories for shifters of the supply of loanable funds and the demand for loanable funds, because if students
situations.
11. Make sure you go through each of the four basic shift scenarios in the investment and saving market.
shifts separately.
12. One helpful way to make sure students have understood the supply and demand for investment and
saving market is to give them a situation where two changes shift the same curve and ask them about
13. Emphasize that while the details are different because we are analyzing a different market than in
14. The crowding-out effect discussed here is the reason why the most essential question about
15. Remind students that in the case where there is a government surplus and positive levels of public
saving, what we have called the crowding-out effect will become a crowding-in effect, as lower interest
rates increase the levels of private investment.
16. It can be worth connecting the open-economy capital flows here to the later discussion of domestic
17. A useful illustration of interest rate sensitivity is to show students how much more their higher
18. In discussing the financial crisis, you can help students understand why people can be hit with a
sudden cash crunch from the sharp housing price declines in terms of the liquidity of their house or home
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confident Fannie Mae or Freddy Mac would buy their investment, it would appear to be a low risk
investment, regardless of the underlying risk in the portfolio itself. When Fanny Mae and Freddy Mac go
bankrupt, this helps explain the sudden jump in perceived risk.
20.
21. It can be worth noting that home loans in the U.S. were historically safe because lenders maintained
policies and standards that reduced the risk of default. What made them suddenly much riskier than
people expected was the largely unrecognized changes in standards being applied to home loans.