THE FINANCIAL WORLD

The financial sector of the economy is important in that it is the market of money and money is the medium of exchange through which all goods and services are traded in all economies. Financial assets are assets owned by an owner under the condition that the issuer of the asset meet certain obligations. If you own a financial asset, than that means that someone gave you that asset and that person owes you in some way. There are many different types of financial assets, which we will go into later.

There are also financial institutions, or insitutions set up for the purpose of trading and holding financial assets. Within financial institutions, there are depositary institutions, which are institutions set up to store money in checking and savings accounts. For example, banks are depositary institutions. You save money there in savings and checking accounts so you can save money until you need it. Financial assets are all traded on financial markets, whose sole purpose is the trading of financial assets. Primary financial markets sell new assets that have been freshly issued while secondary financial markets facilitate trade of assets that have already been distributed into the financial markets.

There are several types of financial assets. They can roughly be divided into those sold in money markets and those sold in capital markets. Those sold in money markets have a maturity of less than one year. Those sold in capital markets have a maturity of more than one year. Financial assets mature, meaning their value increases over time. Many have maturity dates, meaning that their value will be paid back after a certain amount of time.

A CD is one kind of financial asset. A CD is a certificate of deposit. You put money into a bank with a set interest rate and after an agreed amount of time, you are free to retrieve that money from the bank. Interest is a percentage of the original value of the asset that is charged as long as that asset is out there. Interest increases exponentially. For example, if a 2% interest is put on $1000, compounded monthly, then that asset is worth $1020 the next month, and $1040.40 the month after that. The interest is applied to the immediately previous value of the asset, not the beginning value of the asset.

Bonds and stocks are also important types of financial assets. A bond is a guarantee that promises that a loaned amount of money will be paid back in a given amount of time with a given amount of interest charged. A stock, however, is a different type of asset. A stock has no maturity date. A stock is a share in the ownership of a business. Once you own that piece of the business, you keep it until you decide to sell the stock to someone else. Having ownership in the company also means you are entitled to a share of its profits and also theoretically in the decisions the company makes.

The financial sector is crucial in the macroeconomic debate between classical economists and Keynesian economists. The classical economists, as explained previously, believe that all income flowing from business to the people always go back to business in a perfect loop, because the money that does not go back in the form of spending goes back in the form of investment. This is where the financial sector comes in. Classical economics states that the financial sector efficiently turns all savings into investment for growing business.

However, on the other hand, Keynesian economists disagree. As stated before, they do not think that the finance operates completely smoothly. Rough financial markets can have repercussions in the real world, generating wild business cycles. Again, this shows the conflict between Keynesians and classicals. Classicals find that there's no need for government regulation in the smoothly operating market while Keynesians see government regulation to being crucial to maintain stability in the naturally volatile financial world.