Economics Unit 4 Test Questions

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What is money?
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ANYTHING that can be used as a: 1. medium of exchange 2. unit of account 3. store of value
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Medium of Exchange
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used to determine value of goods and services
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How do you buy things?
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-currency -cards -accounts -ownership (equity) -shares -labor -fur -salt -gold -silver -beads
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Unit of Account
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means for comparing value
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Store of Value
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retains value
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Currency
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paper bills/coins used as money
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Where does money get it’s value?
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1. commodity money 2. representative money 3. fiat money
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Commodity Money
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objects that have intrinsic value
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Representative Money
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holder can exchange them for something else
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Fiat Money
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gov. has ordered it to be acceptable means to pay debts (gov. can control supply)
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6 Characteristics of Money
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1. durability 2. portability 3. divisibility 4. uniformity 5. limited supply 6. acceptability
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Bitcoin Article Notes
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1: not physical so can’t break 2. international 3. none 4. equal 5. yes 6. not widely other than a few internet sites
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Volatility
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changes rapidly in unforeseen way
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Why do currency exchange rates change?
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1. demand for certain currencies change 2. demand for products purchased with that currency
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Speculating
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-buy “low” -sell “high”
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How much money is in the U.S.?
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10 trillion dollars
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Why does it matter how much money is in the U.S.?
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-inflation -deflation
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Inflation
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if “too much” money is available overall price level will increase
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Deflation
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if “too little” money is available, it can drive down the overall price level
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Definition of Monetary Supply
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all the money available in the U.S. is divided into two categories
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2 Categories of Monetary Supply
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1. M1 2. M2
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M1
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assets that people can easily access
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Characteristic of M1
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liquidity
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Definition of Liquidity
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directly converted into cash
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Numbers for M1
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*1.3 trillion – 44% as cash – 33% as demand deposits – 22% other checkable deposits
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Another word for Checking Account
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demand deposits
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M2
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M1 plus other assets that cannot be used as cash directly
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Another name for M2
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near money
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Numbers for M2
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*6.1 trillion – 38% savings deposits – 38% money market funds – 24% M1
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What is federal reserve?
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the central banking system of the U.S.
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How does the federal reserve control the supply of money?
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1. control required reserves 2. change interest rates 3. open market operations
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What is the fractional reserve system?
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-banks keep only a fraction of money on hand (required reserve ratio) -lends out the rest (rate is 10% now)
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The money multiplier
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multiple by which deposits increase for every dollar increase in reserves = (1/RRR)
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What happens when you raise the RRR?
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raising the RRR decreases the supply
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What happens when you decrease the RRR?
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lowering it increases the supply
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What is discount rate?
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rate charged to member banks by the Fed
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Are discount rates long term loans or short term loans?
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short term loans
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Where do discount rates get passed on to?
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consumers
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What happens when you lower the discount rate?
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creates more loans/money
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What happens when you raise the discount rate?
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creates fewer loans/less money
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What is open market operations?
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selling/buying government bonds
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What does selling bonds do to the system?
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reduces the money
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What does buying bonds do to the system?
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increases the money
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What is investing? (review guide)
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the act of redirecting resources from being consumed today so that they may create benefits in the future; the use of assets to earn income or profit
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What are financial intermediaries? Examples? (review guide)
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institution that helps channel funds from savers to borrowers; examples: banks, savings and loan associations and credit unions, finance companies, mutual funds, life insurance companies, pension funds
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What is diversification? (review guide)
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spreading out investments to reduce risk
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What is a prospectus? (review guide)
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an investment report to potential investors
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What is the coupon rate? (review guide)
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the interest rate that a bond issuer will pay to a bondholder
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What is maturity? (review guide)
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the time at which payment to a bondholder is due
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What is par value? (review guide)
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the amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity
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What is the yield? (review guide)
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the annual rate of return on a bond if the bond were held to maturity
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What are the main advantages/disadvantages to the issuer? (review guide)
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ADVANTAGES: once a bond is sold, coupon rate for the bond won’t go up or down; bondholders don’t have a part of the company DISADVANTAGES: company make fixed interest payments (even if not enough money); if it doesn’t maintain financial health its bonds may be downgraded to a lower bond rating = harder to sell
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Explain Savings Bonds (review guide)
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low-denomination bond issued by the U.S. gov.
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Explain Treasury Bonds (review guide)
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offer different lengths of maturity, safe investment
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Explain Municipal Bonds (review guide)
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a bond issued by a state or loval gov. or municipality to finance such improvements as highways, state buildings, libraries, parks, and schools
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Explain Corporate Bonds (review guide)
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a bond that a corporation issues to raise money to expand its business
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Explain Junk Bonds (review guide)
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a lower-rated, potentially higher-paying bond
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What is a certificate of deposit? (review guide)
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most common form of investment, available through banks, lend out the funds for a fixed amount of time
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What is the difference between income stock and growth stock? (review guide)
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income stock: pays dividends at regular times during the year; growth stock: pays few or no dividends, instead the issuing company reinvests its earning in its business
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What is the difference between common and preferred stock? (review guide)
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investors who by common stock are voting owners of the company; preferred stock are investors who are nonvoting owners of the company
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What are futures? (review guide)
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contracts to buy or sell at a specific date in the future at a price specified today
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What are the Dow Jones and the S&P 500? (review guide)
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index that shows the price changes of 500 different stocks = S&P 500; the dow: indext that shows how certain stocks have traded
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What is money? (review guide)
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anything that serves as a medium of exchange, a unit of account, and a store of value
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Explain Medium of Exchange (review guide)
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anything that is used to determine value during the exchange of goods and services
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Explain Unit of Account (review guide)
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a means for comparing the values of goods and services
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Explain Store of Value (review guide)
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something that keeps its value if it is stored rather than used
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What are the six characteristics of money? (review guide)
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durability, portability, divisibility, uniformity, limited supply, acceptability
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Where does money get its value? (review guide)
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commodity money- objects that have value in itself + used as money; representative money – objects that have value because the holder can exchange them for something else of value; fiat money – has value because gov. has decreed it
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When was a national bank first established and for what purposes? (review guide)
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in 1791; to hold money the gov. collects from taxes; help the gov. tax, bowwow money in the public interest, regulate interstate/foreign commerce; issue representative money in form of bank notes; ensure that state-chartered banks held sufficient gold + silver to exchange for bank notes if demand arises
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What sorts of problems arose during the free banking era? (review guide)
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prices rose rapidly, different banks had different currencies, bankers faced the temptation to print more money than they had gold + silver to back, no supervision or regulation
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What did the Banking Acts of 1863 and 64 do? (review guide)
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gave the federal gov. the power to charter banks, the power to require banks to hold adequate gold + silver reserves to cover their bank notes, the power to issue a single national currency
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What is the gold standard? (review guide)
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a monetary system in which paper money and coins are equal to the value of a certain amount of gold
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What is the Federal Reserve System? Explain. (review guide)
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the nation’s central banking system; it created up to 12 federal reserve banks throughout the country “member banks: banks that belonged to the fed”, short term loans to prevent bank failures; federal reserve notes: allowed to increase + decrease the amount of money in circulation
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What sorts of reforms were instituted during the Great Depression? (review guide)
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federal deposit insurance corporation: insures customer deposits if a bank fails
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What was the Savings and Loan crisis? (review guide)
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?
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What is the money supply? (review guide)
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all the money available in the U.S. economy
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What are demand deposits? (review guide)
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the money in checking accounts
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What is liquidity? (review guide)
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the ability to be used as, or directly converted to, cash
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What makes up M1? (review guide)
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currency, demand deposits, other checkable deposits, traveler’s checks
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What makes up M2? (review guide)
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saving deposits, retail money market funds, total M1, small denomination time deposits
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What services do most banks provide? (review guide)
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savings accounts, checking accounts, money market accounts, certificates of deposits (CDs)
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What is interest? Explain the difference between simple and compound interest. (review guide)
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the price paid for the use of borrowed money; compound: interest paid on both principal and accumulated interest; simple interest: is paid only on principal
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RRR + Increase Supply
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= decrease (more loans) = more $
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RRR + Decrease Supply
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= ^ RRR (fewer loans)
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Discount Rate + Increase Supply
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= decrease rate (more loans)
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Discount Rate + Decrease Supply
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= ^ rate (less loans)
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Definition of Open Market Operations
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selling/buying government bonds
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What happens when you sell bonds?
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reduces the money in the system
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What happens when you buy bonds?
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increases the money in the system
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What does the Fundamental view look at?
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the company
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What does the Technical view look at?
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the stock value
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4 Kinds of Investment Risk
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1. credit risk 2. liquidity risk 3. inflation risk 4. time risk
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Definition of Credit Risk
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borrowers may not pay back money
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Definition of Liquidity Risk
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inability to convert investment into liquid cash
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Definition of Inflation Risk
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if rate of return on investment is less than the rate of inflation, the investor loses value
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Definition of Time Risk
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loss of ability to invest in other opportunities
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Definition of Diversification
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spreading out investments to reduce risk
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Highest Risk —-> Lowest Risk (for potential return or loss)
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10. commodities 9. collectibles 8. real estate 7. stocks 6. mutual funds 5. corporate bonds 4. gov. bonds 3. certificates of deposits 2. savings accounts 1. cash and checking accounts
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What is a Bond?
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certificate issued which promises to repay the original amount plus interest (savings, treasury, municipal, corporate junk)

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