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Economic Institutions To help students understandthe roles played by economic institutions, ask themto complete a web graphic organizer like the oneshown at the right. Remind students that a webshows a main idea and its supporting details.Around the center circle, labeled “FinancialIntermediaries,” they should fill in types of inter-mediaries and their roles.

Section Reading Support Transparencies A tem-plate and the answers for this graphic organizercan be found in Chapter 11, Section 1 of theSection Reading Support Transparency System.

Graphing the Main IdeaB U I L D I NGB U I L D I NG

K E Y CONCE PTSK E Y CONCE PTS

ChaptChapter er 1111 •• Section Section 11

Saving and Investing

Objectives You may wish to callstudents’ attention to the objectivesin the Section Preview. The objec-tives are reflected in the main head-ings of the section.

Bellringer Ask students to recallwhen and how they first began sav-ing money. Explain that in this sec-tion they will learn some basicprinciples of saving and investing.

Vocabulary Builder Have studentsread through the section to learn themeaning of each key term. Then askthem to use the dictionary to investi-gate each term’s origins and mean-ing.

Guided Reading and Review Unit 4 folder, p. 13 asks students toidentify the main ideas of the sectionand to define or identify key terms.

Answer to . . . Illustration Caption Investment islike sowing seeds, promoting futuregrowth.

II f you go to school today, you give upyour time now so that you will be

prepared for a career in the future. If a firmbuilds a new plant, it spends money todayfor the sake of earning more money in thefuture. A government may spend moneytoday to build a dam to ensure that peoplewill have a source of hydroelectric power inthe future. All of these actions representinvestments.

In its most general sense, investment is theact of redirecting resources from beingconsumed today so that they may createbenefits in the future. In more narrow,economic terms, investment is the use ofassets to earn income or profit.

Investing and Free EnterpriseAs you have read, one of the chief advan-tages of the free enterprise system is thatit allows people to make a profit. Thisprofit motive leads individuals and busi-nesses to make investments. Investing, infact, is an essential part of the free enter-prise system.

Investment promotes economic growthand contributes to a nation’s wealth. Whenpeople deposit money in a savings accountin a bank, for example, the bank may thenlend the funds to businesses. The busi-

nesses, in turn, may invest that money innew plants and equipment to increase theirproduction. As these businesses use theirinvestments to expand and grow, theycreate new and better products and providenew jobs.

investment the act ofredirecting resourcesfrom being consumedtoday so that they maycreate benefits in thefuture; the use of assetsto earn income or profit

Saving and Investing

Chapter 11 � Section 1 271

ObjectivesAfter studying this section you will be able to:1. Understand how investing contributes to

the free enterprise system.2. Explain how the financial system brings

together savers and borrowers.3. Describe how financial intermediaries link

savers and borrowers.4. Identify the trade-offs among risk, liquidity,

and return.

PreviewSection FocusInvestment promotes economicgrowth and contributes to a nation’swealth. The financial system includessavers and borrowers, as well as theinstitutions that transfer savers’dollars to borrowers. Whenborrowers invest these funds, theyfuel economic growth.

Key Termsinvestmentfinancial systemfinancial assetfinancial intermediarymutual funddiversification portfolioprospectusreturn

� How does thisillustration suggestthat investmentpromotes economicgrowth?

Lesson PlanTeaching the Main Concepts

1. Focus Savers and borrowers arebrought together in the financial mar-ketplace by specialized institutions. Askstudents what firms fulfill this role.2. Instruct Begin by discussing the roleof investing in our economy. Describehow financial intermediaries bringtogether savers and borrowers. Afterexplaining risk, diversification, liquidity,and return, discuss the financial trade-offs of saving and investing.3. Close/Reteach Remind students thatsaving and investing involve risk andpotential gain. Ask them what factorsmight affect how much risk an investoris willing to take.

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Economic Institutions Help students understand thefunction and importance of financial intermediariesby asking them to recall what they learned inChapter 10 about the chaotic banking system inthe United States during the 1800s. With no cen-tral bank to set the rules, borrowers and investorswere on their own, often with disastrous results. Intoday’s highly structured nationwide financial system,

intermediaries act as go-betweens, uniting like-minded investors and borrowers and helping tokeep the economy growing. Ask students to suggestdescriptive analogies for financial intermediaries.(Students may suggest trip planners, dating services,or personal shoppers.)

Econ 101: Key Concepts Made EasyEcon 101: Key Concepts Made Easy$

(Reteaching) Have students worktogether in groups of three to create athree-minute advertisement showinghow investment contributes to the pri-vate enterprise system. Ask them toshow through words or actions howinvestment promotes economicgrowth and contributes to a nation’swealth.

Meeting NCEE Standards Use the following benchmark activityfrom the Voluntary National ContentStandards in Economics to evaluatestudent understanding of Standard 12.

Explain why people who savemoney receive interest payments whilepeople who borrow money makeinterest payments.

Math Practice ActivityMath Practice folder, p. 10,“Determining Net Worth,” allows stu-dents to calculate their own net worth.

BackgroundInvestment ClubsInvestment ClubsAmericans can invest their money inmany ways. One popular way is toorganize a group of investors, pool theirmoney, and invest that money accord-ing to the wishes of the majority. Suchgroups have been around for nearly 50years, according to the NationalAssociation of Investment Clubs.

In 1956 the association reported1,967 clubs. By 1960 that number hadrisen to 5,608. The strong economy ofthe 1960s boosted the number of clubsto 13,678 by 1970. During the 1970s,however, the Arab oil embargo sentinflation soaring in the United States.People began to put their limitedfinancial resources into securedinvestments, such as certificates ofdeposit. By 1980 the number of invest-ment clubs had dropped to 3,642.

Investor confidence returned inthe 1980s, however, and by 1990 thenumber of investment clubs hadgrown to 7,085. In 2002 the NationalAssociation of Investment Clubsreported 28,235 clubs throughout theUnited States.

The Financial SystemIn order for investment to take place, aneconomy must have a financial system. Afinancial system includes savers andborrowers and allows the transfer of moneybetween them to take place.

Financial AssetsWhen people save, they are, in essence,lending funds to others. As you read inChapter 10, people can save money in avariety of ways. They may put money in asavings account, purchase a certificate ofdeposit, or buy a government or corporatebond. In each case, savers obtain adocument that confirms their purchase ordeposit. These documents may be pass-books, computer printouts, bond certifi-cates, or other records.

Such documents represent claims on theproperty or income of the borrower. Theseclaims are called financial assets, or securi-ties. If the borrower fails to pay back theloan, these documents can serve as proof incourt that money was borrowed and thatrepayment is expected.

For example, suppose you have $100 ina savings account at your local bank. Yourpassbook (or computer printout) is proofof the money in your account.

The Flow of Savings and InvestmentsFigure 11.1 shows how the financial systembrings together savers and borrowers,fueling investment and economic growth.On one side are savers—households, indi-viduals, and businesses that lend out theirsavings in return for financial assets. On the

other side are borrowers—governmentsand businesses—who invest the moneythey borrow to build roads, factories, andhomes. Borrowers may also use these fundsto develop new products, create newmarkets, or provide new services.

Financial IntermediariesSavers and borrowers may be linkeddirectly. As you examine Figure 11.1, youwill notice that borrowers and savers mayalso be linked through a variety of institu-tions pictured as “in between” the two.These financial intermediaries are institu-tions that help channel funds from saversto borrowers. They include the following:

• Banks, Savings and Loan Associations,and Credit Unions As you read inChapter 10, banks, S&Ls, and creditunions take in deposits from savers, thenlend out some of these funds to busi-nesses and individuals.

• Finance companies Finance companiesmake loans to consumers and smallbusinesses. Because finance companiessometimes lend money to people who donot repay their loans, they take on ahigh degree of risk. Finance companies,therefore, charge borrowers higher feesand interest rates to cover their lossesfrom the loans that are not repaid.

• Mutual funds Mutual funds pool thesavings of many individuals and investthis money in a variety of stocks, bonds,and other financial assets. Mutual fundsallow people to invest in a broad range ofcompanies in the stock market. This way,

financial system thesystem that allows thetransfer of moneybetween savers andborrowers

financial asset claim onthe property or incomeof a borrower

financial intermediaryinstitution that helpschannel funds fromsavers to borrowers

mutual fund fund thatpools the savings ofmany individuals andinvests this money in avariety of stocks,bonds, and otherfinancial assets

� Documents suchas (from left to right)a stock certificate, asavings passbook,and savings bondsare financial assets.

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(Linguistic/Logical) Have studentsstudy the graphic on this page. Thenask them to write a paragraph inwhich they use this graphic toexplain how the elements of thefinancial system—especially financialintermediaries—link savers to bor-rowers.

Place English language learners ingroups of three with two studentswho are proficient in English. Askeach group to name a local orregional example of each of the typesof financial intermediaries explainedin this section. Suggest that they findas much information as possible oneach firm. ELL

Transparency Resource PackageEconomics Concepts, 11A:

Financial Intermediaries

Choose four active students to berepresentatives of financial compa-nies: (1) a bank, (2) a mutual fund,(3) a life insurance company, and (4)a savings and loan. Have studentsresearch and determine the appropri-ate rates of interest or earnings ver-sus risk each institution offers. Giveeach member of the rest of the class$1000 to invest. Allow the financialrepresentatives to solicit investmentsone-on-one, writing down the namesof the investors and amounts on aledger. Compare results. Which com-pany attracted the most money?How well did the investors diversifytheir money? SN

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Answer to . . . Building Key Concepts Financialintermediaries match savers withborrowers so that savers can gaininterest on their money.Intermediaries also provide risksharing, liquidity, and informationto savers.

Consider these suggestions to take advantage ofextended class time:

� Provide each student with a note card that listsinformation about a different fictitious individual:name, job status, income, and so on. At pointsaround the room, post the names of various finan-cial intermediaries as headings on sheets of poster-board. Have students visit the financial intermedi-aries in their assigned roles and record a transaction

they might carry out there. After the activity, discusswith students their transactions at each location.

� Show the Economics Video Library segment“Getting Started,” which explains how to save forretirement. Go over with students the statisticsexplained in the video, and explain the impor-tance of starting to save early. Have studentsresearch investment opportunities and report ontheir findings.

Block Scheduling StrategiesBlock Scheduling Strategies

diversificationspreading outinvestments to reduce risk

investors do not risk their savings bypurchasing the stock of only one or twocompanies that might do poorly.

• Life insurance companies The mainfunction of life insurance is to providefinancial protection for the family orother beneficiaries of the insured.Working members of a family, forexample, may buy life insurance policiesso that if they die, money will be paid tosurvivors to make up for lost income.Insurance companies collect paymentscalled premiums from the people whobuy insurance. They lend out part of thepremiums they collect to investors.

• Pension funds A pension is income thata retiree receives after working a certainnumber of years or reaching a certainage. In some cases, injuries may qualifya working person for pension benefits.Employers may contribute to the pensionfund on behalf of their employees, theymay withhold a percentage of workers’salaries to deposit in a pension fund, orthey may do both. Employers set uppension funds to collect deposits anddistribute payments. Pension fundmanagers invest these deposits in stocks,bonds, and other financial assets.

Now that you know something aboutthe types of financial intermediaries, youmay wonder why savers don’t deal directlywith investors. The answer is that, ingeneral, dealing with financial intermedi-aries offers three advantages. Intermediariesshare risks, provide information, andprovide liquidity to investors.

Sharing Risk As a saver, you may not want to investyour entire life savings in a single companyor enterprise. For example, if you had$500 to invest and your neighbor wasopening a new restaurant, would you giveher the entire $500? Since it is estimatedthat more than half of all new businessesfail, you probably would not want to riskall of your money. Instead, you wouldwant to spread the money around tovarious businesses to reduce the chances oflosing your entire investment.

This strategy of spreading out invest-ments to reduce risk is called diversification.If you deposited $500 in the bank orbought shares of a mutual fund, those insti-tutions could pool your money with otherpeople’s savings and put your money towork by making a variety of investments.

Investors

Figure 11.1 Financial Intermediaries

Commercial banksSavings & loan associations

Savings banksMutual savings banks

Credit unions

Life insurance companiesMutual fundsPension funds

Finance companies

Savers make deposits to . . . Financial Institutions that make loans to . . .

Figure 11.1 Financial Intermediaries

Financial intermediaries, including banks and other financial institutions, accept fundsfrom savers and make loans to investors. Investors include entrepreneurs, businesses,and other borrowers. Economic Institutions What advantages do financialintermediaries provide for savers?

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Learning Styles ActivityLearning Styles Lesson Plans folder, p. 27 asks student groups to createposters tracking the course of con-sumer savings as they move throughthe free enterprise system.

(Reteaching) Organize the class intofour groups, and ask each group towork together as investment coun-selors for two investors, Tom andRachel. They should evaluate eachinvestor’s personal and financial situa-tion, assess trade-offs between risk andreturn, and then make recommenda-tions about how much risk thatinvestor should assume and the typesof investments he or she should make.Share the following information withthe class.

Tom is 26 years old and single, livesin a small studio apartment, works asa Web site designer, and has $50,000to invest. His immediate plans includesaving to buy a house, replacing hisused car, and going to graduate school.

Rachel is 55 years old and a newlyretired teacher. She and her husbandown a home in the city and have asmall summer cottage by a lake.Rachel has $50,000 in retirementfunds to invest. Her immediate plansinclude vacationing in Italy and takingphotography classes at the city’s artmuseum. She and her husband plan tosell their home and purchase a condo-minium.

Transparency Resource Package Economics Concepts, 11B: Risk

and Return

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Answer to . . . Building Key Concepts Studentsshould think of at least one addi-tional example for each type of risk.For example, for credit risk theymay mention a transaction betweena credit card company and a cus-tomer who fails to pay the com-pany’s bill.

Examining Words The word prospectus is derivedfrom the Latin-based prospect, meaning “view” or“lookout.” Prospectus entered the English lan-guage in 1765. In 1841 the British began to useprospect to mean “to explore an area, especially formineral deposits.” Gold miners in the United Stateswere known as prospectors. In a sense a personwho reads a prospectus is looking for “gold,” sinceshe or he hopes to gain wealth.

Making the Connection Ask students to volunteerother words that include the root spect. Ask whatthese words have in common. (Students may sug-gest inspect, spectacles, and aspect, and shouldnote that all have to do with seeing or viewingsomething.)

Interdisciplinary Connections: Language ArtsInterdisciplinary Connections: Language Arts

portfolio a collection offinancial assets

prospectus aninvestment report topotential investors

return the money aninvestor receives aboveand beyond the sum ofmoney initially invested

In other words, financial intermediariesdiversify your investments and thus reducethe risk that you will lose all of your funds ifa single investment fails.

Providing InformationFinancial intermediaries are also goodsources of information. Your local bankcollects information about borrowers bymonitoring their income and spending. Sodo finance companies when borrowers fillout credit applications. Mutual fundmanagers know how the stocks in theirportfolios, or collections of financial assets,are performing. As required by law, allintermediaries provide this informationto potential investors in an investmentreport called a prospectus. Financial inter-mediaries reduce the costs in time andmoney that lenders and borrowers wouldpay if they had to search out such informa-tion about investment opportunities ontheir own.

Providing LiquidityFinancial intermediaries also provideinvestors with liquidity. (Recall thatliquidity is the ease with which people canconvert an asset into cash.) It is intermedi-aries that provide this liquidity in the finan-cial system.

Suppose, for example, that you decide toinvest in a mutual fund. You keep theinvestment for two years, but then mustsell it to pay your college tuition. If youhad purchased an investment-qualitypainting instead, you would need to findanother investor who would buy the artfrom you. As you can see, financial inter-mediaries and the liquidity they provideare crucial to meeting borrowers’ andlenders’ needs in our increasingly complexfinancial system.

Risk, Liquidity, and ReturnAs you have read, most decisions involvetrade-offs. For example, the trade-off forgoing to a movie may be two additionalhours of sleep. Saving and investinginvolves trade-offs as well.

Return and LiquiditySuppose you save money in a savingsaccount. Savings accounts are good ways tosave when you need to be able to get toyour cash for immediate use. On the otherhand, savings accounts pay relatively lowinterest rates, about 2 to 3 percentagepoints below a certificate of deposit (CD).In other words, savings accounts are liquid,but they have a low return. Return is the

Name Description Example

Credit risk

Liquidity risk

Inflation rate risk

Time risk

You lend $20 to your cousin, who promises to pay you back in two weeks. When your cousin fails to pay you on time, you don‘t have money for the basketball tickets you had planned to buy.

Borrowers may not pay back the money they have borrowed, or they may be late in making payments.

Your CD player is worth $100. You need cash to buy concert tickets, so you decide to sell your CD player. To convert your CD player into cash on short notice, you have to discount the price to $75.

You may not be able to convert the investment back into cash quickly enough for your needs.

Ricardo lends Jeff $1,000 for one year at 10 percent interest. If the inflation rate is 12 percent, Ricardo loses money.

Inflation rates erode the value of your assets.

Lili invests $100 in May‘s cleaning business, to be repaid at 5 percent interest one year later. Six months later, Lili is unable to invest in Sonia’s pet-sitting business, which pays 10 percent interest, because she has already invested her savings.

You may have to pass up better opportunities for investment.

Figure 11.2 Types of RiskFigure 11.2 Types of Risk

Investors must weighthe risks explained inthis chart against thepotential rate of returnon their investment.Income Whatadditional examplescan you think of toillustrate each of thetypes of risk explainedin the chart?

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For an additional article from TheWall Street Journal ClassroomEdition, see the Source Articlesfolder in the Teaching Resources,pp. 33–35.

Guide to the EssentialsChapter 11, Section 1, p. 46 providessupport for students who need addi-tional review of the section content.Spanish support is available in theSpanish edition of the guide on p. 46.

Quiz Unit 4 folder, p. 14 includesquestions to check students’ under-standing of Section 1 content.

Presentation Pro CD-ROM Quiz provides multiple-choice

questions to check students’ under-standing of Section 1 content.

Answers to . . .

Section 1 AssessmentSection 1 Assessment1. Investing allows more money to be

used by more people or firms, thusencouraging financial growth.

2. Savers provide funds for borrowersto use. Borrowers use that money toinvest in financial and real assets.Financial intermediaries help chan-nel funds from savers to borrowers.

3. Financial intermediaries share risk,allowing savers to diversify ways inwhich their money is saved; theyprovide information, gathering dataon financial markets and assets forboth savers and investors; and theyprovide liquidity, giving people themeans to convert assets into cash.

4. Possible answer: Investments that offer the chance to earn a lot of money tend also to be riskyinvestments.

5. The $500 is used by borrowersthrough financial intermediaries,providing assets for borrowers andbusinesses, thus contributing to thefinancial system.

6. Factors include how reliable youconsider Bill to be, when you thinkhe will pay you back, and what it willcost you to lend him the money.

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7. Possible questions: How has this fund done in the lastfive years? What companies do you invest in? Howeasily can I convert my investment back into cash?

8. (a) low risk and low return (b) low risk and mediumreturn (c) high risk and high potential return

money an investor receives above andbeyond the sum of money initially invested.

What if, however, you suddenly inherit$5,000? You do not need ready access tothose funds, since your part-time job paysyour day-to-day expenses. If you are willingto give up some degree of ready access toyour money, you can earn higher interestrates than offered by a savings account. Forexample, you can invest your money in acertificate of deposit that pays 4 percentinterest. You would not be allowed towithdraw your money for, say, two yearswithout paying a penalty. Therefore, beforebuying the CD, you would want to weighthe greater return on your investmentagainst the loss of liquidity.

Return and RiskCertificates of deposit (up to $100,000) areconsidered very safe investments becausethey are insured by the federal government.When you buy a CD, you are giving upliquidity for a certain period of time, butyou are not risking losing any money. Whatif, however, you decided to invest themoney in a new company that your friendsare starting? If the company succeeds, you

could double your invest-ment. If it fails, however, youcould lose all or part of themoney you invested.

To take another example,suppose your savings accountis earning 2 percent interest.Would you be willing to lendmoney to your friend Emilyfor that same 2 percentinterest rate, knowing thatshe rarely pays back loans ontime? Probably not. For youto lend Emily the money, shewould have to offer you ahigher return than the bankcould offer. This higher returnwould help offset the greater risk thatEmily will not repay the loan on time.Likewise, investors and lenders mustconsider the degree of risk involved in aninvestment and decide what return theywould require to make up for that risk.

The higher the potential return, theriskier the investment. Whenever individ-uals evaluate an investment, they mustbalance the risks involved with the rewardsthey expect to gain from the investment.

Section 1 Assessment

Key Terms and Main Ideas1. How does investing promote financial growth?2. Explain how savers, borrowers, and financial

intermediaries contribute to the financial system.3. Describe three roles of financial intermediaries.4. Explain the following statement in your own words. “The

higher the potential return on an investment, the higherthe risk.”

Applying Economic Concepts5. Critical Thinking Explain why a student with $500 in a

savings account is participating in the American finan-cial system.

6. You Decide Suppose your cousin Bill asks to borrow $50from you for concert tickets. Bill has offered to pay youinterest on the loan. What factors should you considerbefore you decide how much interest to charge?

7. Try This What are three questions concerning risk,return, and liquidity that you would ask a financialadvisor before investing your savings?

8. You Decide Explain the potential risks and returns of thefollowing savings plans and investments. (a) a savingsaccount (b) a certificate of deposit (c) your neighbor’ssuccessful pet care service

In the News Read more about returnand risk in “How Much Risk Can YouTolerate,” an article in The Wall Street Journal Classroom Edition.

The Wall Street JournalClassroom Edition

For: Current EventsVisit: PHSchool.comWeb Code: mnc-4111

PHSchool.com

For: Writing ActivityVisit: PHSchool.comWeb Code: mnd-4111

Progress Monitoring OnlineFor: Self-quiz with vocabulary practiceWeb Code: mna-4115

Typing in the Web Codewhen prompted will bring students directlyto detailed instructions for this activity.

Typing in the WebCode when prompted will bringstudents directly to the article.

Progress Monitoring OnlineFor additional assessment, have students accessProgress Monitoring Online at Web Code: mna-4115