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It is obvious that economies depend on markets for labor and for products, such as consumption goods. In these markets, the so-called “Main Street”, employers find employees who are most suitable for them, and households find products which are best for them. So why then is there a need for Wall Street? That is, why is there a need for bond markets, stock markets and a variety of option markets, where enigmatic persons such as Warren Buffet, George Soros and Bernard Madoff snatch each other’s money? And why do workers and entrepreneurs of “Main Street” need to rescue institutions of Wall Street (investment banks, commercial banks, mortgage banks, etc.) from collapse with billions of dollars in the end? These controversial questions can only be answered if one understands the functions of financial markets and their institutions.
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A bond is an obligation to pay, which in addition to the repayment of debt usually also requires the payment of interests. Bonds are primarily issued by the state and by large corporations.
The real interest rate describes how many additional goods can be purchased in the next period for one good saved in this period, i.e., the real interest rate equals the nominal interest rate minus the inflation rate.
A credit spread indicates by how much the interest rate on firm issued bonds exceeds that of state issued bonds.
- Financial Markets and Institutions
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