Lecture Notes Finance 3191 Finance 319 Lecture 2 Basic Concepts u Galina A Schwartz u Department of Finance u University of Michigan u Business School

Lecture Notes Finance 3192 Practical Matters Office Hours Change My office: D3270A (Davidson Hall) My My office hours: Mon., 10am -12pm &, Th., 1 pm -3 pm or by appointment Notice a change: was Th., 3 pm - 5 pm

Lecture Notes Finance 3193 Basic Concepts I u Money and Money Functions u Balance of Payments u Perfectly Competitive Market u Imperfect Competition u Monopoly u Market Power u Prisoner’s Dilemma

Lecture Notes Finance 3194 Money and Money Functions u Types of Money –Commodity Money –Fiat Money u Functions of Money, Levich, p.32 –1. Medium of Exchange [goods, services, debt] –2. Store of Value –3. Unit of Account u Sterilization & Sterilized Intervention

Lecture Notes Finance 3195 Current & Capital Account and Balance of Payments Current Account = Exports - Imports Capital Account = Investment - Savings Current Account + Capital Account = Official Balance of Payments Current Account + Capital Account = Changes in Reserves

Lecture Notes Finance 3196 Basic Concepts II u Regulation u Gains from Trade u Competitive Advantage u International division of labor u Specialization u Taxes u Rate of return on capital u Required return

Lecture Notes Finance 3197 Basic Concepts III u Government credibility u Commitment u Commitment constraint u Optimal policies u Objective Function (or just objective) u Time inconsistent optimal policies

Lecture Notes Finance 3198 Basic Concepts IV u Exchange rate –fixed –floating –pegged –currency board u Exchange rates –nominal versus real u Interest rates –nominal versus real

Lecture Notes Finance 3199 Basic Concepts V u Capital controls u Transaction costs u Perfect Capital Market –zero transaction costs –no capital controls –zero taxes –no regulations –no uncertainty

Lecture Notes Finance Basic Concepts VI u Objective Function (or just objective) u Time inconsistent optimal policies u Regulation –loss: costs of regulation –gain: benefits from regulation –net regulatory burden: gain -loss

Lecture Notes Finance Basic Concepts VII u Expected value u Inflation rate u FED objective function is to keep: –1. unemployment  –2. inflation  –controversy between 1 & 2 u Hedging

Lecture Notes Finance Basic Concepts VIII u Types of Risk (Levich, page 5) –counterparty –liquidity –delivery –rollover u Risk neutral & risk-averse u Costs and benefits analysis