Banks & The Federal Reserve Why do we need money?

Money!!! Who is on the… $100 Bill $50 Bill $20 Bill $10 Bill $5 Bill 50 Cent Dime $1000 Bill $100,000 Bill Franklin Grant Jackson Hamilton Lincoln Jefferson JFK FDR Cleveland Wilson Bonus: “E Pluribus Unum” means…. “Out of Many, One”

What would happen if we didn’t have money? Why do we use money? What would happen if we didn’t have money? The Barter System: goods and services are traded directly. There is no money exchanged. Problems: Before trade could occur, each trader had to have something the other wanted. Some goods cannot be split. If 1 goat is worth five chickens, how do you exchange if you only want 1 chicken? Example: A heart surgeon might accept only certain goods but not others because he doesn’t like broccoli. To get the surgery, a pineapple grower must find a broccoli farmer that likes pineapples.

What is Money? Money is anything that is generally accepted in payment for goods and services Money is NOT the same as wealth or income Wealth is the total collection of assets that store value Income is a flow of earnings per unit of time Commodity Money- Something that performs the function of money and has alternative uses. Examples: Gold, silver, cigarettes, etc. Fiat Money- Something that serves as money but has no other important uses. Examples: Paper Money, Coins https://www.youtube.com/watch?v=oCPct3CSLa8&index=2&list=PLlOCkpyjIlHHY3hqk6iMogeUTEzxKTd-e 5

3 Functions of Money 1. A Medium of Exchange 2. A Unit of Account Money can easily be used to buy goods and services with no complications of barter system. 2. A Unit of Account Money measures the value of all goods and services. Money acts as a measurement of value. 1 goat = $50 = 5 chickens OR 1 chicken = $10 3. A Store of Value Money allows you to store purchasing power for the future. Money doesn’t die or spoil.

3 Types of Money Liquidity- ease with which an asset can be accessed and converted into cash (liquidized) M1 (High Liquidity) - Coins, Currency, and Checkable deposits (personal and corporate checking accounts). In general, this is the MONEY SUPPLY M2 (Medium Liquidity) - M1 plus savings deposits (money market accounts), time deposits (CDs = certificates of deposit), and Mutual Funds below $100K. M3 (Low Liquidity) - M2 plus time deposits above $100K.

What backs the money supply? There is no gold standard. Money is just an I.O.U. from the government “for all debts, public and private.” What makes money effective? Generally Accepted - Buyers and sellers have confidence that it IS legal tender. Scarce - Money must not be easily reproduced. Portable and Dividable - Money must be easily transported and divided. The Purchasing Power of money is the amount of goods and services an unit of money can buy. Inflation (increases/decreases) purchasing power. Rapid inflation (increases/decreases) acceptability. 8

The value of money is affected by the point in time it is received. Time Value of Money The value of money is affected by the point in time it is received.

Time Value of Money The value of a given amount of money is greater the earlier that it is received. Money has time value because interest rates are positive. If you earn 5% on your savings account, $1 will grow to $1.05 one year from now. The present value of $1.05 received one year from now is $1.00 PV= FV/(1+r)n The present value of $1.00 received one year from now is $1.00/ (1.05)1 = $0.95 Relationship between bond prices and interest rates.

Business executives need to consider the time value of money when making investment spending decisions. Future profit projections must be converted into the present value in order to make a correct decision about whether a certain business project is profitable. Example: A new machine costs $2,000 now and is expected to generate profits of $1,000 at the end of year one, and $1,400 at the end of year two. If the business borrows the $2,000 at 9% interest, should the business purchase the machine? PV- $1,000/ (1.09)1 + $1,400/ (1.09)1 = $917.43 + $1,178 = $2,095.78 The business should invest in the machine because $2,095 .78 > $2,000

What will $3,000 deposited into a savings account be worth after one year if interest rates are 3% compounded yearly? $3,090 What will $3,000 deposited into a savings account be worth after two years if interest rates are 3% compounded yearly? $3,182.70 What is the present value of $3,000 you are scheduled to receive one year from today if you are currently earning 3% on your savings? $2,912.62 What is the present value of $3,000 you are scheduled to receive two years from today if you are currently earning 3% on your savings? $2,827.79

5. Assume you have owed a bond with a coupon rate of 6% for 17 years 5. Assume you have owed a bond with a coupon rate of 6% for 17 years. If current interest rates are 9%, at what price could you sell the bond today? $924.06 6. Assume a business is deciding whether to invest in a new project that is projected to generate profits of $90,000 each year for the next 3 years. The project start-up costs are $225,000. (A) If the business normally earns 11% on its investments, should the business invest? Explain. No, $225,000.00 > $219.934.32 (B) If the business normally earns 5% on its investments, should the business invest? Explain. Yes, $245,092.32 > $225,000.00