Financial Sector Ashley Ong Courtney Chan Jamie Lam Kevin Co

Key Terms Money – A current medium of exchange in the form of coins and banknotes Stocks – The goods or merchandise kept on the premises of a business or warehouse and available for sale or distribution Bonds – A debt investment in which an investor loans money to an entity that borrows the funds for a defined period of time at a fixed interest rate

Main Ideas Money does not retain its value over time. Banks can “create” money through loans. Money is a product, and has a demand/supply of its own. The Fed can influence the economy through control of the money supply. More money leads to more inflation.

Time Value and Money Idea that money available at the present time is worth more than the same amount in the future (due to inflation)

In other words… The real worth of money today is less than it will be in the future. Ex. A bottle of ketchup cost $0.19 in Today, it costs about $2.99

How to Find Future Value FV = PV (1 + i)^t Future value = present value * (1 + real interest rate)^(# of years)

How to Find Present Value PV = FV / (I + i)^t Present Value = Future Value / (1 + real interest rate)^(# of years)

Therefore, if you get the $10,000 in the present time, it will be worth more in the future. Future vs. Present

Example If the interest rate is 9%, and inflation is at 4%, how much will $1,000 be worth in ten years? FV = PV (1 + i)^t FV = 1000 ( )^10 FV ≈ $

Example 2 In five years time, you will have exactly $2,000 in a bank account. If the interest rate was 7% and inflation was 2%, how much money did you initially invest? PV = FV / (1 + i)^t PV = 2000 / ( )^5 PV ≈ $

Money Supply The entire and total quantity of bills, coins, loans, credit, and other liquid instruments in a single country’s economy.

M1 First category of money supply Includes the most “liquid” or easily spent funds Physical Money (coins & currency) Checking Accounts NOW (negotiable order of withdrawal) accounts

M2 Second category of money supply Second most liquid or spendable funds Includes all of M1 Time related deposits Savings Deposits Non-institutional money market funds

M3 Third category Large time deposits institutional money-market funds Short term repurchase agreements Large liquid assets

Creation of Money Banks can essentially “create” money. Reserve Requirement Ratio – minimum amount of money a bank needs to retain within their vaults.

How do they do it? Bob the Bunny saves in the bank. The bank can use that money to give a loan to Jarvis the Chicken. When Jarvis pays his loan back, the bank will have both Bob’s money and Jarvis’ money.

However… It is a bit more complicated in practice. Banks have many customers, all of whom loan, save, or both. In the end, the bank usually makes a decent amount of money due to interest rates on the amount of money a borrower has to pay back.

More Equations Money Banks Creates = Money Multiplier * Excess Reserves Money Multiplier = 1 / (Reserve Ratio) Excess Reserves = incoming money – required reserves

Example 3 A bank gets a deposit of $10,000. If the reserve ratio is 2%, how much “new money” can the bank create? Money Multiplier = 1 / 0.02 = 50 Excess Reserve = – 200 = 9800 New Money = 50 * 9800 = $490,000

Money (cont.) Think of money as a product. It has supply and demand, just like a normal product such as Computers or Widgets or Gnomes.

Money Market Graph

Money Demand / Supply If the money supply increases, the demand will decrease. This will cause the worth of money to decrease, causing inflation. If the money supply decrease, the demand will increase. This leads to an increase in the worth of money.

Loanable Funds Market

IMPORTANT Money Market Graph ◦ Shows the demand/supply of money in a country’s economy Loanable Funds Market ◦ Shows the relationship between a borrower’s demand for money and a loaner’s supply of money.

Central Bank The Federal Reserve (the Fed) can control the money supply through monetary policy. Open Market Operations Discount Rate Reserve Requirements

Quantity Theory of Money The price level of goods and services sold is directly related to the quantity of money. Ex. If the amount of money in Hyrule doubles, price levels will also double.

Fisher Equation MV = PT Money Supply * Velocity of Circulation = Price Level * Volume of Transactions of Goods and Services

Interest Rates Real Interest Rate = Nominal Interest Rate – Inflation Nominal Interest Rate = Real Interest Rate + Inflation

Works Cited