1 Chapter 1 Money, Banking, and Financial Markets--An Overview ©Thomson/South-Western 2006

2 Money And Banking: Key Elements  money  financial intermediaries (traditionally,especially banks)  interest rates  government budget deficits (or surpluses)

3 Money  Money is the stock of items widely used to make payment for goods and services.  Money, or the money supply, includes:  currency and coins in circulation,  checking accounts in depository institutions, and  other items, such as Certificates of Deposit (CDs), when measured more broadly.

4 What Determines The Money Supply?  The central bank is responsible for the trend or long-run behavior of the money supply.  In the United States, the central bank is the Federal Reserve System (the Fed).  The Fed conducts monetary policy.

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6 Money, Inflation, and Deflation  When the money supply increases more rapidly than the output of goods and services, inflation occurs.  Inflation targeting occurs when a central bank announces an explicit inflation range it pledges to maintain and enforces policies consistent with that goal.  Deflation is a continuing decline in prices and is more damaging to a nation's economic health than inflation.

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8 Banks And Other Financial Intermediaries  Banks accept various types of deposits and use the funds attracted primarily to grant loans.  "Banks" is a generic term for all depository institutions.  Banks are older-generation financial intermediaries. Today, other intermediaries like pension funds and insurance companies are playing an increasingly important role in capital markets, encroaching on banks’ traditional role.  Intermediaries match savers’ money with borrowers’ funding demands.

9 Interest Rates  The interest rate is the cost of borrowing (or the return for lending), expressed as a percent per year.  The real interest rate is the stated interest rate adjusted for expected inflation.  Key interest rates:  prime loan rate  3-month U.S. Treasury securities  short-term corporate debt

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12 The Federal Budget Deficit  The federal government’s budget deficit is the annual amount by which federal government expenditures exceed tax revenues collected.  The national debt is the cumulative sum of past budget deficits less past surpluses.

13 Key Financial Markets  The stock market  The bond market  The foreign exchange (ForEx) market

14 The Stock Market  Shares are claims of ownership in individual corporations.  A company’s stock share price reflects the opinion of the market about the corporation's continually changing prospects.  Major indexes reflect changing sentiment about the nation's economic prospects.  Dow-Jones Industrials Average (DJIA)  Standard and Poor's 500 Average (S&P 500)

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16 The Bond Market  A bond is a debt instrument issued by a corporation, government, or government agency.  A bond’s indenture is an agreement to make a stream of interest payments at specified future dates, and also to return the principal at maturity.  Bondholders are lenders; stockholders are owners.  Interest rates (or yields) are determined by market forces of supply and demand.

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18 The Foreign Exchange Market  Various national currencies trade in the foreign exchange (ForEx) market.  Foreign trade necessitates trade in national currencies in the ForEx market.  The price at which one country's currency exchanges for foreign currency is the exchange rate.

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20 Foreign Exchange and Trade  Appreciation is an increase in the value of one nation’s currency relative to another nation’s currency.  Depreciation is the opposite.  Appreciation causes:  higher prices to foreign buyers of exports,  lower prices to domestic consumers of imports, and  a trade deficit (or a reduction in the trade surplus).  Depreciation causes:  lower prices to foreign buyers of exports,  higher prices to domestic consumers of imports, and  a trade surplus (or a reduction in the trade deficit.)