1. Unit 5: The Financial Sector
Modules 22-29

2. Module 22 Key Terms & Review
YOYO!
The vocabulary in this module will aid in your understanding of Unit 5, but is unlikely to be emphasized on the AP Exam. 1. 2. 3. 4. 5.

3. Module 23 Key Terms & Review
YOYO!
Easy concepts that WILL be tested on the AP Exam. 1. 2. 3. 4. 5.

4. Module 24 Key Terms & Review
Net present value 1. 2. 3. 4. 5.

5. Time Value of Money

6. Economic Decision Making
Cost/benefit analysis is difficult because the benefits & costs of a decision do not always occur at the same time
Chicken nuggets: benefit now / cost now =
College degree: benefit later / cost now =
Car loan: benefit now / cost later =
Would you rather have $1 today or $1 next year? What factors affect your decision?

7. Borrowing, Lending, & Interest
You wish to purchase the new Nimbus racing broom for $1,000. Your parents have agreed to give you the $$ for being such a good kid.
Receive the money at graduation:
Receive the money now:
Moral of the story:

8. Present Value
Costs & benefits that you will receive in the future must be converted to present values in order to make better decisions
What amount would you be willing to accept today as a substitute for receiving $1 a year from now?

9. Present Value cont. Interest rate (r) = 10%
Future value of $Z in N years =
Present value of $1 ~ how much would you need to set aside today to have $1 in N years?

10. Let’s practice!
Net present value = the present value of current & future benefits minus the present value of current & future costs
3 options:
$100 now, no cost
Net present value =
Pay $10 now, receive $115 in a year
$119 now, pay $20 in one year

11. Module 25 Key Terms & Review
Bank reserves
Reserve ratio
Bank run
Deposit insurance
Discount window
Excess reserves
Monetary base 1. 2. 3. 4. 5.

12. Banking & Money Creation
Fractional Reserve Banking System
Banks must keep a certain % of their depositors’ $$ on hand (or in their the Fed) to handle the daily demand for cash

13. T-accounts Both sides must ALWAYS balance.
Deposits are a liability to a bank because their customers can withdraw the $$ at any time
Reserves are an asset because the money is not out in circulation
Loans are an asset because they represent $$ owed to the bank
What happens when people want to withdraw more than $100,000???

14. Give me my money you @#&* !!!
Bank runs!
When too many depositors want to withdraw their money at the same time
Bank regulations should prevent this from happening
Give me my money !!!

15. Bank regulations Deposit insurance Capital requirements
Reserve requirements
Discount window

16. Determining the Money Supply
Banks affect the money supply by

17. Money creation
Harry finds $100 in the Room of Requirement and opens up a checking Gringotts.
Has the money supply changed?
How much does Gringotts have to keep in their vault if the reserve requirement is 10%?
Hermione comes into Gringotts for a broom loan. How much can they lend her? .

18. Money Creation cont.
Now that a new account has been created, the process begins again…
Hermione deposits her $90 in the Bank of Gryffindor. How much does the bank have to keep in their vault?

19. The Money Multiplier
How much money will be created if all of the money is loaned out and redeposited back into the banking system?
Money multiplier =
Original deposit of $100 turns into
Change in total money supply =

20. Is this for real? Sort of…
In reality, not all available money is borrowed and not all loans are redeposited into the system 
Fed controls the monetary base 

21. Module 26 Key Terms & Review
Central bank
Commercial bank
Investment bank
Savings & Loans 1. 2. 3. 4. 5.

22. The 3rd greatest man who ever lived…

23. The Structure of the Fed
Board of Governors
12 District Banks
Federal Open Market Committee

24. District Banks

25. Module 27 Key Terms & Review
Federal funds rate
Discount rate
Open-market operation 1. 2. 3. 4. 5.

26. The Functions of the Fed
Provide financial services to depository institutions (banks) & the government
Supervise and regulate banks
Maintain the stability of the financial system (no pressure!)
Conduct monetary policy

27. Tools of the Fed Reserve requirement Discount rate
Fed can raise or lower to alter bank reserves & loans
What if a bank can’t meet their reserve requirement?
Discount rate

28. Tools cont. Open-market operations
The Fed holds government savings bonds (Treasury bills) as assets

29. Module 28 Key Terms & Review
Short term interest rates
Long-term interest rates
Money demand curve
Money supply curve 1. 2. 3. 4. 5.

30. The Demand for Money Why do people hold money?
What is the opportunity cost of holding money?
What is the relationship between the interest rate and the opportunity cost of holding cash?

31. Short-term v. Long-term rates
Short-term interest rate
Long-term interest rate
We care more about short-term interest rates because they are more relevant to our decision to hold cash

32. Money Demand Curve
Indirect relationship between the nominal interest rate and the quantity demanded of money
Shifts in the money demand curve

33. Money & Interest Rates
The FOMC meets 8 times a year to set a target federal funds rate, which influences all short-term interest rates
How do they do this?

34. Module 29 Key Terms & Review
Rate of return
Crowding out
Fisher effect 1. 2. 3. 4. 5.

35. Loanable Funds Market For the economy as a whole, savings =
Financial markets bring savers & borrowers together

36. Shifts in the Loanable Funds Market
Demand
Supply

37. Inflation & Interest rates
Expectations about future inflation have a huge impact on interest rates
See Module 14 “Winners and Loser from Inflation”
Fisher effect
Both borrowers & lenders change their demands based on inflation expectations

38. Short-run Determination of the Interest Rate

39. Types of Monetary Policy
Easy money = expansionary
Increase MS to stimulate AD
___ securities
___ the reserve ratio
___ the discount rate
Tight money = contractionary / restrictive
Decrease MS to slow down AD

40. Helpful Hints
Money converted from cash  a checking account does NOT change the total amount of M1, just its composition
Reserve requirement applies to
Checking and savings accounts
Money earned by the public from the sale of a bond
Reserve requirement does NOT apply to
Money earned by a bank from the sale of a bond to the Fed
Money that a bank borrows from the Fed (discount rate)
Total change in demand deposits
Include the cash that was converted to a checking account
Total change in the money supply
Do NOT include cash – it was already part of M1

41. Crowding-out effect Or there’s the easier way to look at it… 
Government deficit spending leads to an increase in the # of government savings bonds available
Greater supply of bonds = lower price = higher rate of return on your investment
Bonds look more attractive to savers = other institutions that offer investments have to raise their interest rates to compete for customers
Higher interest rates hurt borrowers (decrease in C and Ig)
Banks will use loanable funds to invest in bonds = less available to consumers and businesses
Or there’s the easier way to look at it… 
Government borrowing is part of the demand for money
Increase in demand leads to higher interest rates