1. Banks and Financial Sector

2. What is a bank?
On the whiteboard at the front of the room, write down a phrase or word that describes a bank

3. Definition
A bank is a financial institution that uses bank deposits to finance investments

4. Huh?
Banks receive deposits from savers (households) and loans them out to investors (firms).
Banks earn profits by making loans
They loan out most (NOT ALL) deposits they receive
They have to keep some money in stock in order for customers to withdraw their funds whenever needed

5. I Know What You’re Thinking…
Mary Poppins
People don’t usually ask for all of their money out of a bank all at once
Which is why banks are able to loan out money for investments

6. Useful Terms
Demand Deposits = a deposit of money that can be withdrawn without prior notice
Reserves = the fraction of deposits that banks keep on hand (in their vault or in the Federal Reserve)
Required Reserves = banks are required by law to keep a certain minimum fraction of their deposits on reserve
Excess Reserves = any reserves in excess of the required ones
Fractional Reserves = when banks keep only a fraction of their deposits and loan out the rest

7. More Useful Terms
Assets = a resource with economic value that an individual, company or country owns/controls with the expectation it will provide future benefit
Includes loans, deposits within the Federal Reserve, stocks and bonds
Liabilities = a company’s legal debts or obligations that arise during the course of business
Settled through a transfer of economic benefits (money, goods, or services)

8. Deposit Expansion Multiplier
The Deposit Expansion Multiplier determines how much money can be created in the economy from an initial deposit
DEM = rr
Rr = the reserve requirement

9. Expansion of the Money Supply
Expansion of the money supply = excess reserves x the multiplier (DEM)
Remember = Excess reserves is the money that is loaned out of the bank

10. Let’s try it!
Let’s say there’s a $5,000 deposit into a bank with a 10% required reserve
The DEM is 1/0.1= 10
ASSETS__________________________LIABILITIES
Loans $4,500 Deposits $5,000
Reserves $500
EMS = $4,500 x 10 = $45,000
Is this M1, M2, or M3? M1

11. Mr. Clifford
Mr. Clifford
Mr. Clifford 2

12. Time Value of Money Money changes! Why?
Interest rates and value of the dollar!
PV = FV / (1 + r)ⁿ
PV = present value
FV = future value
R = rate of interest per period
n = number of compounding periods per year

13. Useful Term Compounded = “to add to”
In reference to compounded interest, it means that interest is added on top of interest
It accumulates over time

14. Example Part 1
What happens in a year if you put $3,000 into a savings account now and it has a compounded interest of 3%?
$3,000 ( )
$3,090

15. Example Part 2
Calculate what $3,000 deposit into a savings account will be worth after 1 year if the current interest rate is 3%.
PV = $3,000 / ( )¹
PV = $3,000 / (1.03)
Answer = $
The value dropped because the dollar value isn’t worth the same in the future

16. Example Part 3
What will the same $3,000 be worth after two years if compounded interest rates are 3%?
$3,000 (1.03)²
$3,182.70

17. Stock Market
Definition = the market where publicly held companies’ shares are traded or exchanged
One of the most vital components of a free- market economy
Investors get a “slice” of ownership in the company
Stock Market

18. Functions of a Financial System
1) Reduce transaction costs
The costs of negotiating and executing a legal deal
2) Reduce financial risk
People are more willing to invest if the risk is minimized
3) Provide liquidity
Liquid investments can be turned into cash easily

19. Stocks
Stocks have value because of their ability to generate future income
Companies pay interest, or dividends, to shareholders
Shareholders can sell their stock for profit as well
A stock’s price is determined by expectations of the future
If a stock’s future looks good = demand increases, supply decreases
If a stock’s future looks bad = demand decreases, supply increases

20. So, what’s the Dow Jones?
The Dow Jones is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ (National Association of Securities Dealers Automated Quotations)
Dow Jones
Nasdaq

21. The DOW The Dow includes:
3M, American Express, Apple, Boeing, Caterpillar, Chevron, Cisco Systems, Coca- Cola, DuPont, Exxon Mobile, General Electric, Goldman Sachs, The Home Depot, Intel, IBM, Johnson & Johnson, JP Morgan Chase, McDonald’s, Merck, Microsoft, Nike, Pfizer, Procter & Gamble, Travelers, UnitedHealth Group, United Technologies, Verizon, Visa, Wal-Mart, Walt Disney