1. Chapter 1 Why Study Money, Banking, and Financial Markets?

2. Quick Review What is Money? Which items would be willing to accept as a medium of exchange for a good or service? And Why a.Traveler’s check; b. computer; c. an ounce of gold; d.A refrigerator; e. a guitar; f. a bond or security. Rank the following assets from the most liquid to least liquid: a.Checking account deposits; b. Houses; c. Currency; d. Washing machines; e. Savings deposits; f. Common stock. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-2

3. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-3 Why Study Money, Banking, and Financial Markets To examine how financial markets such as bond, stock and foreign exchange markets work To examine how financial institutions such as banks and insurance companies work To examine the role of money in the economy

4. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-4 Financial Markets Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds

5. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-5 The Bond Market and Interest Rates A security (financial instrument) is a claim on the issuer’s future income or assets A bond is a debt security that promises to make payments periodically for a specified period of time An interest rate is the cost of borrowing or the price paid for the rental of funds

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7. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-7 The Stock Market Common stock represents a share of ownership in a corporation A share of stock is a claim on the earnings and assets of the corporation

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9. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-9 The Foreign Exchange Market The foreign exchange market is where funds are converted from one currency into another The foreign exchange rate is the price of one currency in terms of another currency The foreign exchange market determines the foreign exchange rate, the price of one country’s currency in terms of another’s.

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11. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-11 Banking and Financial Institutions Financial Intermediaries—institutions that borrow funds from people who have saved and make loans to other people Banks—institutions that accept deposits and make loans Other Financial Institutions—insurance companies, finance companies, pension funds, mutual funds and investment banks Financial Innovation—in particular, the advent of the information age and e-finance

12. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-12 Money and Business Cycles Evidence suggests that money plays an important role in generating business cycles Recessions (unemployment) and booms (inflation) affect all of us Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level

13. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-13 Measures of the Monetary Aggregates Value as of Dec 2005 (In Billions) M1 = Currency 725.2 + Travelers checks 7.3 + Demand deposits 338.8 + Other checkable deposits 317.8 Total M1 1389.1 M2 = M1 + Time Deposits 968.8 + Savings and Money Markets 3625.5 + Money Market Mutual Fund 723.9 Total M2 5319.2 Total of M1 +M2 6708.3

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15. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-15 Discussion Questions – In pairs 1. If history repeats itself and we see a decline in the rate of money growth, what might you expect to happen to a.real output? b. the inflation rate c. interest rates? 2. When interest rates fall, how might you change your economic behavior? 3. Can you think of any financial innovation in the past 10 years that has affected you personally? Has it made you better off or worse? Why? 4. Is everybody worse off when interest rates rise?

16. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-16 Money and Inflation The aggregate price level is the average price of goods and services in an economy A continual rise in the price level (inflation) affects all economic players Data shows a connection between the money supply and the price level

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19. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-19 Money and Interest Rates Interest rates are the price of money Prior to 1980, the rate of money growth and the interest rate on long-term Treasure bonds were closely tied Since then, the relationship is less clear but still an important determinant of interest rates

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21. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-21 Monetary and Fiscal Policy Monetary policy is the management of the money supply and interest rates  Conducted in the U.S. by the Federal Reserve Bank (Fed) Fiscal policy is government spending and taxation  Budget deficit is the excess of expenditures over revenues for a particular year  Budget surplus is the excess of revenues over expenditures for a particular year  Any deficit must be financed by borrowing

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23. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-23 How We Will Study Money, Banking, and Financial Markets A simplified approach to the demand for assets The concept of equilibrium Basic supply and demand to explain behavior in financial markets The search for profits An approach to financial structure based on transaction costs and asymmetric information Aggregate supply and demand analysis

24. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-24 Summary of Lesson 1. Activities in financial markets have direct effects on individuals’ wealth, the behavior of businesses, and the efficiency of an economy. Three financial markets deserve attention: the bond market (where interest rates are determined), the stock market, and the foreign exchange market. 2. Banks and other financial institutions direct funds from people who might not put them to productive use to people who can do so thus improving the efficiency of the economy. 3. Money appears to be a major influence on inflation, business cycles and interest rates. Because these economic variables are so important to the health of an economy, we need to understand how monetary policy is and should be conducted.

25. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-25 More Discussion Questions 5. What is the basic activity of banks? 6. Why are financial markets important to the health of the economy? 7. What effect might a fall in stock prices have on business investment? 8. What effect might a rise in stock prices have on consumer’s decisions to spend?

26. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-26 www.federalreserve.govwww.federalreserve.gov/ General information, monetary policy, banking system, research, and economic data of the Federal Reserve. www.stockcharts.com/charts/historicalwww.stockcharts.com/charts/historical/ Historical charts of various stock indexes over differing time periods. www.brillig.com/debt_clock/ USA National debt clock. www.myeconlabcommunity.com To help you learn more about this course Web References

27. Office Hours 8 am till Noon every Thursday morning at the Peter Hall lobby. Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 1-27 Class Website businessatsias.weebly.com