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Why Study Money, Banking, and Financial Markets?

The document discusses why studying money, banking, and financial markets is important. It examines how financial markets like bond, stock, and foreign exchange markets work and how financial institutions like banks operate. It also examines the role of money in the economy and the connection between money supply, business cycles, inflation, and interest rates.

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91 views17 pages

Why Study Money, Banking, and Financial Markets?

The document discusses why studying money, banking, and financial markets is important. It examines how financial markets like bond, stock, and foreign exchange markets work and how financial institutions like banks operate. It also examines the role of money in the economy and the connection between money supply, business cycles, inflation, and interest rates.

Uploaded by

Trang Vũ
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 1

Why Study Money,


Banking, and
Financial Markets?
Preview

•  To examine how financial markets such as bond,


stock and foreign exchange markets work
•  To examine how financial institutions such as
banks, investment and insurance companies work
•  To examine the role of money in the economy

1-2 © 2013 Pearson Education, Inc. All rights reserved.


Why Study Financial Markets?

•  Financial markets are markets in which


funds are transferred from people and
Firms who have an excess of available
funds to people and Firms who have a
need of funds

1-3 © 2013 Pearson Education, Inc. All rights reserved.


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.

1-4 © 2013 Pearson Education, Inc. All rights reserved.


Figure 1 Interest Rates on Selected
Bonds, 1950–2011

Sources: Based on Federal Reserve Bulletin; www.federalreserve.gov/releases/


H15/data.htm.

1-5 © 2013 Pearson Education, Inc. All rights reserved.


The Stock Market

•  Common stock represents a share of


ownership in a corporation
•  A share of stock is a claim on the residual
earnings and assets of the corporation

1-6 © 2013 Pearson Education, Inc. All rights reserved.


Why Study Financial Institutions
and Banking?
•  Financial Intermediaries: institutions that
borrow funds from people who have saved
and make loans to other people:
–  Banks: accept deposits and make loans
–  Other Financial Institutions: insurance
companies, finance companies, pension funds,
mutual funds and investment companies
•  Financial Innovation: the development of
new financial products and services
–  Can be an important force for good by making
the financial system more efficient

1-7 © 2013 Pearson Education, Inc. All rights reserved.


Figure 2 Stock Prices as Measured by
the Dow Jones Industrial Average,
1950–2011

Source: Based on Dow Jones Indexes: http://nance.yahoo.com/?u.

1-8 © 2013 Pearson Education, Inc. All rights reserved.


Why Study Money and Monetary
Policy?
•  Evidence suggests that money plays an
important role in generating business cycles
•  Recessions (unemployment) and expansions
affect all of us
•  Monetary Theory ties changes in the money
supply to changes in aggregate economic
activity and the price level

1-9 © 2013 Pearson Education, Inc. All rights reserved.


Money, Business Cycles 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

1-10 © 2013 Pearson Education, Inc. All rights reserved.


Figure 3 Money Growth (M2 Annual
Rate) and the Business Cycle in the
United States 1950–2011

Source: Based on Federal Reserve Bulletin, p. A4, Table 1.10;


www.federalreserve.gov/releases/h6/hist/h6hist1.txt.

1-11 © 2013 Pearson Education, Inc. All rights reserved.


Figure 4 Aggregate Price Level and
the Money Supply in the United
States, 1950–2011

Sources: Based on www.stls.frb.org/fred/data/gdp/gdpdef; www.federalreserve.gov/releases/


h6/hist/h6hist10.txt.

1-12 © 2013 Pearson Education, Inc. All rights reserved.


Figure 5 Average Inflation Rate
Versus Average Rate of Money Growth
for Selected Countries, 2000-2010

Source: Based on International Financial Statistics. www.imfstatistics.org/imf.

1-13 © 2013 Pearson Education, Inc. All rights reserved.


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 Treasury
bonds were closely tied
•  Since then, the relationship is less clear but
the rate of money growth is still an
important determinant of interest rates

1-14 © 2013 Pearson Education, Inc. All rights reserved.


Figure 6 Money Growth (M2 Annual
Rate) and Interest Rates (Long-Term
U.S. Treasury Bonds), 1950–2011

Sources: Based on Federal Reserve Bulletin, p. A4, Table 1.10; www.federalreserve.gov/


releases/h6/hist/h6hist1.txt.

1-15 © 2013 Pearson Education, Inc. All rights reserved.


Fiscal Policy and Monetary Policy

•  Monetary policy is the management of the money


supply and interest rates
–  Conducted in the U.S. by the Federal Reserve System
(Fed)
•  Fiscal policy deals with 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

1-16 © 2013 Pearson Education, Inc. All rights reserved.


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

1-17 © 2013 Pearson Education, Inc. All rights reserved.

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