Chapter 1 Why Study Money Banking and Financial
Chapter 1 Why Study Money, Banking, and Financial Markets? 1 Copyright © 2008 Pearson Education Canada
Why Study Financial Markets? 1. Financial markets channel funds from savers to investors, thereby promoting economic efficiency 2. Financial markets are a key factor in producing economic growth 3. Financial markets affect personal wealth and behaviour of business firms 2 Copyright © 2008 Pearson Education Canada
The Bond Market & Interest Rates • A security (financial instrument) is a claim on the issuer’s future income or assets • An asset is any financial claim that is subject to ownership 3 Copyright © 2008 Pearson Education Canada
The Bond Market & Interest Rates • A bond is a debt security that promises periodic payments for a specified time • An interest rate is the cost of borrowing or the price paid on the rental of funds 4 Copyright © 2008 Pearson Education Canada
The Bond Market & Interest Rates 5 Copyright © 2008 Pearson Education Canada
The Stock Market • A stock represents a share of ownership in a corporation • A stock is a security that is a claim on the earnings and assets of that corporation 6 Copyright © 2008 Pearson Education Canada
Stock Market 7 Copyright © 2008 Pearson Education Canada
Foreign Exchange Market • The foreign exchange market is where one country’s currency is exchanged for another • The exchange rate is the price of one country’s currency in terms of another • Appreciation/depreciation is a rise/fall in the value of a country’s currency 8 Copyright © 2008 Pearson Education Canada
Foreign Exchange Market 9 Copyright © 2008 Pearson Education Canada
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 10 Copyright © 2008 Pearson Education Canada
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 11 Copyright © 2008 Pearson Education Canada
Money and Business Cycles 12 Copyright © 2008 Pearson Education Canada
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 13 Copyright © 2008 Pearson Education Canada
Money and the Price Level 14 Copyright © 2008 Pearson Education Canada
Money Growth and Inflation 15 Copyright © 2008 Pearson Education Canada
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 bonds were closely tied • Since then, the relationship is less clear but still an important determinant of interest rates 16 Copyright © 2008 Pearson Education Canada
Money Growth and Interest Rates 17 Copyright © 2008 Pearson Education Canada
Monetary and Fiscal Policy • Monetary policy is the management of the money supply and interest rates – Conducted by the Bank of Canada • Fiscal policy is government spending and taxation – Budget deficit/surplus is the excess of expenditures/revenue over revenues/expenditures for a particular year – Any deficit must be financed by borrowing 18 Copyright © 2008 Pearson Education Canada
19 Copyright © 2008 Pearson Education Canada
How We Study Money and Banking Basic Analytic Framework • Simplified approach to the demand for assets • Concept of equilibrium • Basic supply and demand approach to understand behaviour in financial markets • Search for profits • Transactions cost and asymmetric information approach to financial structure • Aggregate supply and demand analysis 20 Copyright © 2008 Pearson Education Canada
How We Study Money and Banking (Cont’d) Features: 1. Case studies 2. Applications 3. Special-interest boxes 4. Financial News boxes 6. Web Exercises and References 21 Copyright © 2008 Pearson Education Canada
Appendix: Definitions • Aggregate Output Gross Domestic Product (GDP) = Value of all final goods and services produced in domestic economy during year. • Aggregate Income - Total income of factors of production (land, capital, labour) during year • Nominal = values measured using current prices • Real = quantities measured with constant prices 22 Copyright © 2008 Pearson Education Canada
Appendix: Definitions • Aggregate Price Level GDP Deflator = Nominal GDP/Real GDP Consumer Price Index = (CPI) price of a “basket” of goods and services Inflation rate = growth rate of the aggregate price level (percent change from previous period) 23 Copyright © 2008 Pearson Education Canada
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