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An Introduction to Money and the Financial System

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Title: An Introduction to Money and the Financial System


1
Chapter 1
  • An Introduction to Money and the Financial System

2
Introduction
  • The Five Parts of the Financial System
  • The Five Core Principles of Money and Banking

3
Five Parts of the Financial System
  • Money
  • To pay for purchases and store wealth
  • Financial Instruments
  • Transfer wealth (capital) from savers (people
    with excess capital) to borrowers
  • Transfer risk to those best equipped to bear it.
  • Insurance, Sub-prime mortgage securities
  • Financial Markets
  • Buy and sell financial instruments
  • Financial Institutions (Intermediaries).
  • Provide access to financial markets
  • Central Banks
  • Monitor financial Institutions and stabilize the
    Economy

4
Evolution of Five parts of financial system
  • Money has evolved from coins to paper money to
    todays electronic funds transfers.
  • Financial instruments where once investing was
    an activity reserved for the wealthy, todays
    small investors have the opportunity to purchase
    shares in mutual funds.
  • Financial markets have evolved from trading
    places to electronic networks. Transactions are
    cheaper and markets offer a broader array of
    financial instruments than were available even 50
    years ago.
  • Financial institutions Todays banks are more
    like financial supermarkets offering a huge
    assortment of financial products and services for
    sale.
  • Central banks what had been government
    treasuries have evolved into the modern central
    bank that controls the availability of money and
    credit in such a way as to ensure low inflation,
    high growth, and the stability of the financial
    system.

5
Five Core Principles of Money and Banking
  • Time has value
  • Risk requires compensation
  • Information is the basis for decisions
  • Markets determine prices and allocation resources
  • Stability improves welfare
  • ? TRIMS

6
Five Core Principles of Money and Banking
  • 1. Time has value
  • Time affects the value of financial instruments
  • Interest payments exist because of time
    properties of financial instruments
  • If the interest rate is zero, what does that
    mean?
  • If everything else is equal, Long-term government
    bonds offer higher/lower interest rates than
    short-term government bonds.

7
Five Core Principles of Money and Banking
  • 2. Risk requires compensation
  • In a world of uncertainty, individuals will
    accept risk only if they are compensated in some
    form.
  • An increase in the perceived risk associated with
    corporate bonds will cause the interest rate on
    corporate bonds to increase/decrease.
  • college students pay higher/lower rates for
    credit cards than do individuals with an
    established (and positive) credit history.

8
Five Core Principles of Money and Banking
  • 3. Information is the basis for decisions
  • The collection and processing of information is
    the basis of foundation of the financial system.
  • Individuals will devote more/less resources to
    acquiring information when the expected benefits
    from acquiring the information are higher.

9
Five Core Principles of Money and Banking
  • 4. Markets determine prices and allocate
    resources
  • The places where buyers sellers meet are
    the core of the economic system
  • (True/False) most stock and bond prices are
    determined primarily by government pricing
    authorities.

10
Five Core Principles of Money and Banking
  • 5. Stability improves welfare.
  • A stable economy reduces risk and improves
    everyone's welfare.
  • (True/False) The rate of economic growth tends
    to be higher in countries that experience high
    and unstable inflation rates.

11
Chapter 2
  • Money and the Payments System

12
A Roadmap
  • Money and how we use it
  • The Payments System
  • The Future of Money
  • Measuring Money

13
MoneyThe Definition
  • Money is an asset that is generally accepted as
    payment for goods and services or repayment of
    debt.

14
MoneyCharacteristics
  • 1. Means of payment Used in exchange for goods
    services
  • 2. Unit of account Used to quote prices
  • Store of value Used to move purchasing power
    into the future

15
1. Means of payment 2. Unit of account 3.
Store of value
  • A student cashes his paycheck and spends all of
    it on groceries. (1/2/3)
  • An individual uses money to buy stocks. (1/2/3)
  • A firm constructs its current balance sheet,
    expressing all credits and debits in dollars.
    (1/2/3)
  • A criminal holds 10,000 in a wall safe to have
    in case he needs to leave the country quickly.
    (1/2/3)
  • A student uses money to pay for textbooks.
    (1/2/3)
  • A high school student deposits funds from a
    summer job into a savings account that will help
    be used to pay college tuition. (1/2/3)
  • A storeowner records all receipts and
    expenditures in dollars. (1/2/3)

16
MoneyHow We Pay for Things (I)
  • Commodity Money Objects with intrinsic value
  • Fiat Money Value comes from government decree
    (or fiat)
  • Checks
  • Instructions to the bank to shifts funds from
    your account to that of the person or firm
    whose name is written in the Pay to the Order
    of line.
  • Are checks money? Yes/No
  • ex) 20 dollar bills, gold coins, checking
    deposits,
  • U.S. currency, salt, copper

17
  • Checks are legal proof of payment
  • Customers wanted them back
  • Starting in 2004
  • Banks can transmit digital images
  • Substitute checks are proof of payment
  • Paper checks are now disappearing

18
MoneyHow We Pay for Things (II)
  • Credit Cards
  • Debit Cards
  • Electronic Funds transfers especially
    automated clearing house (ACH transactions)
  • Stored Value Cards
  • E-Money

19
  • Debit cards
  • Like a check
  • Electronic message to your bank to transfer funds
    immediately
  • Credit cards
  • Deferred payment
  • Issuer makes payment for you
  • You have to pay it back

20
The Future of Money
  • Which function of money will be with us for a
    long time?
  • Means of payment disappearing
  • Unit of account likely to remain
  • Store of value disappearing

21
Measuring Money
  • Changes in the quantity of money are related to
  • Interest Rates
  • Economic Growth
  • Inflation ( change of general price level) CPI
  • How do we measure money?
  • based upon degree of liquidity.

22
Liquidity Definition
  • Liquidity a measure of the ease an asset can be
    turned into a means of payment (Money).

23
The Liquidity Spectrum
24
Measuring Money
  • Different Definitions of money are based upon
    degree of liquidity.
  • M1 Narrowest definition Only most liquid
    assets
  • M2 Broader definition Includes assets not
    used as means of payment.

25
Monetary Aggregates
26
Measuring Money
  • Suppose that the public shifts funds from
    checking accounts to savings accounts. Other
    things equal,
  • M1 increases/decreases/remains unchanged.
  • M2 increases/decreases/remains unchanged.

27
Growth Rates in M1 and M2
28
Money Growth (M2) and Inflation
29
Money Growth and Inflation
  • When inflation is high/low, money growth helps
    forecast inflation.
  • When inflation is high/low, the relationship is
    not as close.

30
Chapter 2
  • End of Chapter
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