Chapter 1 Why study Money, Banking and Financial Markets PDF

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Chapter 1: Why study Money, Banking and Financial Markets? Book notes and lecture notes Why study financial markets? First, what is a financial market? Is a market in which funds are transferred from people who have an excess of available funds to people who have a shortage. Creditors Are the people...

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Chapter 1: Why study Money, Banking and Financial Markets? Book notes and lecture notes Why study financial markets? ● First, what is a financial market? Is a market in which funds are transferred from people who have an excess of available funds to people who have a shortage. ○ Creditors → Are the people who have excess money. They want high interest rates. ■ Creditors compete between themselves through the interest rates. A borrower will go to the creditor with the lowest interest rate. ○ Borrowers → Are the people who want money to buy physical goods. They want low interest rates. ● Why are financial markets important? ○ Financial markets have a DIRECT effect on personal wealth, the behaviour of business and consumers. ■ Bullish market: Its expected for the prices to go up, in general. This makes you richer if you are holding a portafolio. ■ Bearish market: Its expected that the prices go down, in general. This makes you less rich if you are holding a portafolio. ○ Well functioning financial markets are a key factor in producing high economic growth. ○ Poorly performing financial markets is one of the reasons that many countries in the world remain poor. ■ Bad financial markets → poor economic growth ■ Good financial markets → good economic growth ● What are financial instruments? ○ A security (also called financial instrument) is a claim on the issuer’s future income or assets. ■ Assets: Any financial claim or piece of property that is subject to ownership. ○ There two main types of securities: ■ Bond: A debt security that promises to make payments periodically for a specified amount of time. ● The bond market is very important because in the bond markets os where the interest rates(cost of borrowing) are determined.

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The different types of interest rates in the market tend to move in unison. Hard cash and bond markets compete. We will analyze this in the next chapters. Common Stock: equity or just Stock represents a share of ownership in a corporation. It is a security that is a claim on the earnings and assets of the corporation. ● Issuing stock and selling it to the public is a way for corporations to raise fund to finance their activities. ● The stock market, where stocks are traded, is extremely volatile. According to the book is a place where people get rich and poor quickly. According to the professor it is risky. ● Why do people buy stocks?

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People try to enhance (increase) their wealth. People speculate stocks will increase their wealth. Greed Knowing that stocks are risky people always balance between risk and security. ○ “Pulling risk” - diversify portfolio? Why study money and monetary financial institutions and banking? ● In short, without them, financial markets would not be able to move fund from people who save to people who have productive investment opportunities. ● But what are financial markets? Institutions that borrow funds from people who have saved and in turn make loans to others. Like: ○ Banks ■ Financial institutions that accept deposits and makes loans. ○ Insurance companies ○ Pension funds ○ Mutual funds ○ Investment banks ● Financial structure(very simple): Borrowers ← financial intermediaries → creditors *all of them regulated by the government. ● Random definition| e-finance: Delivering financial services electronically. Why study money and monetary policy? ● In short, because money is linked to changes in economic variables that affects all of us and are important to the health of the economy. ● First, what is money? Anything that is accepted in payment for goods or services or in the repayment of debts. ● Some important definitions to later make a few observations: ○ Business cycles: The upward and downward movement of aggregate output produced in the economy. ○ Monetary theory: The theory that relates changes in quantity of money to changes in aggregate economic activity and the price level. ○ Recessions: Periods of declining aggregates output. ○ Aggregate price level: The average price of goods and services in the economy. ○ Inflation: Continued increase in the price level. ● Now the observations: ○ Every recession has been preceded by a decline in the rate of money growth BUT a decline in the rate of money growth doesn’t necessarily lead to a recession ○ A continuing increase in the money supply might be an important factor in inflation ○ “Inflation is always and everywhere a monetary phenomenon” - Friedman ● The central bank is the organization responsible for the conduct of a nation’s monetary policy. ● What is monetary policy? The management of money and interest rates. ● While fiscal policy involves decisions about government spending and taxation. ○ Please see relationship between Y, G and t here. ● Budget surplus: Tax revenue > Government expenditure ● Budget deficit: Tax revenue < Government expenditure Why study international finance? ● Because globalization has lead to local financial markets increasingly integrated with others. ● Foreign exchange market: Where currencies are converted, bought and sold. ● Foreign exchange rate: The price of one country’s currency in terms of another’s. There are two ways of quoting an exchange rate: ○ Either as the amount of domestic currency that can be purchased with a unit of foreign currency

e=

domestic currency foreigncurrency

This is how you would calculate it:

y ⋅usd = x ⋅ cad x 1⋅usd = ⋅cad y ○

Or as the amount of foreign currency that can be purchased with a unit of domestic currency. This is the one preferred in the book. In this case the exchange rate will be equal to:

e=

foreigncurrency domestic currency

This is how you would calculate it:

x ⋅cad = y ⋅usd y 1⋅ cad= ⋅usd x This means that:

e ↑ ⇒domestic currency is appreciating ⇒cheaper ¿ import e ↓ ⇒domestic currency is depreciating ⇒more expensive ¿ buy foreign goods...