ECON 345- Section 001

Money and Banking

Term 1 (September 08 - December
04, 2015)
Chapter 1
FAll, 2015

PART I: INTRODUCTION AND REVIEW

Why Study Money, Banking, and Financial
Markets?
I We all use money and most of us use banks.
Despite this, the actual working of the banking
system is a bit of a mystery to most (especially
fractional reserve banking).
I

Barter incrementally builds to a modern society

with fractional reserve banking. Through this
process, you will hopefully gain a deep
understanding of how money and banking
works in our modern world.

Why Study Financial Markets?

Financial markets are markets in which funds

are transferred from people and who have an
excess of available funds to people who have a
shortage.

The Bond Market and Interest Rates

I

A security (financial instrument) is a claim on

the issuers 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.

Interest Rates on Selected Bonds

The Stock Market

I

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.

Market capitalization or market cap is the total

money market value of the shares outstanding
of a publicly traded company; it is equal to the
share price times the number of shares
outstanding.

Stock Prices

Why Study Financial Institutions and

Banking?
I

Banks and other financial institutions are what

make financial markets work.

They play a crucial role in the economy.

The financial system is complex and heavily

regulated by the government.

Financial Intermediaries
I

Institutions that accept deposits and make

loans: chartered banks, trust and mortgage
loan companies, and credit unions and caisses
populaires (Credit Union).

Other Financial Institutions: insurance

companies, finance companies, pension funds,
mutual funds and investment banks

A mutual fund- pools money from many

investors to purchase securities. It is most
commonly applied only to those collective
investment vehicles that are regulated and sold
to the general public.

Financial Innovation
I

The development of new financial products and

services can be an important force for good by
making the financial system more efficient.

Side Note: a security is a tradable financial

asset of any kind. Securities are broadly
categorized into: debt securities,
e.g.,banknotes, bonds and debentures) and
equity securities, (e.g.,common stocks)
derivatives, (e.g.,forwards,futures,options and
swaps).

Financial Crises

Financial crises are major disruptions in

financial markets that are characterized by
sharp declines in asset prices and the failures of
many financial and nonfinancial firms.

Why Study Money and Monetary Policy?

I

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.

Money Growth and the Business Cycle

Price Level and the Money Supply

Average Inflation Rate Versus Average

Rate of Money Growth for Selected
Countries, 2000-2010

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.

Money Growth and Interest Rates.

Monetary Policy

Monetary policy is the management of the

money supply and interest rates conducted
by the Bank of Canada (the Bank)

Fiscal Policy
I

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.

Government Budget Surplus or Deficit

Why Study International Finance?

I

Financial markets have become increasingly

integrated throughout the world.

Canadian companies borrow in foreign financial

markets and foreign companies borrow in
Canadian financial markets.

Banks and other financial institutions

increasingly international.

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 Foreign Exchange Rate

The exchange rate is the price of one countrys

currency in terms of another

Appreciation is a rise in the value of the

Canadian dollar

Depreciation is a fall in the value of the

Canadian dollar

Exchange Rate of the Canadian Dollar

The International Financial System

The international financial system has a growing
impact on domestic economies:
I Exchange rate policies are an important
determinant of how monetary policy is
conducted.
I

Capital controls have an effect on domestic

financial systems

What role international financial institutions

such as the International Monetary Fund play?

How We Will Study Money, Banking, and

Financial Markets
I

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.

Bank of Canada Website