Why Study Money, Banking, and Financial Markets
To examine:
how financial markets work (bond, stock and foreign exchange markets)
how financial institutions work (banks and insurance companies
the role of money in the economy
Financial Market
What is a financial market?
These are markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds
The Bond Market and Interest Rates
Securities or Financial Instruments: 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
The Stock Market
Common stock represents a share of ownership in a corporation
A share of stock is a claim on the earnings and assets of the corporation
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
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
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
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
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 Treasure bonds were closely tied
Since then, the relationship is less clear but still an important determinant of interest rates
Monetary and Fiscal Policy
Monetary policy is the management of the money supply and interest rates
Conducted in the U.S. by the Federal Reserve Bank (Fed)
Fiscal policy is 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
