Giovannie Alvarez

Form 5

Economics

Contents
The Financial Sector.....................................................................................................................................2
The concept of the financial sector.........................................................................................................2
The role of the financial sector................................................................................................................4
The concept of money.............................................................................................................................7
Stages in the development of money......................................................................................................8
Qualities and Functions of Money.........................................................................................................15
Liquidity.................................................................................................................................................16
Demand for money................................................................................................................................19
Money Supply........................................................................................................................................20
Central Bank..........................................................................................................................................22
Commercial Banks.................................................................................................................................29
Commercial Bank & Central Bank..........................................................................................................30
Functions of `Other financial institutions..............................................................................................31
Stock Exchange......................................................................................................................................40
Financial Instruments............................................................................................................................44
Strategies to Manage Personal Income.................................................................................................46
The Financial Sector

The concept of the financial sector.

The financial sector is a section of the economy made up of firms and institutions that provide
financial services to commercial banks and retail customers. This sector comprises of a broad
range of industries including banks, investment companies, insurance companies, and real
estate firms.

According to the syllabus, the financial sector is the complex mix or networks of markets,
households, businesses, governments, law and institutions interacting with one another.
The following image describes the financial institutions.
The role of the financial sector

The financial sector plays an important role in the functioning of the economy through
intermediation. The financial sector sits between savers and borrowers: it takes funds from
savers and lends them to those who wish to borrow.

The financial sector may take funds from savers through deposits. Some examples of borrowers
can be households, governments and or businesses.

The financial sector mobilizes savings and facilitates payments and trades of goods and
services. They also promote efficient allocation for resources. The financial sector is seen as
playing a critical role in facilitating economic growth.

According to the syllabus, the role of the financial sector is to mobilize and make loanable
funds available to savers to spenders for consumption and investment purposes.
Extra notes on the concept behind the financial sector.

The financial sector regulates economic activities that are not officially regulated and which take
place outside the formal norms of business transactions.
The following image show the role or roles of the financial sector
The concept of money

Money is an item that considered acceptable to be used as payment for goods and services. It is
also an item that is used to settle debts.

However, money was not always present. The following terms are associated with the steps in
the development of money. There are 5 steps.
1. Commodity Money
2. Metallic Money
3. Paper Money
4. Credit Money
5. Plastic Money
6. Cryptocurrency

For an item to be classified as money, it needs to have certain qualities. Those qualities are as
follows:

 It needs to be Acceptable
 It needs to be Durable
 It needs to be Portable
 It needs to be Divisible
 It needs to be Homogenous
 It needs to have Legal Tender
 It needs to be Relatively-scarce

Money also serves a variety of functions. The following are some functions of money:

 It serves as a medium of exchange

 It acts as a store of value
 It acts as a unit of account
 It is a standard of deferred payment
 It also acts as a measure of value.
Stages in the development of money

Commodity Money

Money is a common thing used in the exchange for purchasing goods and services. In ancient
times, the barter system was used.

Battering is the exchange of goods and services for goods and services without the use of
money.

Battering has a problem. The problem was the double coincidence of wants. The double
coincidence of wants is a ubiquitous problem in a barter economy, where in order to trade,
each party must have something the other party wants.

When all parties use and willingly accept an agreed-upon currency, they can avoid this problem.

Some examples of Commodity Money are as follows:

 Red Shells
 Copper Bells
 Cocoa

Commodity Money had many problems. Some are as follows:

 Perishability
 Indivisibility
 Heterogeneity
Metallic Money

Metallic Money refers to the metallic money which is made of pure and superior metals like
gold and silver. Metallic Money replaced Commodity Money. Metallic Money was durable and
it can be used for future repayments.

Metallic Money could also be divided. Metallic Money was also accepted in many different
societies.

People of ancient times manufactured coins in different metals to indicate different values.
Gold coins were used for highest valuable goods and so on.

Some examples of Metallic Money are as follows:

 Gold coins
 Silver coins
 Bronze coins
Paper Money

Paper Money is a country’s official, paper currency that is circulated for the transactions
involved in acquiring goods and services.

Paper Money is usually printed and regulated by a country’s central bank or treasury. This is
done in order to keep the flow of funds in line with monetary policy.

Paper Money replaced Metallic Money. Metallic Money was not portable and people wanted
way of carrying their wealth. So, people devised paper money.

Some examples of Paper Money are as follows:

 The U.S. dollar $

 The British Pound £
Credit Money

Credit Money is monetary value created as the result of some future obligation or claim.

Credit is generally defined as a contractual agreement in which a borrower receives something

of value now and agrees to repay the lender at a later date

Credit Money utilizes a systematic institution from which people can purchase goods or services
by transferring money from their account to the seller’s account easily by using an instrument
named cheque. Any amount of money, high or low, can be transferred through cheque by
writing that amount of money on it.

Some examples of Credit Money are as follows:

 Treasury Bonds
 Municipal Bond
 Corporate Bonds

Credit also refers to the creditworthiness or credit history of an individual or company.

Plastic Money

Plastic Money is a slang phrase for credit cards, especially when such cards are used to make
purchases. The ‘plastic’ portion of this term refers to the plastic construction of credit cards, as
opposed to paper and metal.

Credits cards are used every day by people in place of actual bank notes. They can come in
many different forms such as cash cards, credit cards, debit cards, pre-paid cash cards and store
cards.
Cryptocurrency

Cryptocurrencies are digital money in electronic payment systems that generally do not require
government backing or the involvement of an intermediary, such as a bank.

Instead, the users of the system validate payments using certain protocols.

Some examples of cryptocurrencies are as follows:

 Bitcoin
 Dash
 Litecoin
The following images shows the different stages in the development of money.
Qualities and Functions of Money

The following video best explains the qualities and functions of money

https://www.youtube.com/watch?v=YucNCWyOddk
Liquidity

A liquid asset is an asset that can easily be converted into cash into a short amount of time.
Liquid assets include things like cash, money market instruments, and marketable securities.

Both individuals and businesses can be concerned with tracking liquid assets as a portion of
their net worth.

Liquidity is a term that refers to the ease with which assets can be turned into cash.

Cash is universally accepted as a means of spending and so it is the most liquid form of
money. However, a person may decide to keep their money in a building society account, this
person would have to give a notice on when they would want to withdraw their money.

This person still has money, but it is much less liquid than cash.
The following image shows the liquidity of money as a spectrum.

A spectrum being a range of different types.

This spectrum is shown from the perspective of an individual. The same assets may possess a
different liquidity to different people.

Gilt – edged security – It is a loan to the government through the purchase of a bond.
The following image also shows the difference between more liquid assets and less liquid
assets.
Demand for money

According to the syllabus, there are 3 types of demand for money. They are as follows:
1. Transaction demand
2. Precautionary demand
3. Asset motive/speculative demand.

Transaction demand -> Money needed to buy goods – this is related to income. This is the
money a person needs to purchase goods and services in day-to-day life.

Precautionary demand -> Money needed for financial emergencies. This is the money a person
may need for unexpected purchases or emergencies.

Asset motive/speculative demand -> When people wish to hold money rather than buy
assets/bonds/risky investments. The asset motive states that people demand money as a way
to hold wealth.
Money Supply

The money supply is the total stock of money circulating in an economy. The circulating money
involves the currency, printed notes, money in the deposit accounts and in the form of other
liquid assets.

According to the syllabus, the money supply is the total stock of money in the economy at any
moment.

The Supply of money can be classified into 3 terms. Those terms are as follows:
1. M0
2. M1
3. M2

M0 – This refers to the most liquid form of money. That being cash. These include central bank
notes and coins.

M1 – This includes those monies that are very liquid such as cash, checkable (demand) deposits,
and traveler’s checks. M1 is also called narrow money.

M2 – M2 money supply is less liquid in nature and includes M1 plus saving and time deposits,
certificates of deposits, and money market funds. M2 is also called broad money.
The following image shows narrow or M1 money
Central Bank

The Central Bank carry out a nation’s monetary policy and control its money supply. Central
banks influence interest rates and participate in open market operations to control the cost of
borrowing and lending throughout an economy.

The central banks have roles associated with the following:

 Interest Rates
 Reserve Requirement
 Open Market Operation
 Moral suasion

The roles of the Central Banks are as follows:

 The Central Bank has the sole authority to issue notes and coins.
 The Central Bank is a banker to the government as it keeps the government accounts.
 The Central Bank manage the national debt.
 It is a banker to all banks. Commercial banks must keep an account with the central
bank.
 They act as a last resort for other financial institutions
 It is a financial agent for the government.

The Central Bank also supervises other financial institutions.

Monetary policy refers to the actions undertaken by a nation's central bank to control money
supply and achieve sustainable economic growth.
With respect to interest rates

The Central banks controls or dictates the interest rates. They do this to manage the macro-
economy. If they raise interest rates, it makes borrowing more expensive and slows down
economic growth. If they reduce interest rates, it encourages borrowing and investment

The lower the interest rate, the more willing people are to borrow money to make big
purchases, such as houses and cars. When consumers pay less in interest, this gives them more
money to spend, which can create a ripple effect on increased spending throughout the
economy.
With respect to the Reserve Requirement Ratio

The central banks also dictate or control the reserve requirement ratio. The reserve
requirement ratio is the portion of reservable liabilities that commercial banks must hold onto
rather than invest or lend out.

The reserve ratio is the primary principal direct monetary policy instrument used by the Central
Banks to influence monetary conditions.

If the Central Banks lower the reserve requirement ratio, banks would have more money to
lend or invest. This in turn influences monetary conditions and consumption.

If the Central Banks increase the reserve requirement ratio, banks would have less money to
lend or invest.

Also, by lowering or increasing this fraction, the bank can increase or reduce liquidity in the
banking system.
With respect to the Open Market Operations

The central bank uses the open market operation to influence to money supply and
consumption.

Open Market Operations refers to the central bank purchases or sales of government securities
in order to expand or contract money in the banking system and influence interest rates.

The Open Market Operation does influence consumption. If the money supply increases, it
makes money less valuable and reduces interest rates.
With respect to moral suasion

Moral suasion is a moral act of persuasion appeal to influence or change behavior using verbal
or rhetorical techniques as opposed to force.

In economics, central bankers try to influence market and public sentiment through persuasive
techniques that they are in control of the economy and ready to act if needed.

Moral suasion is a request by the central banks to the commercial banks to take specific
measures as per the economy’s trends.

For example, Central Banks may direct banks not to give out certain loans. It includes
psychological means and informal means of selective credit control.
The Central Banks acts as a supervisor to other financial institutions. To reiterate, the Central
Bank is the head of the financial sector. They dictate the interest rates, reserve requirement
ratio and open market operations.

The other financial institutions must abide by the central bank’s rules.

The Central Banks play a crucial role in ensuring economic and financial stability. They conduct
monetary policy to achieve low and stable inflation.
Monetary policy – This the demand side of economic policy. It refers to the actions undertaken
by a nation’s central bank to control money supply and achieve macroeconomic goals that
promote sustainable development.

Monetary policy consists of the following:

 Reserve requirement
 Interest rate
 Open Market Operation
Commercial Banks

The Commercial Banks

The term commercial bank refers to a financial institution that accepts deposits, offers checking
account services, makes various loans, and offers basic financial products. They also offer saving
accounts to individuals and businesses.

Role of the Commercial Banks

The following are roles of the commercial bank:

 Accept money deposits and therefore provide a safe place for saving money.
 Offer loans and overdrafts to persons
 Assist customers to make easily payments through standing orders, current accounts
and debit cards.

Services offered by the Commercial Bank

The following are services offered by the Commercial Bank.

 They provide advisory services for clients who wish to borrow a loan to make
investments and persons who wish to purchase securities.
 They provide safety deposit boxes.
 They sell traveler’s cheques.
 They also provide credit cards for persons. There is a limit on how much the bank makes
available to credit card holders.
Commercial Bank & Central Bank

As stated before, the Central Bank is the head of the financial system. All financial institutions
including commercial banks are regulated and monitored by the Central Bank.

All commercial banks must keep an account with the central bank. These balances are used for
cheque clearing purposes between banks. Payments for cheques between banks are set off at
the Central Bank’s clearing house.

The Central Bank can also demand commercial banks to deposit a certain percentage of their
total deposits with the central bank in order to control the money supply.

The Central Bank is a lender of last resort and will assist commercial banks when needed. The
Central Bank dictates the interest rate that commercial banks can offer by setting the bank
rate.

The bank rate is the rate charged by Central banks for lending funds to Commercial banks.
(Interest Rates)
Functions of Other financial institutions

The following are other financial institutions found within the financial sector.

 Stock Exchange
 Credit Union
 Development Bank
 Insurance Company
 Mutual Fund
 Building Society
 Investment Trust Company
 Sou-Sou, Box, Partner, Sindicatos, Meeting Turns
Credit Union

These are non-profit financial institutions which are owned and operated by its members. They
offer services to members of a particular group; employees of the same firm, members of the
same union, people who reside in a certain geographical area etc.

They obtain funds called shares through deposits and use these deposits to issue loans and in
some cases mortgages to members.
Development Bank

These are government owned institutions whose priority is to fund new and upcoming
businesses which facilitate growth and development in all areas of the economy.

They issue these loans either directly or through Approved Financial Institutions. They also offer
financial structuring.
Insurance Company

These are companies that obtain funds from premiums which are paid annually or in
installments. These companies in turn provide protection to clients. They provide protection in
a variety of ways. For example:

 Life
 Health
 Automobile
Mutual Fund

These are investment companies which raise money from selling shares to shareholders and
invest these funds by buying stocks, bonds and money market instruments.
Building Society

These are institutions which raise funds through deposits and use these funds to issue loans,
and in most cases mortgages.
Investment Trust Company

It is a financial institution that issues its own shares to the investing public and specializes in
investment in financial securities.
Sou-Sou

A sou-sou is a group of people who come together and make regular weekly, biweekly or
monthly monetary contributions to a common fund, which is then disbursed as a lump sum to
one member in each cycle.

This is an example of an informal financial institution.

Stock Exchange

This institution provides a medium through which companies who are registered with the stock
exchange board, can buy and sell stock and common stock equivalents in other companies.

The Stock market facilitates the trading of stocks/shares between buyers and sellers. The Stock
Exchange is the governing body that overseas and regulates the activities of the stock market.
Companies that wish to obtain capital to expand may offer shares for sale on the stock market.
It is therefore essential to the expansion of businesses in an economy.

It provides a form of investment for persons who are very speculative and will buy stocks for
resale at higher anticipated prices.

Types of speculators/stock market investors.

 Bears
 Bulls
 Stags
 Cross List
 Stock Broker
Bears
These are speculators who sell securities because they expect the price to fall soon. A bear
market is a stock market that is slow moving. For example, investors are not keen on buying
stocks.

Bulls
These are speculators who buy securities because they expect the price will rise soon. A bull
market is one which is very active with high interest in the buying and selling of shares.

Stags
Stags are short term speculators. They are also known as day traders. They carefully watch the
movement of stock prices and buy stocks with the intention of quick resale for profits.

Cross List
Cross listing occurs when a company lists shares on more than one stock exchange. It not only
lists stocks for sale on the exchange in the country which it operates but also on other
exchanges.

Stock Broker
This is someone who is authorized to buy and sell shares. Persons wishing to buy or sell shares
must contact a stock broker who will buy or sell shares on their behalf.
Financial Instruments

The following are financial instruments:

 Treasury bills, notes and bonds

 Corporate bonds
 Municipal bonds
 Equity securities
 Share and stock certificates
 Certificates of deposit
Treasury Bonds, Notes and Bills
These are long term debt obligations which have maturities of over 7 years and receive interest
payments semi-annually.

Corporate Bonds
These are bonds issued by corporations and yield higher rates than municipal bonds. These
bonds mature from anywhere between 1 to 30 years, with the principal being repaid to bond
holders’ maturity.

Municipal Bonds
These are bonds issued by governments, to raise capital for specific projects being undertaken.
The bond holders receive interest and they are exempted from taxes.

Equity securities
These are shares which represent ownership of a firm. Owners of shares receive dividends
which fluctuate in market value.

Share and stock certificates

A share certificate is a written document signed on behalf of a corporation that serves as legal
proof of ownership of the number of shares indicated. These are also called stock certificates.

Certificates of deposit
A certificate of deposit, commonly called a CD, is a special savings account you can open at
most banks and credit unions. But unlike a regular savings account, CDs require you to lock your
funds away for a specific period of time until a maturity date. In return, you'll get a higher
interest rate
Strategies to Manage Personal Income

A person must exercise and develop habits of careful spending and saving techniques. A person
should know how to budget themselves.

A budget outlines how much of an individual’s income is to be spent on his or her various
expenses. It teaches a person to live within the boundaries of their personal income.

The process of preparing a budget involves the record keeping of past expenditures. The
person uses these past expenditures to make decisions about future expenditures.

A person must prioritize their needs over their wants.

Example of a simple budget

Short- and Long-Term Finances

Short-term capital may be accessed through the money market. Institutions in the money
market include commercial banks, merchant banks, credit unions and discount houses.
Borrowers are required to repay within a short-term e.g., 1 to 5 years.

Long –term capital may be accessed through building societies, the stock exchange, unit trust
companies and development banks. Borrowers are given a much longer repayment periods
e.g., up to 20 years.
Savings vs Investments

Savings is defined as money set aside or not spent from one’s personal income. Money saved is
most effective in an interest-bearing facility such as a commercial bank to keep up with inflation
which reduces the value of money over time. Other forms of savings include, the credit union
and partner (meeting turn, sou-sou, box hand).

Investment is defined as methods of increasing wealth. It differs from savings as it involves

risks. Earning from capital invested is usually much higher than interest earned on savings.
Forms of investments include: unit trust companies, the stock exchange and starting a business.
Expenditures – The action of spending funds. Expenditure is a reference to spending. In
economics, another term for consumer spending is demand. The total spending, or demand, in
the economy is known as aggregate demand.

Dividends - A dividend is a distribution of profits by a corporation to its shareholders