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An Introduction to Money and the Financial System

Six Parts of the financial

System:
1. Money
To pay for purchases and
store wealth.
2. Financial
Instruments
To transfer resources
from savers to investors
(borrowers) and to
transfer risk to those best
equipped to bear it.
(Stocks, shares,
cheques…)
3. Financial Markets
To buy and sell financial
instruments. (Stock
market, primary and
Five Core Principles
secondary markets…)of Money and Banking:
1.4. Time has value.
Financial
2. RiskInstitutions compensation.
requires
To3.provide
Information
access to is the basis for decisions.
4. Markets
financial markets,determine
collect prices and allocate resources.
information & provide welfare.
5. Stability improves
services. (Banks,
insurance, pensions…)
Core 5.Principle 1: Time has value
Regulatory
• Time affects the value of financial instruments.
Agencies
Example:
To•provide Borrowing
oversight for money, the payback is high as the value of money decreases
overtime. So,
financial system / settinga pound today is worth lower tomorrow.
• Interest
regulations, noisrisky
paid to compensate the lenders for the time the borrowers have their
money.
activities (government,
the central bank…)
6. Central Banks
Core Principle(supervise)
To monitor 2: Risk requires compensation
• In aInstitutions
financial world of uncertainty,
and individuals will accept risk only if they are compensated.
• In the
stabilize (lowfinancial
inflation) world,
the compensation comes in the form of explicit payments: the
economy.higher the risk the bigger the payment.

Core Principle 3: Information is the basis for decisions

• The more important the decision, the more information we gather.
• Collection and processing of information is the foundation of the financial system.
• To be better informed to know where to allocate money.
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Core Principle 4: Markets determine prices and allocate resources

• Markets are the core of the economic system.
• Markets channel resources and minimize the cost of gathering information and
making transactions.
• In general, the better developed the financial markets, the faster the country will
grow.

Core Principle 5: Stability improves welfare

• A stable economy reduces risk and improves everyone's welfare.
• Financial instability in the autumn of 2008 triggered the worse global downturn since
the Great Depression.
• A stable economy grows faster than an unstable one.
• One of the main roles of central banks is stabilizing the economy.

Money and the Payments System

Money has three characteristics:
1. It is a means of payment
2. It is a unit of account
3. It is a store of value (keeping money and knowing it won’t perish)
 The first of these characteristics is the most important

Liquidity:
This is the ease by which an asset can be turned into payments.
 Market liquidity and funding liquidity are both needed to market financial
markets function smoothly.

The Liquidity Spectrum

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Money has a store of value:

- Market Liquidity: The ability to sell assets for money.
- Funding Liquidity: Ability to borrow money to buy securities or make loans.

The Payments System:

The payments system is a web of arrangements that allow for the exchange of goods and
services, as well as assets.
The efficient operation of the economy depends on the payments system.

The possible methods of payment are:

1. Commodity and Fiat Monies
2. Checks
3. Electronic Payments

Measuring Money:

M1 = Cash (Currency in the hands of the public)

M2 = Cash (M1) + Deposits

 As M1 increases inflation goes up