Professional Documents
Culture Documents
Hasan Ersel
HIGHER SCHOOL OF ECONOMICS,
MOSCOW
May 20, 2011
I. HISTORY OF FINANCE IN A NUTSHELL
THE BIRTH OF FINANCE
“2: 275 Those that live on usury shall rise before Allah
like men whom Satan has demented by his touch; for
they claim that usury is like trading. But Allah has
permitted trading and forbidden usury…” Koran, Al-
Baqara, 2:275, translated by N.J. Dawood,
Hammondsworth, Middlesex: Penguin Books, 1974, p.
363.
HINDU AND BUDDHIST VIEWS ON
INTEREST-1
• Vedic texts of Ancient India (2,000-1,400 BC) in
which the “usurer” (kusidin) is interpreted as any
lender at interest. More frequent and detailed
references to interest payment are to be found
• In the later Sutra texts (700-100 BC), as well as the
also made detailed references to interest.
• Vasishtha, a well known Hindu law-maker of that
time, made a special law which forbade the higher
castes of Brahmanas (priests) and Kshatriyas
(warriors) from being usurers or lenders at interest.
HINDU AND BUDDHIST VIEWS ON
INTEREST-2
• In the Buddhist Jatakas (600-400 BC), usury is referred
to in a demeaning manner: “hypocritical ascetics are
accused of practicing it”.
• By the 2nd century AD, however, usury had become a
more relative term, as is implied in the Laws of Manu of
that time: “Stipulated interest beyond the legal rate
being against (the law), cannot be recovered: they call
that a usurious way (of lending)”
• The dilution of the concept of usury seems to have
continued through the remaining course of Indian history
so that today, while it is still condemned in principle,
usury refers only to interest charged above the prevailing
socially accepted range and is no longer prohibited or
controlled in any significant way.
FINANCIAL INNOVATIONS: PAPER
MONEY and FOREIGN EXCHANGE
CONTRACT
• 806-821 AD: In China, Emperor Hien-Tsung is
reigning… Shortage of copper causes emperor to issue
paper money… Chinese liked the idea.
• In 1032 AD there were 16 note-issuing houses in China.
Paper money increased so much that in 1166 China
went into hyperinflation…. In 1455 China abandoned
paper money.
• 1156: First foreign exchange contract: two brothers
borrowed 115 Genoa pounds and agreed to pay 560
bezants in Constantinople one month after their arrival to
the that city.
INTEREST IN CHRISTIANITY-1
Households Firms
Factors Market
Labor
Wages
II. THE ROLE OF THE FINANCIAL
SYSTEM
MACROFINANCIAL SYSTEM-2
Goods Market
Goods
Expenditure
Households Firms
Factors Market
Labor
Wages
Savings Investment
MACROFINANCIAL SYSTEM-3
Goods Market
Goods
Expenditure
Households Firms
Factors Market
Labor
Wages
Savings Investment
Financial System
STRUCTURE OF THE FINANCIAL
SYSTEM
Financial Markets
Households Firms
Banks
COMPONENTS OF FINANCIAL SYSTEM
1. Money
To pay for purchases and store wealth
2. Financial Instruments
To transfer resources from savers to investors and to transfer risk to those best
equipped to bear it.
3. Financial Markets
Buy and sell financial instruments
4. Financial Institutions.
Provide access to financial markets, collect information & provide services
5. Central Banks
Monitor financial Institutions and stabilize the economy
FINANCIAL MARKETS
• Reduce Risk
– Risk Sharing (Asset Transformation)
– Diversification
• Asymmetric Information
– Adverse Selection (before the transaction)—more likely to select
risky borrower
– Moral Hazard (after the transaction)—less likely borrower will
repay loan
WELL KNOWN (!) “CORE PRINCIPLES”
FROM MICROECONOMICS
1. Time has value
2. Risk requires compensation
3. Information is the basis for decisions
4. Markets determine prices and allocation
of resources
5. Stability improves welfare
TIME HAS VALUE
1. What is money?
2. How do we use money?
3. How do we measure money?
DEFINITION OF MONEY
• Credit Cards
• Debit Cards
• Electronic Funds transfers:
• Stored Value Cards
• E-Money
CREDIT AND DEBIT CARDS
• Credit cards:
– Deferred payment
– Issuer makes payment for you
– You have to pay it back
• Debit cards:
– Like a check
– Electronic message to your bank to transfer
funds immediately
THE FUTURE OF MONEY
Bh
Bf
Bb
Households L+ Firms
D+
Banks
L-
D-
CONSUMER-1
U U U
( 1) (1 r ) 0
Bh C1 C2
U U U
( 1) (1 rD ) 0
D C1 C2
from these
U C1
(1 r )
U C2
U C1
(1 rD )
U C2
and therefore
r=rD (4)
FIRM-1
The firm chooses its investment level (I) and its mode of
financing; i.e. by bank credit (L) or through issuing
securities Bf. The firm’s problem is, then, can be
formulated as:
max f (5)
f f (I ) (1 r )Bf (1 rL )L (6)
I Bf L (7)
FIRM-2
f f
(1) (1 r ) 0
Bf I
f f
(1) (1 rL ) 0
L I
from these two equations we obtain
f
(1 r ) (1 rL )
I
or
r rL (8)
BANK-1
max b (9)
b rLL rBb rD D (10)
L Bb D (11)
BANK-2