Chapter 1

An Introduction to Money
and the Financial System

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008

 Introduction

• The Five Parts of the Financial System

• The Five Core Principles of Money

and Banking

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Five Parts of the 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

1-3
 Five Core Principles of
Money and Banking
1. Time has value
2. Risk requires compensation
3. Information is the basis for decisions
4. Markets determine prices
and allocation resources
5. Stability improves welfare

1-4
 Five Core Principles of
Money and Banking
1. Time has value

– Time affects the value of financial

instruments
– Interest payments exist because of time
properties of financial instruments

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 Five Core Principles of
Money and Banking
2. Risk requires compensation

– In a world of uncertainty, individuals will

accept risk only if they are compensated in
some form.

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 Five Core Principles of
Money and Banking
3. Information is the basis for decisions

– The collection and processing of

information is the basis of foundation of
the financial system.

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 Five Core Principles of
Money and Banking
4. Markets determine prices
and allocate resources

– The “places” where buyers & sellers “meet”

are the core of the economic system

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 Five Core Principles of
Money and Banking
5. Stability improves welfare.

– A stable economy reduces risk and

improves everyone's welfare.

1-9
• Do your best not to tell people your
– Date of birth
– Birthplace
– Your mother’s maiden name
– Your address
• Guard your Social Security Number
– Don’t tell anyone unless you have to
– Remove it whenever you can

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 Sources of Financial News
• Daily • Data
– Wall Street Journal – www.bls.gov
– Financial Times – www.bea.gov
– Bloomberg.com – www.stls.frb.org
• Weekly • Personal Financial
– The Economist Information
– Business Week – www.choosetosave.org
– www.dinkytown.net
– www.wsj.com

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Measuring Economic Activity

• Gross Domestic Product:

The market value of final goods and services
produced in a country during a year.
• Real vs. Nominal GDP:
– Need to distinguish changes in prices from
changes in quantities
– Real GDP uses base-year prices
Isolates change in quantities.
– Nominal GDP = Prices x Real GDP

1-12
 Chapter 1

End of Chapter

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2008