Money and Banking

Chapter 1
Introducing
Money
and the
FinanciaI
System
1oplcs ln llnanclal ueclslons
W llnanclal sysLem and economy connecLlons
W llnanclal markeLs
W llnanclal lnsLlLuLlons
W Money
W Lconomlc approach
Copyright 2008 Pearson Addison
Wesley. All rights reserved.
12
llnanclal SysLem and
Lhe Lconomy
W llnanclal sysLem
A neLwork of markeLs and lnsLlLuLlons Lo brlng savers and
borrowers LogeLher
W Savers and borrowers
3 groups of poLenLlal savers and borrowers are households
buslnesses and governmenLs
W llnanclal lnsLrumenLs
AsseLs llablllLles
13
llnanclal Servlces
provlded by Lhe flnanclal sysLem
W 8lsk sharlng
8orrowers savers reduce Lhe uncerLalnLy Lo whlch Lhey
are exposed
W LlquldlLy
A measure of how readlly one asseL can be converLed Lo
cash
W lnformaLlon
1he flnanclal sysLem gaLhers lnformaLlon abouL borrowers'
clrcumsLances so lndlvldual savers do noL need Lo search for
prospecLlve borrowers
14
llnanclal MarkeLs
W 1ransfers funds from savers Lo borrowers
W lnLernaLlonal caplLal markeL (lendlng
borrowlng across naLlonal boundarles) ls
growlng rapldly
W AsseL prlces communlcaLe lnformaLlon
1S
llnanclal lnsLlLuLlons
W lnLermedlarles beLween borrowers and savers
W ueposlL lnsurance crlsls (1980's and early
1990's) and recenL reforms
W Loans from flnanclal lnsLlLuLlons accounL for
Lhe ma[orlLy of funds borrowers ralse (raLher
Lhan Lhe sLock and bonds markeLs as seen ln
llgure 11)
16
I|gure 11 Sources of lunds for nonflnanclal
8uslnesses MarkeLs versus lnsLlLuLlons
17
Money
W ueflned as anyLhlng LhaL people are wllllng Lo
accepL ln paymenL for goods servlces or Lo
pay off debLs
W Money supply LoLal quanLlLy of money ln Lhe
economy
18
Money ln Lhe uS
W lederal 8eserve SysLem
1he cenLral bank ln Lhe unlLed SLaLes
CollecLs daLa on varlous measures of Lhe money supply
W MoneLary pollcy
1he managemenL of Lhe money supply and lLs llnks Lo
prlces lnLeresL raLes and oLher economlc varlables
W MoneLary Lheory
Lxplores Lhe relaLlonshlps llnklng changes ln Lhe money
supply Lo changes ln economlc acLlvlLy and prlces
13
Lconomlc Analysls as a 1ool
Lxplaln currenL developmenLs evenLs
redlcL fuLure developmenLs evenLs
ueveloplng an economlc approach
Applylng an economlc approach
110
Chapter 2
;er;iew
of the
FinanciaI
System
Copyright 2008 Pearson
AddisonWesley. All rights
reserved.
312
urpose of Lhe llnanclal SysLem
W rovldes channels Lo Lransfer funds from savers Lo
borrowers
W Savers are suppllers of funds
W 8orrowers are demanders of funds
W llnanclal markeLs lssue clalms on borrowers
dlrecLly Lo savers
W llnanclal lnLermedlarles acL as gobeLweens by
holdlng a porLfollo of asseLs and lssulng clalms Lo
savers
reserved.
313
I|gure 21 Movlng lunds 1hrough Lhe llnanclal
SysLem
reserved.
314
I|gure 22 ey Servlces rovlded by Lhe
llnanclal SysLem
reserved.
31S
ey Servlces rovlded by Lhe llnanclal
SysLem
W |sk shar|ng by allowlng savers Lo hold many
asseLs
W |qu|d|ty whlch ls Lhe ease wlLh whlch an
asseL can be exchanged for money
W nformat|on abouL borrowers and reLurns on
flnanclal asseLs
reserved.
316
llnanclal MarkeLs
W rlmary markeLs are Lhose ln whlch newly
lssued clalms are sold Lo lnlLlal buyers
W Secondary markeLs are Lhose ln whlch
prevlously lssued clalms are resold
W 8lsksharlng llquldlLy and lnformaLlon
servlces are provlded ln secondary markeLs
reserved.
317
1ypes of Secondary llnanclal MarkeLs
W MaLurlLy money and caplLal markeLs
W 1radlng places aucLlon and
overLhecounLer markeLs
W SeLLlemenL cash or derlvaLlve
reserved.
318
llnanclal lnLermedlarles' 1asks
W MaLch savers and borrowers
W rovlde rlsksharlng llquldlLy and lnformaLlon
servlces
reserved.
313
CompeLlLlon and Change
W llnanclal lnnovaLlon resulLs from change
W Lase of communlcaLlng lnformaLlon has
allowed for greaLer flnanclal lnLegraLlon
reserved.
320
oals of llnanclal 8egulaLlon
W rovlslon of lnformaLlon
W MalnLenance of flnanclal sLablllLy
W ConLrolllng Lhe money supply
W Lncouraglng parLlcular acLlvlLles (llke home
ownershlp)
W 8egulaLlon affecLs Lhe ablllLy of flnanclal
markeLs and lnsLlLuLlons Lo provlde rlsk
sharlng llquldlLy and lnformaLlon servlces as
seen ln 1able 31
reserved.
321
@ab|e 31 8egulaLlon of llnanclal
lnsLlLuLlons and MarkeLs ln Lhe unlLed SLaLes
Chapter 3
Money and
the Payments
System
MeeLlng Lhe needs of Lxchange
W 3 meLhods Lo galn Lhe efflclency beneflLs of
speclallzaLlon lnclude barLer governmenL
allocaLlon and money
W Money can help people beneflL from
speclallzaLlon wlLhouL lncurrlng Lhe hlgh
Lradlng cosLs of barLer or Lhe mlsallocaLlons of
governmenL allocaLlon
223
I|gure 31 MeLhods of Lxchange
224
luncLlons of Money
W Medlum of exchange
W unlL of accounL
W SLore of value
W SLandard of deferred paymenL
22S
CrlLerla for Medlum of Lxchange
W AccepLable Lo mosL Lraders
W SLandardlzed quallLy
W uurable
W valuable relaLlve Lo lLs welghL
W ulvlslble
226
aymenLs SysLems
W CommodlLy money
hyslcal goods (preclous meLals) by whlch Lrade was accompllshed
W llaL money
Money auLhorlzed by a cenLral bank ls Lhe deflnlLlve money and
doesn'L have Lo be exchanged for gold or commodlLy money
W Checks
romlses Lo pay deflnlLlve money on demand drawn on money
deposlLed ln a flnanclal lnsLlLuLlon
W LlecLronlc funds
CompuLerlzed paymenLclearlng
227
Measurlng Lhe Money Supply
W 1o undersLand money's role as an economlc
varlable we need Lo measure lL
W ueflnlLlons of Lhe money supply are based o
Lhe asseLs lncluded as money and depend on
how subsLlLuLable dlfferenL asseLs are for
money
W LlquldlLy refers Lo Lhe cosL aL whlch an asseL
can be converLed lnLo deflnlLlve money
228
MoneLary AggregaLes
W 1he lederal 8eserve has developed 3
deflnlLlons of money LhaL lnclude asseLs
broader Lhan currency called moneLary
aggregaLes
,
,
8roader moneLary aggregaLes
223
I|gure 32 Measurlng MoneLary AggregaLes
lebruary 2006
230
SelecLlng MoneLary AggregaLes
W , currenLly consldered besL
W AggregaLes move broadly LogeLher over
long Llme perlods
W Some slgnlflcanL dlfferences ln moneLary
aggregaLe movemenLs have occurred
durlng cerLaln perlods
W 1he dlfferenL moneLary aggregaLes glve a
dlfferenL plcLure of movemenLs ln Lhe
money supply over Llme
231
I|gure 33 rowLh 8aLes of , and
, 19602006
232
Chapter 4
Interest Rates
and Rates of
Return
reserved.
434
1ypes of 8onds
CaLegorles of bonds are used Lo ldenLlfy
varlaLlons ln Lhe Llmlng of paymenLs
Slmple loan
lnvolves Lhe prlnclpal (9) and lnLeresL ( )
1oLal paymenL 9+ 9 9(1 + )
ulscounL bond
8epays ln a slngle paymenL
8epays Lhe face value aL maLurlLy buL recelves
less Lhan Lhe face value lnlLlally
reserved.
43S
1ypes of 8onds conL'd
W Coupon bond
8orrowers make mulLlple paymenLs of lnLeresL aL regular
lnLervals and repay Lhe face value aL maLurlLy
Speclfles Lhe maLurlLy daLe face value lssuer and coupon
raLe (equals Lhe yearly paymenL dlvlded by face value)
W llxedpaymenL loan
8orrower makes regular perlodlc paymenLs Lo Lhe lender
aymenLs lnclude boLh lnLeresL and prlnclpal and no lump
sum paymenL aL maLurlLy
reserved.
436
resenL value
W Comparlng reLurns across debL Lypes ls dlfflculL
slnce Llmlng of repaymenL dlffers
W SoluLlon ls Lhe concepL of presenL value Lo
flnd a common measure for funds aL dlfferenL
Llmes presenL each ln Loday's dollars
W 1he presenL value of $1 recelved years ln Lhe
fuLure ls 1](1 + )

reserved.
437
Figure 4.1 %2e L3es for Credt
Market 3stru2e3t Repay2e3t
reserved.
438
8ond ?lelds
W 1he lnLeresL raLe LhaL equaLes Lhe presenL
value Lo prlce ls Lhe yleld Lo maLurlLy
W CurrenL yleld coupon/currenL prlce
W Coupon raLe coupon/face value0
reserved.
433
CurrenL rlce and lace value
W lf currenL prlce face value Lhen yleld Lo
maLurlLy currenL yleld coupon raLe
reserved.
440
I|gure 42 SenslLlvlLy of 8ond rlces Lo Changes
ln lnLeresL 8aLes
reserved.
441
1oLal 8aLe of 8eLurn
W 1he LoLal raLe of reLurn ls Lhe sum of currenL
yleld and acLual caplLal galn or loss
W 8aLe of reLurn can dlffer from yleld Lo
maLurlLy
W 1he formula for LoLal raLe of reLurn ls
/9
+ (9
+
9
)/9

reserved.
442
8eal and nomlnal lnLeresL 8aLes
W LxpecLed real lnLeresL raLe nomlnal lnLeresL
raLe Lhe expecLed raLe of lnflaLlon
W llsher hypoLhesls change ln expecLed lnflaLlon
change ln nomlnal lnLeresL raLe
W 1he real raLe of reLurn equals Lhe nomlnal raLe
of reLurn ad[usLed for expecLed lnflaLlon
reserved.
443
I|gure 43 8eal and nomlnal lnLeresL
8aLes 1hreeMonLh 1reasury 8llls 19602003
Chapter 5
etermining
Market
Interest Rates
reserved.
64S
vlews of 8ond MarkeL
We can vlew Lhe buyer of bonds and Lhe seller of
bonds ln 2 ways
1) 1he bond ls Lhe good Lhe lender ls buylng Lhe
bond and Lhe borrower ls selllng Lhe bond
rlce amounL lender pays
2) use of funds ls Lhe good Lhe borrower ls
buylng Lhe use of funds and pays wlLh a
promlse Lo repay rlce lnLeresL raLe
Copyright 2008 Pearson AddisonWesley. All rights reserved.
646
8uyer
Lender buys the bond Borrower raising
Iunds
Borrower selling
bond
Lender supplying
Iunds
Bond price Interest rate
Seller
Price
Bond is the Good Use oI Funds is the
Good
reserved.
647
I|gure S1 uemand for 8onds by Lenders
reserved.
648
I|gure S2 Supply of 8onds by
8orrowers
reserved.
643
I|gure S3 Lqulllbrlum ln MarkeLs for 8onds and
Loanable lunds
reserved.
6S0
Lxplalnlng Changes
ln Lqulllbrlum lnLeresL 8aLes
W Changes ln bond demand or supply wlll
change Lhe bond prlce and lnLeresL raLe
W 1heory of porLfollo allocaLlon can explaln
bond demand curve shlfLs
W Changes ln wllllngness and ablllLy Lo borrow
shlfLs Lhe supply curve
reserved.
6S1
I|gure S4 ShlfLs ln Lhe uemand for
8onds
reserved.
6S2
lacLors ShlfLlng lncreaslng
8ond uemand
W lgher wealLh
W lgher expecLed reLurns on bonds
W Lower expecLed lnflaLlon
W Lower expecLed reLurn on oLher asseLs
W Lower relaLlve rlsklness of bonds
W lgher relaLlve llquldlLy of bonds
W Lower relaLlve lnformaLlon cosLs of bonds
reserved.
6S3
lacLors lncreaslng 8ond Supply
W lgher expecLed proflLablllLy of caplLal
W Lower buslness Laxes
W Lower expecLed lnflaLlon
W lgher governmenL borrowlng
reserved.
6S4
I|gure SS ShlfLs ln Lhe Supply of
8onds
reserved.
6SS
I|gure S6 lnLeresL 8aLe Changes ln an Lconomlc
uownLurn
reserved.
6S6
I|gure S7 LxpecLed lnflaLlon and
lnLeresL 8aLes
reserved.
6S7
1he lnLernaLlonal CaplLal MarkeL and Lhe
lnLeresL 8aLe
Closed Lconomy an economy LhaL nelLher borrows
nor lends Lo forelgn counLrles
Cpen Lconomy caplLal ls moblle lnLernaLlonally
World real lnLeresL raLe (r
w
) Lhe lnLeresL raLe LhaL ls
deLermlned ln Lhe lnLernaLlonal caplLal markeL
reserved.
6S8
I|gure S8 llow of lunds ln an Cpen
Lconomy
reserved.
6S3
Cpen Lconomles
W Small open economy Lhe quanLlLy of loanable
funds supplled ls Loo small Lo affecL Lhe world
lnLeresL raLe and Lhe economy Lakes rw as
glven
W Large open economy an economy LhaL ls large
enough Lo affecL Lhe world lnLeresL raLe
reserved.
660
I|gure S9 ueLermlnlng Lhe 8eal
lnLeresL 8aLe ln a Small Cpen Lconomy
reserved.
661
I|gure S10 ueLermlnlng Lhe 8eal lnLeresL 8aLe ln a
Large Cpen Lconomy
reserved.
662
@ab|e S11 lacLors 1haL ShlfL Lhe
uemand Curve for 8onds
reserved.
663
@ab|e S12 lacLors 1haL ShlfL Lhe
Supply Curve for 8onds
Chapter 6
Risk Structure
and Term
Structure
of Interest
Rates
reserved.
76S
uefaulL 8lsk
W uefaulL rlsk ls measured relaLlve Lo rlskfree
uS 1reasury bonds
W uefaulLrlsk premlum bond yleld yleld on a
comparable defaulLrlskfree bond
W 1he rlsk premlum reflecLs ln parL Lhe bond
raLlng
reserved.
766
@ab|e 61 8eadlng Lhe 8aLlngs rovlded by
Moody's and SLandard oor's
reserved.
767
I|gure 61 ueLermlnlng uefaulL 8lsk
remlum ln ?lelds
reserved.
768
I|gure 62 Long1erm and ShorL1erm ?lelds ln Lhe
unlLed SLaLes 19602006
reserved.
763
I|gure 63 LffecL on Lhe 8lsk remlum of a
uecrease ln LlquldlLy
reserved.
770
I|gure 64 LffecL on 8lsk remlum of an lncrease
ln lnformaLlon CosLs
reserved.
771
I|gure 6S LffecL of ulfferences ln 1ax 1reaLmenL
on ?lelds
reserved.
772
@ab|e 61 8lsk SLrucLure of
lnLeresL 8aLes
reserved.
773
?leld Curve
W ?leld curve ls a graph of uS 1reasury debL
lnsLrumenLs as a funcLlon of maLurlLy
W ?leld curve generally slopes upward
W ?lelds on 1reasury securlLles of dlfferenL
maLurlLles have Lyplcally moved LogeLher
reserved.
774
@ab|e 62 1heorles of Lhe 1erm SLrucLure
reserved.
77S
I|gure 66 uslng Lhe ?leld Curve Lo redlcL lnLeresL
8aLes 1he LxpecLaLlons 1heory
reserved.
776
I|gure 67 lnLerpreLlng Lhe ?leld Curve

Money and Banking

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Money and Banking

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Chapter 1

Copyright 2008 Pearson

Copyright 2008 Pearson

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