Chapter 1 Why Study Money, Banking, and Financial Markets?
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1 Chapter 1Why Study Money, Banking, and Financial Markets?
2 Why Study Financial Markets? Financial markets channel funds from savers to investors, thereby promoting economic efficiency2. Financial markets are a key factor in producing economic growth3. Financial markets affect personal wealth and behaviour of business firms
3 The Bond Market & Interest Rates A security (financial instrument) is a claim on the issuer’s future income or assetsAn asset is any financial claim that is subject to ownership
4 The Bond Market & Interest Rates A bond is a debt security that promises periodic payments for a specified timeAn interest rate is the cost of borrowing or the price paid on the rental of fundsInterest rate and the US subprime mortgage crisis
8 Ten Largest Canadian Companies by Market Cap Royal Bank of CanadaManulife FinancialBank of Nova ScotiaToronto-Dominion BankEnCana Corp.Suncor EnergyImperial OilCdn. Natural ResourcesCIBCBank of Montreal
9 Foreign Exchange Market The foreign exchange market is where one country’s currency is exchanged for anotherThe exchange rate is the price of one country’s currency in terms of anotherAppreciation/depreciation is a rise/fall in the value of a country’s currencyRecent exchange rate fluctuation of CND
11 Banking and Financial Institutions Financial Intermediaries - institutions that borrow funds from people who have saved and make loans to other peopleBanks - institutions that accept deposits and make loansOther Financial Institutions - insurance companies, finance companies, pension funds, mutual funds and investment banksFinancial Innovation- in particular, the advent of the information age and e-finance
12 Money and Business Cycles Evidence suggests that money plays an important role in generating business cyclesEvidence also suggests that monetary policies are often a response to business cyclesRecessions (unemployment) and booms (inflation) affect all of usMckenzie and Fort St. John
14 The decline of money supply is an indication of recession, not the driving force behind recession. Most Canadian recessions are caused by recessions south of border.When was the last recession in Prince George? Was it caused by any monetary policy?
15 Money and InflationThe aggregate price level is the average price of goods and services in an economyA continual rise in the price level (inflation) affects all economic playersData shows a connection between the money supply and the price level
20 Money and Interest Rates Interest rates are the price of moneyPrior to 1980, the rate of money growth and the interest rate on long-term bonds were closely tiedSince then, the relationship is less clear but still an important determinant of interest rates
22 The sharp turning point at 1998 was during Asian financial crisis when money flowed to North America, keeping Money Growth Rate High and Interest Rate low.Another point when the direction of money growth rate differ very much from interest rate is at 1985, when oil price reach the lowest point and Iran-Iraq was at war.
23 Monetary and Fiscal Policy Monetary policy is the management of the money supply and interest ratesConducted by the Bank of CanadaFiscal policy is government spending and taxationBudget deficit/surplus is the excess of expenditures/revenue over revenues/expenditures for a particular yearAny deficit must be financed by borrowing
24 How We Study Money and Banking Basic Analytic FrameworkSimplified approach to the demand for assetsConcept of equilibriumBasic supply and demand approach to understand behaviour in financial marketsSearch for profitsTransactions cost and asymmetric information approach to financial structureAggregate supply and demand analysis
25 How We Study Money and Banking (Cont’d) Features:1.Case studies2. Applications3. Special-interest boxes4. Financial News boxes6. Web Exercises and References
26 Appendix: Definitions Aggregate OutputGross Domestic Product (GDP) = Value of all final goods and services produced in domestic economy during year.Aggregate Income - Total income of factors of production (land, capital, labour) during yearNominal = values measured using current pricesReal = quantities measured with constant prices
27 Appendix: Definitions Aggregate Price LevelGDP Deflator = Nominal GDP/Real GDPConsumer Price Index = (CPI) price of a “basket” ofgoods and servicesInflation rate = growth rate of the aggregate pricelevel (percent change from previous period)
28 Note on the definition of inflation Inflation rate often underestimate the cost of housing because new houses only represent a small percentage of housing purchases and even smaller percentage of potential house buyers. Inflation rate is especially not helpful in indicating the difficulty of first time house buyers.