1. Money and Investment
Economics
Mr. Bordelon

2. Money
Money. Anything that serves as a medium of exchange, unit of account, and a store of value.
Currency. Coins and paper bills used as money.

3. Money as a Medium of Exchange
Medium of exchange. Anything that is used to determine value during the exchange of goods and services.
Barter. Direct exchange of one set of goods or services for another.
Think of it as the method of payment.
How are we paying?

4. Money as a Unit of Account
Unit of account. A means for comparing the value of goods and services.
Numerical. In this case, we’re talking about the actual price in number.
Currency. This allows us to compare prices of g/s between different countries.
Think of it as the amount we are paying.
How much is it?
Are we paying in U.S. Dollars or Chinese Yuan, and how much in that currency?

5. Money as a Store of Value
Store of value. Something that keeps its value if it is stored rather than used.
Think of it as the value of the money.
How much is my money actually worth?
What can it buy, and in what amount?

6. Characteristics of Money
Durability. Objects used as money must withstand the wear and tear from being used again and again.
Portability. People need to be able to take money with them.
Divisibility. Money must be easily divided into smaller denominations.
Uniformity. Any two units of money must be the same in terms of what they can buy—accuracy.
Acceptability. Everyone must be able to exchange the objects that server as money for g/s.
Limited supply. To be useful, money must have a limited supply. Otherwise, it becomes worthless.

7. Types of Money Commodity Money
Objects that have value in and of themselves and that are also used as money. Gold, silver, copper.
Commodity. Product that is the same no matter who makes it. Oil, milk, etc.
Representative Money
Objects that have value because the holder can exchange them for something else of value.
They are representative of commodities (gold, silver, and copper) that are in a government bank.
Fiat Money
Money that has value because the government has ordered that it is an acceptable means to pay.
Based on the full faith and credit of a country (their word).
Affected by the strength of that country’s economy.

8. Questions
Two units of the same type of money must be the same in terms of what they will buy, that is, they must be
divisible.
portable.
acceptable.
uniform.
What is the source of fiat money’s value?
it represents the value of another item
government decree
presidential pardon
it is equal to the value of the stock market

9. Questions
Two units of the same type of money must be the same in terms of what they will buy, that is, they must be
divisible.
portable.
acceptable.
uniform.
What is the source of fiat money’s value?
it represents the value of another item
government decree
presidential pardon
it is equal to the value of the stock market

10. Measuring the Money Supply in the U.S.
M1. Represents money people can gain access to easily and immediately.
These assets have liquidity, the ability to be used as or directly converted into cash.
Cash, demand deposits (checking accounts), traveler’s checks.
M2. All the assets in M1 plus illiquid assets, assets that can’t be converted easily into cash (near money).
Savings accounts, money market mutual funds, time deposits.
Money market mutual funds. Fund that pools money from small savers to purchase short-term government and corporate securities (stocks and bonds).

11. Measuring the Money Supply in the U.S.
M1 Components
Billions
Currency
$646.3
Demand deposits
$322.0
Other checkable deposits
$296.2
Traveler’s Checks
$8.0
Total M1
$1,272.6
M2 Components
Billions
Savings
$3037.6
Money market mutual funds
$886.8
Time deposits
$855.6
Total M1
$1,272.6
Total M2
$6,052.5
Money Supply in the United States, July 17, 2003

12. Measuring the Money Supply
Why measure it?
The Federal Reserve is active in the economy, stimulating it primarily by changing interest rates.
By changing interest rates, they can either expand or shrink the money supply.
The Federal Reserve does this as a tool to fight inflation.

13. Functions of Financial Institutions
Storing money
Saving money
Savings and checking accounts (most common). Used to make withdrawals often. Small of interest at an annual rate.
Money market accounts. Pay a higher rate of interest. Limited number of checks. Interest rates change based on the market it is tied to.
Certificates of deposit (CDs). Guaranteed rate of interest over a certain period of time. Funds can not be removed until the end of that time period without substantial penalty.

14. Functions of Financial Institutions
Loans. Banks can help new businesses to get started and help established businesses grow. Interest is charged on the loan.
Mortages. A mortgage is a loan that is used to buy real estate.
Credit cards. Cards entitling their holder to buy g/s based on card holder’s promise to pay. Short-term loan with high interest.

15. Simple and Compound Interest
Interest. Price paid for the use of borrowed money.
Principal. Amount of money borrowed.
Simple interest: I = prt
p: principal
r: rate
t: time
Calculate the simple interest on a loan of $5,000 at 10% for 6 years.

16. Simple and Compound Interest
Simple interest: I = prt
p: principal
r: rate
t: time
Calculate the simple interest on a loan of $5,000 at 10% for 6 years.
I = ($5,000)(0.10)(6)
I = $3,000
This means on a loan of $5,000, you’d have to pay $3,000 interest, for a total of $8,000 over 6 years.

17. Simple and Compound Interest
Compound interest. Paid on original principal and on accumulated past interest.
A = p(1 + r)n
A: amount of money accumulated after n years, including interest
p: principal
r: annual rate of interest
n: number of years amount is deposited or borrowed for

18. Simple and Compound Interest
A = p(1 + r)n
A: amount of money accumulated after n years, including interest
p: principal
r: annual rate of interest
n: number of years amount is deposited or borrowed for
Calculate compound interest for a 401(k) for $100,000 at 3% over 30 years.

19. Simple and Compound Interest
A = p(1 + r)n
Calculate compound interest for a 401(k) for $100,000 at 3% over 30 years.
A = ($100,000)( )30
A = ($100,000)(2.43)
A = $243,000
This means that after 30 years, your initial investment of $100,000 would jump to $243,000.

20. Simple and Compound Interest
A = p(1 + r)n
Calculate compound interest for a student loan for $50,000 at 3.4% over 30 years.

21. Simple and Compound Interest
A = p(1 + r)n
Calculate compound interest for a student loan for $50,000 at 3.4% over 30 years.
A = ($50,000)( )30
A = ($50,000)(2.73)
A = $136,500
This means that a student loan of $50,000 will end up as $136,500 at the end of 30 years.

22. Types of Financial Institutions
Commercial Banks
Commercial banks offer checking services, accept deposits, and make loans.
Savings and Loan Associations
Savings and Loan Associations were originally chartered to lend money for home-building in the mid-1800s.
Savings Banks
Savings banks traditionally served people who made smaller deposits and transactions than commercial banks wished to handle.
Credit Unions
Credit unions are cooperative lending associations for particular groups, usually employees of a specific firm or government agency.
Finance Companies
Finance companies make installment loans to consumers.

23. Questions
1. The money supply of the United States is made up of which of the following? (a) M1 (b) M1 and parts of M2 (c) all the money available in the economy (d) all the money available in the economy plus money that the country could borrow 2. Why are funds in checking accounts called demand deposits? (a) they are available whenever the depositor demands them by writing a check (b) they are not liquid (c) they are usually in great demand (d) they are held without interest by the bank

24. Questions
1. The money supply of the United States is made up of which of the following? (a) M1 (b) M1 and parts of M2 (c) all the money available in the economy (d) all the money available in the economy plus money that the country could borrow 2. Why are funds in checking accounts called demand deposits? (a) they are available whenever the depositor demands them by writing a check (b) they are not liquid (c) they are usually in great demand (d) they are held without interest by the bank

25. Saving and Investing
Investment. Act of redirecting resources from being consumed today so that they may create benefits in the future; use of assets to earn income or profit.
In short, investment is the use of assets to earn income or profit.
When people save or invest their money, their funds become available for businesses to use to expand and grow. In this way, investment promotes economic growth.

26. Financial Intermediaries
Financial intermediaries. Institutions that help channel funds from savers to borrowers.
Banks, Savings and Loan Associations, and Credit Unions. Take in deposits from savers and then lend some of these funds to various businesses
Finance Companies. Make loans to consumers and small businesses, but charge borrowers higher fees and interest rates to cover possible losses
Mutual Funds. Pool the savings of many individuals and invest this money in a variety of stocks and bonds
Life Insurance Companies. Provide financial protection to the family, or other beneficiaries, of the insured
Pension Funds. Are set up by employers to collect deposits and distribute payments to retirees

27. Services Provided by Financial Intermediaries
Sharing risk through diversification
Diversification. Spreading out of investments to reduce risk. Financial intermediaries help individual savers diversify their investments.
Providing information. Reduce costs in time and money that lenders and borrowers would pay if they had to search out investment information on their own.
Providing liquidity. Allow savers to easily convert their assets into cash.

28. Risk and Return Return and Liquidity Return and Risk
Savings accounts have greater liquidity, but in general have a lower rate of return.
Certificates of deposit (CDs) usually have a greater return but liquidity is reduced.
Return and Risk
Investing in a friend’s internet company could double your money, but there is the risk of the company failing.
The higher potential return on investment, the greater the risk involved.
Return. Money an investor receives above and beyond the sum of money initially invested.

29. Questions Investment is
providing money for your family.
the act of redirecting resources from being consumed today so that they may create benefits in the future.
an institution that helps channel funds from savers to borrowers.
a collection of financial intermediaries.
The money an investor receives above and beyond the money initially invested is called
investment
savings
return
prospectus

30. Questions Investment is
providing money for your family.
the act of redirecting resources from being consumed today so that they may create benefits in the future.
an institution that helps channel funds from savers to borrowers.
a collection of financial intermediaries.
The money an investor receives above and beyond the money initially invested is called
investment
savings
return
prospectus

31. Bonds
Bonds are loans that represent debt that the government or a corporation must repay to an investor. Three components:
Coupon rate. Interest rate paid to bondholder.
Maturity. Time when payment to bondholder is due.
Bond yield. Annual rate of return on bond if bond held to maturity.
Par value. Amount investor pays to purchase bond that will be repaid to investor at maturity.
Bonds can be held to maturity, traded or sold. Price of a bond can change also.

32. Advantages and Disadvantages of Bonds
Once bond is sold, coupon rate for bond will not go up or down.
Unlike stock, bonds are not shares of ownership in a company.
Company must make fixed interest payments, even in bad years when it does not make money.
If bond issuer does poorly, the bonds can be downgraded. Makes it harder to sell bonds.

33. Types of Bonds
Savings bonds. Low amount bonds issued by U.S. govt. Interest paid only when bond matures.
Treasury bonds, bills, and notes. Issued by U.S. Dept. of Treasury.
Municipal bonds. Issued by state or local govts to finance things like highways, libraries, and schools.
Corporate bonds. Bond that corporation issues to raise money to expand its business.
Junk bonds. Lower rating, but potentially higher-paying bonds.

34. Other Financial Assets
Certificates of Deposit (CDs)
Money Market Mutual Funds
Available through banks, which use funds for a fixed amount of time.
Low risk.
Investors receive higher amount of interest on these funds than from savings or CD. Not FDIC insured.
High risk.

35. Questions
A bond is a
loan that represents debt that the government or corporation must repay to an investor.
portion of ownership in a corporation.
system that allows the transfer of funds between savers and borrowers.
collection of financial assets.
How does risk involved in a money market mutual fund compare with the risk of a CD?
The risk of the money market mutual fund is less than the CD.
The risk of the money market mutual fund is greater than the CD.
The risk of the money market mutual fund is much greater than the CD.
The risk of both is about the same.

36. Questions
A bond is a
loan that represents debt that the government or corporation must repay to an investor.
portion of ownership in a corporation.
system that allows the transfer of funds between savers and borrowers.
collection of financial assets.
How does risk involved in a money market mutual fund compare with the risk of a CD?
The risk of the money market mutual fund is less than the CD.
The risk of the money market mutual fund is greater than the CD.
The risk of the money market mutual fund is much less than the CD.
The risk of both is about the same.

37. Stock
Corporations can raise money by issuing stock, which represents ownership in the corporation. A portion of stock is called a share. Stocks are also called equities.
Stockowners can earn a profit in two ways:
1. Dividends, which are portions of a corporation’s profits, are paid out to stockholders of many corporations. The higher the corporate profit, the higher the dividend.
2. A capital gain is earned when a stockholder sells stock for more than he or she paid for it. A stockholder that sells stock at a lower price than the purchase price suffers a capital loss.

38. Types of Stock
Dividend Differences
Decision-Making Differences
Income stock. Pays dividends at regular times during the year.
Growth stock. Pays few or no dividends; earnings reinvested into business.
Common stock. Voting owners of the company.
Preferred stock. Non-voting owners, receive dividends before common stock owners.

39. Stock Risks
Risky because firm selling the stock may encounter economic downturns that force dividends down or reduce the stock’s value. It is considered a riskier investment than bonds.

40. Stock Exchanges
New York Stock Exchange (NYSE). Largest stock exchange in the U.S. Largest and most established companies.
NASDAQ. Primarily high-tech and energy stock.

41. Stock Averages
Dow Jones Industrial Average (DJIA). Shows how certain stocks have traded over the day. Reliable and established companies.
S&P Shows price changes of 500 different stocks.

42. Random Bull market. Steady rise in stock market over a period of time.
Bear market. Steady decline in stock market over a period of time.