Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada CHAPTER 18 Understanding Money and Banking

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-2 Learning Objectives Define money and identify the different forms it takes in the nations money supply. Describe the different kinds of financial institutions that make up the Canadian financial system and explain the services they offer. Explain how banks create money and identify the means by which they are regulated. Explain the functions of the Bank of Canada and describe the tools it uses to control the money supply. Identify ways in which the banking industry is changing. Understand some of the activities in international banking and finance

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-3 Money Characteristics: Portable: lightweight and easy to handle Divisible: easily broken down to match the value of goods Durable: must not spoil or easily wear out Stable: must be stable enough to hold its value over time, apart from minor fluctuations Any object generally accepted as payment for goods & services

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-4 Functions of Money Medium of exchange a single medium of exchange for goods and services instead of barter Store of value can be used for future purchases Unit of account allows measurement of the relative value of goods and services

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-5 The Money Supply Buyers and sellers must agree on the value of money The value of money depends on its supply as supply, value Narrow definition is called M-1 Wider definition is called M-2

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-6 M-1 Money Supply The most liquid forms of money currency: paper money and coins issued by the Canadian government demand deposits: money in chequing accounts, which can be transferred to others by cheque

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-7 M-2 Money Supply Everything in M-1 plus Savings deposits: savings account holdings Time deposits: deposit requiring prior notice before withdrawal of funds Money market mutual funds Pooled assets from many investors invested in short-term, low risk financial securities Measures the store of monetary value that is available for making financial transactions

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-8 Credit Cards Not included in M-1 or M-2 Not money no store of value Money substitute temporary medium of exchange Popular: Convenient Profitable annual fees, merchants fees & interest

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada 18-9 Financial Institutions Traditionally consisted of four financial pillars Chartered banks Alternate banks (trust companies, credit unions, caisses populaires) Life insurance companies and specialized lending and saving intermediaries Investment dealers Differences are now blurred due to changes in financial industry regulations

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Pillar #1: Chartered Banks Privately owned, profit-oriented, financial intermediary Largest and most important of financial institutions Each bank has many branches Schedule A Banks must be Canadian-owned with no more than 10% of voting shares controlled by a single interest (90% of all bank assets) Schedule B Banks may be foreign-owned and need not meet the 10% limit (foreign-owned bank deposits cannot exceed 8% of the total domestic assets of all banks)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Services Offered by Banks Pension services Trust services International services Financial advice Electronic technologies Bank deposits Bank loans Bank accounts

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Bank Deposits Accept deposits from some customers to obtain money to lend to others chequing accounts term deposits (money that remains with the bank for a period of time with interest paid to the depositor)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Bank Loans Major source of short- term financing Prefer to finance inventories or accounts receivable rather than long-term loans to many businesses Secured loan backed by collateral (e.g.: inventory) Unsecured loan backed only by promise Prime rate of interest lowest rate charged to best customers

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Banks as Creators of Money

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Other Changes in Banking Deregulation is causing banks to shift from their historical role as intermediaries between borrowers and depositors Diversification into other financial products Investment banking Commercial paper

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Electronic Funds Transfer Debit cards Plastic money that immediately adjusts the consumers account balance and pays the merchant Point of Sale terminals Electronic device used to facilitate debit card use Smart Cards A credit card sized computer that can be programmed with electronic money Ecash Money that moves among consumers and businesses via digital electronic transmission

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada The Bank of Canada The central bank of Canada Managed by a Board of Governors Regulates operations of chartered banks Manages the money supply by Buying/selling securities Changing the bank rate Bank rate = rate at which chartered banks can borrow from Bank of Canada

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Monetary Policy Actions of the Bank of Canada Expansionary PolicyRestrictive Policy Tools (stimulate business(slow down business activity activity and increase theand decrease the money money supply)supply) Open Buy government securities:Sell government securities: Market (increases bank reserves(decreases bank reserves Operations enabling banks to make loanslimiting the banks' abilities to businesses andto make loans to businesses consumers)and consumers) Lower the bank rate:Raise the bank rate: (increase the willingness of(decrease the willingness of Bank Rate banks to borrow, more loans canbanks to borrow, fewer loans can be made to businesses and consumers)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Pillar #2: Alternate Banks Trust companies safeguard funds and estates entrusted to it serves as a trustee, transfer agent, & registrar for corporations Credit unions (caisses populaires) cooperative savings and lending institution formed by a group of individuals with common interests offer savings accounts, loans, mortgages to members invest its own funds in corporate & government securities

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Pillar #3: Specialized Lending and Savings Intermediaries Life insurance firms Factoring companies Financial corporations Venture capital or development firms Pension funds

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Life Insurance Firms Life Insurance companies mutual or stock company that shares risks with policy holders for payment of premiums some money from premiums is lent back out substantial investments in real estate, mortgages and government bonds largest financial intermediaries in Canada next to the chartered banks

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Factoring Companies Buy uncollected accounts receivable from a firm for less than its face value Attempts to collect the face value of the receivables from customers The difference between the amount collected and the cost of the receivables is the firms profit Allows firms with old, or uncollectible, accounts receivable to redeem at least part of their value rather than writing them off completely

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Financial Corporations Sales finance company finances instalment purchases made by individuals or businesses loans are secured by the item being financed (e.g.: computer) Consumer finance company makes personal loans to consumers collateral may or may not be required

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Venture Capital or Development Firms Provide funds for new or expanding firms that have great potential Obtains funds from individual investors, financial intermediaries, retained earnings While accepting increased risk with new ventures, VC firms seek to earn higher than normal returns

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Pension Funds Accumulate cash that will be paid out to subscribers in the future in the form of pension income Money is invested until it is needed Investments include stocks and bonds, mortgages

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Pillar #4: Investment Dealers Underwriters Distribute new stock and bond issues (underwriting) Stock brokers Facilitate trading of stock and bond on exchanges (brokerage)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Other Sources of Funds Government financial institutions and granting agencies Business Development Bank of Canada (BDC) Canada Mortgage and Housing Corporation (CMHC) Export Development Corporation Canada and its provinces borrow from international sources of funds, including other nations The Canadian Capital Market (international funds)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada Exchange Rates and Trade Exchange rates influence the willingness to invest abroad and buy imported items A trade surplus occurs when Canada is exporting more products than it is importing (likely to occur when the dollar is undervalued) A trade deficit occurs when Canada is importing more products than it is exporting (likely to occur when the dollar is overvalued)

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada The Law of One Price a basic commodity should be priced equally across all countries (if prices differ it is assumed to be due to over or under valuation of the local currency) CountryBig Mac Price Equiv. (US Dollars) Over/Under Valuation United States$ Canada % Switzerland (francs) % Britain (pounds) % China (yuan) % The Big Mac Index

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada International Payments Process When equal values of money are moving back and forth between nations, no real funds need to be transferred between nations because the payments are in balance Local banks convert payments to the currency required by foreign trade associates Local banks then send payment, in foreign currency, to the foreign trade partner The foreign trade partner deposits the payment in his/her own foreign-based bank

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education Canada International Bank Structure World Bank UN agency that funds infrastructure projects in developing countries IMF 150 nations who combined resources to promote stable exchange rates, provide temporary short-term loans, encourage cooperation on international monetary issues, and develop a system for international payments International banking is governed by a network of loose agreements between individual countries or groups of countries.