ECON 304 Money and Banking Instructor: Bernard Malamud –Office: BEH 502 Phone (702) 895 –3294 Fax: 895 – 1354 » Website: Office hours: TR pm; 2:30 - 3:30 pm; and by appointment

Money, Banking, and Financial Markets The role of money and monetary policy in the economy TRUST How financial markets such as bond, stock and foreign exchange markets work TRUST How financial institutions such as banks and insurance companies work TRUST

A security (financial instrument) is a claim on the issuer’s future income or assets A bond is a debt security that promises to make specified payments over time –An interest rate is the cost of borrowing or the price paid for the rental of funds Common stock represents a share of ownership in a corporation –A share of stock is a claim on the earnings and assets of the corporation

Banking and Financial Institutions Financial Intermediaries—institutions that borrow funds from people who have saved and make loans to other people and businesses Banks—accept deposits and make loans Other Financial Institutions—insurance companies, finance companies, pension funds, mutual funds and investment banks Financial Innovation –The information age and e-finance –Derivatives –Securitization

Money and Business Cycles Recessions (unemployment) and booms (inflation) affect all of us Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level

Money and Inflation The aggregate price level is an average price of goods and services in an economy A continual rise in the price level (inflation) affects all economic players

Monetary and Fiscal Policies Monetary policy is the management of the money supply and interest rates –Conducted by the Federal Reserve Bank (Fed) Fiscal policy is government spending and taxation –Any deficit must be financed by borrowing … government borrowing affects interest rates

Bernanke’s Focus Inflation Targeting –Adjust “real” rate of interest with eye on pre- announced target rate of inflation –Wiggle room for other objectives/emergencies –Transparency and accountability Joined by Mishkin on Board of Governors Other Governors: –Oppose Deflation Great Depression and clogged credit channel

Core Principles of Money and Banking Time has Value  Interest rate Time has Value  Interest rate Risk Requires Compensation Risk Requires Compensation Financial decisions are based on Information and on TRUST Financial decisions are based on Information and on TRUST Markets set prices and allocate resources Markets set prices and allocate resources Stability reduces risk and spurs enterprise Stability reduces risk and spurs enterprise

Where to Find the Numbers

Function of Financial Markets Channel funds from economic players that have saved surplus funds to those that have a shortage of funds Promotes economic efficiency by producing an efficient allocation of capital –increases production Improves consumer well-being – allows them to time purchases better

Structure of Financial Markets Debt and Equity Markets Primary and Secondary Markets –Investment Banks underwrite securities in primary markets –Brokers and dealers work in secondary markets Exchanges and Over-the-Counter (OTC) Markets Money and Capital Markets –Money markets deal in short-term debt instruments –Capital markets deal in longer-term debt and equity instruments

Internationalization of Financial Markets Foreign Bonds—sold in a foreign country and denominated in that country’s currency Eurobond—bond denominated in a currency other than that of the country in which it is sold Eurocurrencies—foreign currencies deposited in banks outside the home country –Eurodollars—U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. banks World Stock Markets

Function of Financial Intermediaries: Indirect Finance Lower transaction costs –Economies of scale –Liquidity services Reduce Risk –Risk Sharing (Asset Transformation) –Diversification Asymmetric Information –Adverse Selection (before the transaction)—more likely to select risky borrower –Moral Hazard (after the transaction)—less likely borrower will repay loan

Regulation of the Financial System To increase the information available to investors: –Reduce adverse selection and moral hazard problems –Reduce insider trading To ensure the soundness of financial intermediaries: –Restrictions on entry –Disclosure –Restrictions on Assets and Activities –Deposit Insurance –Limits on Competition –Restrictions on Interest Rates