1. Unit IV The Financial Sector
Objectives:
The functions of money
Definition of Money Supply
Financial assets
The concept of time value of money

2. What are the characteristics of a dollar bill that makes it a good form of money?
1. Portable
2. Stable
3. Acceptable
4. Durable
5. Divisible
6. Valuable
7. Uniform
8. Difficult to counterfeit

3. Barter: What’s the weakness?
Inefficient
Double coincidence of wants required for effective bartering
Trade requires people to find someone who wants what they have and has what they want.

4. Money facilitates trade
Three functions of money in an economy:
1. Median of Exchange= any items that sellers accept as payment.
2. Standard of Value ( or unit of account)= a way to measure the relative value of goods by comparing their prices; make economic decisions
3. Store of Value= it can be saved, or stored for later use; holds purchasing power

5. Sources of Money’s Value
Commodity money: An item used as money that also has value of its own (like gold, silver or tobacco ).
Representative money: An item that has value because it “represents” something else; can be exchanged for that something else. (A sheet of paper that can be redeemed for currency.)
Fiat money: this money has value because a government “fiat”, or decree states that it has value (like currency= coins and paper bills).
U.S. dollars are fiat money and are not backed by gold, silver or any commodity.

6. Definition of Money
Difficult to define because anything that serves the function of money, can be considered money.
U.S. gov. defines what is included
in money when it measures the
Supply of money in the economy.
Monetary Aggregates: M0 M1 M2
tobacco

7. Definition of Money
Liquidity refers to how easy it is to convert an asset into cash.
M0- most liquid
M2-least liquid

8. Definition of Money
M0: Coins and paper money, already CASH, most liquid.
MI: All of M0 plus demand deposits; checking accounts, traveler’s checks Checks can be paid “on demand” at any time.
M2: Includes M1 and near money, assets that can easily be converted into cash when needed, like savings accounts and small time deposits, money market shares

9. Financial Markets
Facilitate the flow of funds from lenders to borrowers
Households invest their savings in financial assets, which provide funds for investment spending
The financial system is important to the econ: makes savings available for investment which leads to long-run growth.

10. Financial Markets Transaction costs Risk liquidity
The financial system addresses three problems:
Transaction costs
Risk
liquidity

11. What are financial assets?
Any paper claim that entitles the buyer to future income from the seller.
4 types
Loans
Stocks
Bonds
Bank deposits
Activity 4.1

12. A dollar today or a dollar next year? Why?
Money today may be put in the bank and earn interest for a year.
So dollar today is worth more than the dollar next year.
Money has time value because interest rates are positive.

13. Time value of money
Let’s say you earn 5% per year on your savings account.
$1 will grow to $1.05 after one year.
Since the present value of $1.05 to be received one year from now ( if interest rates are 5%) is $1, then the present value of $1 to be received one year from now (again if interest rates are 5%)must be
some value less than $1.00
The present value :PV=FV/(1+r) n

14. present value :PV=FV/(1+r)
PV is present value
FV is future value
R is the rate of interest per period
n is the number of compounding periods (per year)
Therefore, PV=$1.00/ (1.05)
PV= $0.95
Today’s value of $1.00 to be received one year from now is the interest rate is 5%, is $0.95
Activity 4.2 1