1. Chapter 1
Why Study Money, Banking, and Financial Markets?

2. Why Study Financial Markets?
Financial markets channel funds from savers to investors, thereby promoting economic efficiency
2. Financial markets are a key factor in producing economic growth
3. 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 assets
An 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 time
An interest rate is the cost of borrowing or the price paid on the rental of funds
Interest rate and the US subprime mortgage crisis

5. The Bond Market & Interest Rates

6. The Stock Market
A stock represents a share of ownership in a corporation
A stock is a security that is a claim on the earnings and assets of that corporation

7. Stock Market

8. Ten Largest Canadian Companies by Market Cap
Royal Bank of Canada
Manulife Financial
Bank of Nova Scotia
Toronto-Dominion Bank
EnCana Corp.
Suncor Energy
Imperial Oil
Cdn. Natural Resources
CIBC
Bank of Montreal

9. Foreign Exchange Market
The foreign exchange market is where one country’s currency is exchanged for another
The exchange rate is the price of one country’s currency in terms of another
Appreciation/depreciation is a rise/fall in the value of a country’s currency
Recent exchange rate fluctuation of CND

10. Foreign Exchange Market

11. Banking and Financial Institutions
Financial Intermediaries - institutions that borrow funds from people who have saved and make loans to other people
Banks - institutions that accept deposits and make loans
Other Financial Institutions - insurance companies, finance companies, pension funds, mutual funds and investment banks
Financial 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 cycles
Evidence also suggests that monetary policies are often a response to business cycles
Recessions (unemployment) and booms (inflation) affect all of us
Mckenzie and Fort St. John

13. Money and Business Cycles

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 Inflation
The aggregate price level is the average price of goods and services in an economy
A continual rise in the price level (inflation) affects all economic players
Data shows a connection between the money supply and the price level

16. Money and the Price Level

17. Question
Why inflation rates lower than growth rate of money supply, especially after 1998?

19. Money Growth and Inflation

20. Money and Interest Rates
Interest rates are the price of money
Prior to 1980, the rate of money growth and the interest rate on long-term bonds were closely tied
Since then, the relationship is less clear but still an important determinant of interest rates

21. Money Growth and 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 rates
Conducted by the Bank of Canada
Fiscal policy is government spending and taxation
Budget deficit/surplus is the excess of expenditures/revenue over revenues/expenditures for a particular year
Any deficit must be financed by borrowing

24. How We Study Money and Banking
Basic Analytic Framework
Simplified approach to the demand for assets
Concept of equilibrium
Basic supply and demand approach to understand behaviour in financial markets
Search for profits
Transactions cost and asymmetric information approach to financial structure
Aggregate supply and demand analysis

25. How We Study Money and Banking (Cont’d)
Features:
1.Case studies
2. Applications
3. Special-interest boxes
4. Financial News boxes
6. Web Exercises and References

26. Appendix: Definitions
Aggregate Output
Gross 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 year
Nominal = values measured using current prices
Real = quantities measured with constant prices

27. Appendix: Definitions
Aggregate Price Level
GDP Deflator = Nominal GDP/Real GDP
Consumer Price Index = (CPI) price of a “basket” of
goods and services
Inflation rate = growth rate of the aggregate price
level (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.

29. Homework
2, 4, 6, 10