Week 1-ch 1 and 2

Chapter 1: Why study money, banking, and financial markets? Why Study Financial Markets? Financial Markets  Transfer funds from people who have an excess of available funds to people who have a shortage  It directly affects our lives, businesses, and economy  To learn about bond markets, interest rates, and stock markets The Bond Market and Interest Rates: PRICE DISCOVERY Security (or a financial instrument)  Is a claim on the issuer's future income or assets Bond  Is a debt security that promises to make payments periodically for a specified period of time Interest rate  Is the cost of borrowing or the price paid for the rental of funds  Usually expressed as a %  EXAMPLE: 4% interest on $100 means you must pay $104 when due Interest rates on selected bonds EXAMPLE: 1. Long-term corporate bonds 2. Canadian government long-term bonds  Different interest rates have a tendency to move in unison  Often differ substantially  Spreads between them fluctuate The Stock Market: Stock  A share of ownership in a corporation  Gives claim to the corporations earnings and assets Stock market  Where stocks are bought and sold The value of stocks reflects the current value of a company, and expectations of future growth  Big swings in share price are often major news stories  An important factor in business investment decisions

Why study financial institutions and banking? INTERMEDIERIES  They play a crucial role in the economy  Banks and other financial institutions ae what make financial markets work  Entities that move funds from people who save TO people who have productive investment opportunities Financial Intermediaries  Institutions that borrow funds from people who have saved and then make loans to people who need funds  BANKS: Accepting deposits to make loans  Chartered banks  Trust and mortgage loan companies  Credit unions  OTHER FINANCIAL INSITITUIONS:  Insurance companies  Finance companies  Pensions funds  Mutual funds  Investment banks Financial Innovation  Innovation in financial markets is the development of new financial products and services  Innovation in any sector  Important force for good by making the financial system more efficient  E-Finance  Delivering financial services electronically  Creating thinking can improve efficiency, increase profits, but can sometimes cause financial disasters Financial Crises:  Major disruptions in financial markets  Sharp declines in asset prices and failures of many financial and nonfinancial firms  Are a feature of economies throughout history  Severe business cycle downturns EXAMPLE: August 2007 (U.S. experience a serious crisis)  Defaults in subprime residential mortgages  Major losses in financial institutions with many failing Why Study money and monetary policy? TAXUP/SPENDUP

Money  Anything that is generally accepted as payment for goods or services, or to repay debts  It affects a wide variety of other economic variables  It affects a wide variety of other economic variables  Business cycles  Inflation  Interest rates  Monetary policy used to influence the economy  Central role of Bank of Canada Money and Business Cycles Business cycles  Are the upward and downward movement of aggregate output in the economy Unemployment rate  The % of the available labour force unemployed Recessions  Are periods of declining aggregate output  Evidence suggests money plays and important role in generating business cycles Money and Inflation: Aggregate price level  Is the average price of goods and services in an economy Inflation  Is a continual and broad-based increase in the price level  Affects individuals, businesses, and the government What explains inflation?  Inflation rate (% change of the price level) strongly related to growth rate of the money supply  This is true both within and across countries Money and Interest Rates  An interest rate is the cost of borrowing, or the price paid for the rental of funds -Must compensate borrowers for expected inflation  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