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
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