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ECON 310 009 Money & Banking J. Scott Sperling Fall 2001 [email protected]
Lecture 1: 1 September, 2001
Introductionā
What happens when the Fed cuts interest rates? What does it mean for you? What effects does it have on the economy? What are interest rates anyway?
These are some of the questions we will address this semester. We will be focusing on three major areas: Financial Markets, Financial Institutions, and Money (Monetary Theory and Policy).
1 Financial Markets
Financial markets channel funds from people who have an excess of funds (lender-savers) to those who need funds (borrower-spenders).
Financial markets promote economic efficiency.
1.1 The Bond Market
A bond is a debt instrument which promises to make payments (interest payments) over a specified period of time.
When you hear of people talking about āinterest ratesā they are talking about those which are determined in the bond market.
When interest rates are high, people tend to borrow less and save more. Conversely, when interest rates are low, people tend to borrow more and save less.
Some types of bonds: federal, municipal, corporate
1.2 The Stock Market
A stock is a share of ownership in a corporation. Corporations use stocks to raise funds. This is the market you most frequently hear about, but remember it is only one of many markets in the economy.
1.3 The Foreign Exchange Market
The Foreign Exchange Market is where one currency is transferred into another. The foreign exchange rate is determined in this market. ā If you find any errors or have any questions about these notes, please email me at [email protected].
Fall 2001 Introduction Page 2 of 7
2 Financial Institutions
Financial institutions serve as intermediares and improve economic efficiency. In this course, the financial institution we will investigate most closely is banks.
We will also talk about financial innovation. Why? Financial institutions are highly regulated. In the face of regulation, financial innovation can improve efficiency.
3 Monetary Theory & Policy
We will investigate how the money supply affects interest rates, inflation, unemployment and the business cycle. For example, prior to each resession of the last century, money growth has declined.
We will also investigate how the Fed conducts monetary policy.
Fall 2001 Overview of the Financial System Page 4 of 7
The disadvantage of being a residual claimant is that a company must pay off its debt holders before it pays its equity holders. The advantage of being an equity holder is that the value of your share(s) increase with the value of the company whereas the value of a debt holders contract remains the same.
5.2 Primary and Secondary Markets
5.2.1 Primary Market
New issues of securities are sold in the primary market. This is done mostly behind closed doors at large investment banks.
5.2.2 Secondary Market
Previously issued securities can be resold on a secondary market. The secondary markets you are probably most familiar with are the NYSE and NASDAQ.
Secondary markets provide liquidity to securities, i.e. they are more easily converted to money.
Secondary markets can be organized as exchanges (buyers and sellers, or their agents, meet in a central location) or as OTC markets (over-the-counter, dealers at different locations).
5.3 Money Market and Capital Market
We can also classify markets by the maturity of the securities that are traded in that market. Securities with terms less than one year (typically) are traded in the money market, while securities with longer terms (generally one-year or greater) and equities are traded in the capital market.
Money market instruments tend to be traded more frequently than capital market instruments, and thus tend to be more liquid. Money market instruments also tend to see smaller price fluctuations.
5.4 Financial Market Instrumentsā
5.4.1 Money Market Instruments
- T-bills āMake sure you read your book to get more information on the instruments listed in this section.
Fall 2001 Overview of the Financial System Page 5 of 7
- Negotiable bank certificates of deposit
- Commercial paper
- Bankerās acceptances
- Repurchase agreements (repos)
- Fed funds
5.4.2 Capital Market Instruments
- Stocks
- Mortgages
- Corporate bonds
- U.S. Government securities
- State and local government bonds
- Consumer and bank commercial loans
5.5 International Financial Markets^1
- International Bond Market: foreign bonds sold in a foreign country in that countryās currency, e.g. Volvo (Sweden) sells bonds in U.S. denominated in U.S. dollars.
- Eurobonds: bond denominated in a currency other than that of the country in which its sold
- Eurocurrencies: foreign currency deposited in banks outside the home country
- Eurodollars: U.S. dollars deposited in foreign banks
- World Stock Markest: e.g., Nikkei, FTSE, DAX, CAC
6 Financial Intermediaries
Financial intermediaries play an important role because they reduce transaction costs and assy- metric information problems. (^1) I didnāt get to these in class, but you should have read about them in your book.
Fall 2001 Overview of the Financial System Page 7 of 7
- Commercial banks
- Savings and Loan associations
- Mutual savings banks
- Credit unions
6.3.2 Contractual Savings Institutions
- Life insurance companies
- Fire & Casualty insurance
- Pension funds & government retirement funds
6.3.3 Investment Intermediaries
- Finance Companies
- Mutual Funds
- Money Market Mutual Funds
