Chapter 1 Why Study Money, Banking, and Financial Markets

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 Financial markets and institutions affect flow of funds through economy >> affects business profits, production,
elections, economic well-being of other countries

Why Study Financial Markets

 Financial markets: markets in which funds are transferred from people who have an excess of available funds to
people who have a shortage
 Financial markets (bond/stock markets) are crucial to promoting greater economic efficiency
o Move funds from people who don’t have productive use for them to those who do
 Financial markets affect personal wealth, business/consumer behaviour, cyclical performance of economy

The Bond Market and Interest Rates

 Security: claim on issuer’s future income or assets that is sold by the borrower to lender
 Asset: financial claim or piece of property that is subject to ownership
 Bond: debt security that promises to make payments periodically for a specified period of time
 Bond market is important to economic activity because: (1) allows companies/govts to borrow (2) is where
interest rates are determined
 Interest rate: cost of borrowing or price paid for the rental of funds
o Impacts economic health bc affects consumer willingness to spend/save + business investment decisions

The Stock Market

 Common stock: share of ownership in a corporation

o Security that is claim on earnings and assets of the corporation
 Issuing/selling stock to the public is way for corporations to raise funds to finance activities
 Stock market is most widely followed financial market
 Stock prices are extremely volatile
o 10/19/1987 Black Monday, index falls 11% >> up till 2000, market experiences great rise (bull market) >>
2000 high tech bubble pops, drops 40% by 2002 >> rises to all time high in 2008 >> falls 50% in 2009

Why Study Financial Institutions and Banking

 Financial institutions are what make markets work >> couldn’t move funds without them

Structure of the Financial System

 Financial intermediaries: institutions that borrow funds from people who have saved and in turn make loans to
people who need funds
 Go to financial intermediary to make loan to company

Banks and Other Financial Institutions

 Banks: financial institutions that accept deposits and make loans

 Banks = charted banks, trust and loan companies, credit unions, caisses populaires
 Banks are largest financial intermediaries in economy >> average person interacts with most frequently

Financial Innovation

 Financial innovation: development of new financial products/services

 Improvements in IT have led to new financial products and ability to deliver services electronically (e-finance)
Chapter 1 Why Study Money, Banking, and Financial Markets
Financial Crises

 Financial crises: major disruptions in markets characterized by sharp declines in asset prices and failures of firms
 Feature of capitalist economies and are followed by severe business cycle downturns
 2007 Great Recession >> worst economic downturn since Great Depression

Why Study Money and Monetary Policy

 Money/money supply: anything generally accepted as payment for goods or repayment of debts

Money and Business Cycles

 Aggregate output: total production of goods/services
 Unemployment rate: percentage of available labor force unemployed
 Business cycle: upward/downward movement of aggregate output produced in economy
 Recession: periods of declining aggregate output
 Monetary theory: theory that relates quantity of money and monetary policy to changes in aggregate economic
activity and inflation

Money and Inflation

 Aggregate price level: average price of goods and services in an economy

o 1968 to 2014 >> price level increased more than sixfold
 Inflation: continual increase in price level
 Price level and money supply rise together
 Inflation rate: rate of change of price level

Money and Interest Rates

 Money supply grows >> interest rates grow

Conduct of Monetary Policy

 Monetary policy: mgmt. of money and interest rates

 Central bank: organization responsible for conduct of nation’s monetary policy
o Bank of Canada can affect interest rates, quantity of money

Fiscal Policy and Monetary Policy

 Fiscal policy involves decisions about govt spending and taxation

 Budget deficit: excess of govt expenditures with respect to tax revenues for particular time period
 Budget surplus: excess of tax revenues over govt expenditures
 Gross domestic product (GDP): value of all final goods and services produced in the economy in a year

Why Study International Finance

 Globalization of financial markets has accelerated at rapid pace in recent years >> financial markets have
integrated globally >> countries can borrow from each other

The Foreign Exchange Market

 Foreign exchange market: market in which exchange rates are determined

 Foreign exchange rate: price of one country’s currency in terms of another’s
o Affects costs of imports
 Increase in capital flows between countries has increased intl financial system’s impact on domestic economies
Chapter 1 Why Study Money, Banking, and Financial Markets
Appendix
Aggregate Output and Income

 GDP: value of all final goods/services produced in the economy during the course of a year
o Purchases of goods produced in the past and purchases of stocks/bonds not included
o Don’t include materials that go into final products
 Aggregate income: total income of factors of production (land, labour, capital) from producing in a year
 Aggregate Output = Aggregate Income

Real vs Nominal Magnitudes

 Nominal indicates values measured in current prices >> can be misleading measures of economic wellbeing
 Real indicated values measured in terms of fixed prices
o Real income measure indicates your income in terms of goods it can buy
 Aggregate income and output is always talked about in real terms

Aggregate Price Level

 Three measures
 GDP Deflator = todays nominal GDP / real GDP in past
o Tells you how much prices have risen/fallen
o In terms of index >> multiply by 100
 PCE Deflator = nominal personal consumption expenditures / real PCE
 CPI = (new COGS – old COGS) / old COGS