Lecture 1

Why Study
Money,
Banking,
and
Financial
Markets?
Why Study Financial Markets (FM)?
ex: such as bond market and stock market

1. Channel funds from savers to investors,

thereby promoting economic efficiency

- promoting greater economics efficiency by

channeling funds from people who do not
have a productive use for them to those
who do.
2. Affect personal wealth and behavior of
business firms or individual

- market in which funds are transferred from

people who have and excess of available
funds to people who have a shortage.
- also have direct effect on personal wealth
behavior of business and consumers and the
cyclical performance of economics
Financial Market
- key factor in producing high economics
growth.

! FM - economics - POOR COUNTRY

 1. The Bond Market and Interest
Rate
Security ( also call financial instrument) – a claim on
the issuer’s future income or
Asset – a financial claim or piece of
property that is subject to ownership
Bond – a debt security that promises to
make payment periodically for a specific
period of time.
 Bond Market
– important to economics activity because it
enable government or corporation to
borrow to finance their activities.
- will determine Interest Rate

Interest rate
– the cost of borrowing or the price for the
rental of funds
• IR are important ;

• 1. for personal
– high interest rate could deter you from
buying a house or car – because the cost
of financing it would be high
- high interest rate could encourage you to
save because you can earn more interest
income by putting aside some of your
earning as saving.
2. for general
- give an impact on the overall health of
the economy – effect not only the
consumer willingness to spend or save but
also businesses’ investment decision.
ex: high IR – cause a corporation to postpone building a
new plant – contribute to the unemployment
 Bond Market

The IR on several types of bonds can differ

!
substantially
Type of IR:

• 1. mortgage IR
• 2. car loan rate
• 3. IR on many different types of bonds
( figure 1)
 2. The Stock Market
• A Common Stock or Stock - A share of
ownership in a corporation
• Security that is a claim on the earning and
assets of the corporation
• Issuing and Selling to public - is the way for
corporation to raise funds to finance their
activities.

this is a place where people can get

! rich / poor - QUICKLY
 • SM important factor in business
investment decisions because :
- the price of shares affect the
amount of funds that can be raised by
selling newly issued stock to finance
investment spending.
 Stock Market

Stock price are extremely volatile

- These considerable fluctuations in stock prices affect
the size of people’s wealth and as result may affect
their willingness to spend.
 3. Foreign Exchange Market
• The place where the funds transferable or
conversion happen and determination of foreign
exchange rate
– so it is instrumental in moving funds between
countries.

• Funds to be transferred from one country to

another – they have to converted from the currency in
the country of origin ( say Malaysia) into the currency of
the country they are going to ( say, USD)
 Foreign Exchange Market

The fluctuations in prices in this market (FEM) have also been substantial.
* A weaker in Malaysia Ringgit leads to more expansive foreign goods,
makes vacationing abroad more expensive, and raises the cost of indulging
your desire for imported delicacies. When the value of MR drop, Malaysians
decrease their purchases of foreign goods and increase their consumptions
of domestic goods ( travel in Malaysia)
Why Study Banking and Financial
Institutions?

Banks and other Financial Institutions

are what make financial markets
WORK.
- To move funds from people to another who
have productive investment opportunities.
- * play a crucial role in the economy
 1. Structure of the Financial
System
• Comprising many different types of private
sector financial institutions – banks,
insurance companies, mutual funds, investment
bank – regulated by the government.
• Financial Intermediaries – institutions that
borrow funds from people who have saved
and in turn make loans to other.
 2. Banks and Other Financial
Institutions
• The largest Financial Intermediaries in our
economy
• Crucial role in creation and distribution of
money to those who are need a money-
accept deposit and make loan
- bank included – commercial bank, saving
and loan association, credit union, mutual
savings banks etc.
 3.Financial Innovation
- merging in banking sector – for a better in
term of services, capital, management etc.
- Say good bye to “teller” and say hello to
“ATM”
- due to improvement in information
communication technology (ICT) – led to new
means of delivering financial services
electronically – e-finance

shows us how creative thinking on the part of

! financial innovations can lead to higher profits.
 5 Core Principles of Money & Banking

1.Time has value

Value of a financial instrument depends on SIZE and TIMING of
payments ex: $100 today vs. $100 in one year
2.Risk requires compensation
Risk comes from uncertainty .Risk is unavoidable. We pay to avoid
certain risks- Auto life insurance,, savings accounts
3.Information is the basis for decisions
Rational decisions use all available info. Asymmetric info can impede
markets
4.Markets set prices and allocate
resources
Markets set a price that rations scarce resources. Financial market
prices allocate funds
5.Stability improves welfare
Financial stability feeds economic growth and standards of living
 Why Study Money and
Monetary Policy?
MONEY
- referred to Money Supply (Ms)
- anything that is generally accepted in
payment for goods or services or in the
repayment of debts.
- linked to changes in economics variables
that affect all of us and are important to the
health of the economy.
 1. Money and Business Cycles
• Case:
- 1981-1982 : aggregate output (total of production of
goods and services) fell – unemployment rate (the
percentage of the available labor force unemployed) rose
to over 10% - US case
- after 1982 – economics expend – 1989 – unemployment
rate declined to 5%
- 1990 – unemployment rate increase 7% - economics
bottomed out in 1991 with unemployment rate falling to
around 4%.
- mild economics downturn began 2001.
 Money and Business Cycles

Why did the economics of US expend from

1982-1990, contract 1990-1991, boom again
! 1991-2001 then contact again 2001 ?????
• BUSINESS CYCLES
- the upward / downward movement of
aggregate output produce in the economy.

Affect all of us in immediate and important

! way

* When output is rising – it is easier to find a

good job , vice versa
• Recession
- periods of declining aggregate output

(figure)
• Show that the rate of money growth has
declined before every recession, indicating that
changes in money might be a driving force
behind business cycles fluctuations.

however, not every decline in the rate of money

! growth is followed by a recession.
 2. Money and Inflation

• Aggregate Price Level (the average price of goods and

services in an economy) – or call price level.
• Inflation – a continual increase in Price Level -
affect individuals, business, government.
• What explain inflation????
- continuing increasing in Ms might be
an important factor in causing the
continuing increasing in Price Level
that we call Inflation.
 Money and the Price Level

Milton Friedman : “ Inflation is always and

everywhere a monetary
phenomenon”
 3. Money and Interest Rate

• Money play an important role in

interest-rate fluctuation, which are of
great concern to business or
consumers.
 Money Growth and Interest Rates

More detail in chapter 5

 4. Conduct of Monetary Policy

• Monetary Policy – management of money

and Interest rate – by politician or policy
maker
- central bank
- federal reserve system –the fed. (US)
- bank negara malaysia – central bank
for malaysia

More detail in chapter 12-16

 5. Fiscal Policy and Monetary
Policy

• Fiscal policy – involves decision about

Government spending and taxation.

Budget deficit – excess of government

expenditure overtax revenues ( G > t )

Budget surplus – increase when tax revenue

more then government expenditure ( t > G )
Fiscal Policy and Monetary Policy