Money and Banking: Requirements Grades

Professor Yamin Ahmad, Money and Banking ECON 354
ECON 354
Money and Banking
Resources Needed For This Class

Aplia Website:
http://econ.aplia.com
Use course code: N797-QVAJ-S4W8
Professor Yamin Ahmad
Mishkin, Frederick S. (2010), The Economics of

Money, Banking and Financial Markets, 9th
Edition, Pearson
Lecture 1
Syllabus
Introduction to Financial
Markets and Money
Real World Observations
and Basic Definitions
8th edition is also fine if you have it.
Course Homepage:
http://facstaff.uww.edu/ahmady/courses/econ354/
Note: These notes are incomplete without having attended lectures
Requirements
Grades
Homework Assignments, Experiments

Option A:
4 Quizzes
Multiple choice questions
Homework assignments
Quizzes
Final
10%
15% each
30%
One Final Exam

Multiple choice questions
Option B:
Homework Assignments
3 Best Quizzes
Final
15%
15% each
40%
Extra Credit
Extra Credit will be available during the summer session
in the following manner:
Additional Extra Credit problem sets on Aplia
These are used to replace low scoring problem sets
Count only towards the homework part of the
course score
Success in an (Any!) Economics Course

To do well in Economics, you need to be able to
do 3 things well (in conjunction):
1. Think Mathematically: Dont be afraid of
equations!
2. Think graphically!
3. Abstract Logic! (Often the hardest part)
The Keys to Success in this Course
Things to Review from Principles of Macro
Do homework assignments on Aplia

Designed to make you think about topics! Oftentimes,
challenging
Typically, questions here are harder than those you will face in
exam
Dont be shy!
Come to class ready to ask questions! Use lecture time to fill in
the gaps!
Understand differences between movements

and shifts of curves!
(Aggregate) Demand and (Aggregate) Supply
Market Equilibrium
Practice and Discuss!!!

Think about what happens if ? Its the only real way to grasp
concepts in economics and economics itself!
Utilize my office hours!!

Come chat with me about concepts you are having trouble with,
ideas you havent grasped fully etc.
The structure of the economy

Make sure you read (and understand) Appendix of
Chapter 1 in Mishkin!
A Model of the Economy
The Agents in the System
As in Principles of Macro, divide the economy

into different sectors and see how those sectors
interact:
There are four agents that we will focus on when

constructing a model of the economy:
Households
Agents in the Economy
Firms
Markets where Agents Interact
Government
Equilibrium
The Rest of the World (ROW)
Markets
There are three markets that we typically focus
on in macroeconomics:
The Map of the Economy

That is: Y = C + I + G + X - M
The Factor Market

The Goods Market
The Financial Market (- we examine in detail in this
course)
Overview of the Course
GOVERNMENT
Money
HOUSEHOLDS
Financial Markets:
Central Banking &

Monetary Policy
-Interest Rates
-Risk
-Expectations
Monetary Theory and Monetary Policy

Financial Markets and Financial Intermediaries
FIRMS
Financial Institutions
- Financial Intermediaries
The Economy
REST OF THE
WORLD
Role of Money
Some Definitions
Money: Anything that is generally accepted in payment
for goods and services
Medium of exchange
Form of transaction technology
In the United States:
M1 = Currency + Traveler's Checks + Demand Deposits +

Other Checkable Deposits
Unit of account
M2 = M1 + Small denomination time deposits & repurchase

agreements + Savings Deposits and money market deposit
accounts + retail Money Market mutual fund shares
Store of value
Purchasing Power
Hence money helps to:

There also used to be a broader measure of money, M3
which was discontinued as of March 2006.
Lower transaction costs

Increase Liquidity in an economy
See: http://www.federalreserve.gov/releases/h6/hist/

Monetary Theory and Policy
Money
Why study Monetary Theory and Policy?

Influence on business cycles, inflation, and interest
rates
How Central Bank (Fed) can have a big influence on

the economy
Money and Business Cycles
Money and the Price Level
Money (M2) Growth and the Business Cycle: 1950 - 2010

120
11
100
Index (2005 = 100)
13
Money Growth Rate (%)
15
140
80
60
40
3
20
1
1960 1962 1965 1967 1970 1972 1975 1977 1980 1982 1985 1987 1990 1992 1995 1997 2000 2002 2005 2007 2010
-1
0
1960
1965
1970
1975
1980
M2
Shaded areas represent Recessions

Note: Figure above shows a decline in money growth rate
prior to every recession (except the most recent one)!
1985
1990
1995
2000
2005
2010
GDP Deflator
Note: Positive Relationship between Money and the Aggregate

Price Level
Money Growth and Inflation
Money Growth and Interest Rates
Positive correlation between money growth rates and

interest rates in 1960s & 1970s
Relationship breaks down in 1980s
Note: Across different countries, positive correlation between avg.

money growth rates and avg. inflation rates
Surpluses and Deficits

3.0
2002
2007
expansion
2.0
Government Budget Balance (percentage of GDP)
Figure 10(a) shows the

changing surplus and
deficit of the federal and
provincial governments
in the United States
since 1971.
Persistent federal deficit
during the 1970s
through 1990s.
Surplus from 1998 to
2001
More deficits following.
1990s
expansion
1.0
0.0
1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006
-1.0
1980s
expansion
International Surplus and Deficit

If a nation imports more than it exports, it has an
international (trade) deficit.
If a nation exports more than it imports, it has an
international (trade) surplus.
-2.0
The current account deficit or surplus is the

balance of exports minus imports plus net
interest paid to and received from the rest of the
world.
-3.0
-4.0
OPEC
Recession
2001
2002
Recession
-5.0
-6.0
-7.0
1982
Recession
1991
Recession
(a) U.S. Government Budget Deficit

Source: Congressional Budget Office
23
24
Persistent current
account deficit since
1983
The deficit has
swollen during the
past few years
2.000
OPEC
Recession
1981-82
Recession
Surpluses good? Deficits bad?
1991
Recession
1.000
Current Account Balance (percentage of GDP)
Figure 10(b) shows

The U.S. current
account balance
since 1960.
Interaction of Monetary and Fiscal Policy
2001
2002
Recession
0.000
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004
-1.000
Examine how fiscal irresponsibility can lead to

the onset of financial crises.
-2.000
2008
Recession
-3.000
1980s
Expansion
Why deficits might lead to a higher money

growth rate, a higher rate of inflation and higher
interest rates.
1990s
Expansion
-4.000
-5.000
-6.000
-7.000
(b) U.S. International Deficit
Source: Bureau of Economic Analysis

Money
25
Financial Markets
Why Study Financial Markets?
Channel funds from savers to investors, thereby
promoting economic efficiency
Affect personal wealth and behavior of business firms
Brief Introduction to:

Bond Market
Stock Market
Foreign Exchange Market
Function of Financial Markets: Flow of Funds
Bond Market: 1953 - 2010
20
Indirect Finance
18
16
Financial
Intermediaries
Interest Rate (%)
14
12
10
8
6
Lender-Savers
Households
Firms
Government
Foreigners
Borrowers-Spenders
Business-Firms
Government
Households
Foreigners
Financial
Markets
4
2
0
1953
1963
1968
1973
3 Month T-Bills
1978
1983
1988
Corporate BAA Bonds
1993
1998
2003
2008
U.S. Government Long-Term Bonds
Bonds, securities. what are they?
Direct Finance
Allows transfers of funds from person or business

without investment opportunities to one who has them
Improves economic efficiency
1958
Bond Market (and Money Markets):

determines interest rates
Stock Market: 1950 - 2010
Foreign Exchange Market
16000
Dollar-Sterling Exchange Rate
Stocks:
14000
Share of ownership in a
corporation/firm.
12000
10000
3.000
2.500
2.000
1.500
1.000
Stock Price volatility
8000
0.500
0.000
Q1
1970
6000
4000
2010
2006
2003
2000
1996
1993
1990
1986
1983
1980
1976
1973
1970
1966
1963
1960
1956
1953
1950
Dow Jones Industrial Average
Q1
1975
Q3
1977
Q1
1980
Q3
1982
Q1
1985
Q3
1987
Bull Market vs. Bear

Market
Foreign Exchange Market:
Stock Price Bubbles
Changes in Exchange rate:
2000
Q3
1972
Technology bubble in
1990s?
Q1
1990
Q3
1992
Q1
1995
Q3
1997
Q1
2000
Q3
2002
Transfer funds from one country to another

Changes in relative prices
Q1
2005
Q3
2007
Q1
2010
Some Basic Definitions

Debt Instrument:
Classifications of Financial Markets

1. Primary Market
1. Debt Instrument: Contractual agreement by borrower to

pay holder of the instrument a fixed dollar amount at
regular intervals (principal + interest), until a specified
date
Example: Car loan
New security issues sold to initial buyers (often behind closed

doors)
Investment banks typically underwrite securities (i.e.
guarantees a price for the security and then sells it to the
public)
2. Secondary Market
Securities previously issued are bought and sold

E.g.: NASDAQ, Futures, Options, Foreign Exchange
Exchanges
o
2. The maturity of a debt instrument is the number of

years (term) until the instrument expires
Methods of Raising Private Sector Funds

Debt Markets
Short-term (maturity < 1 year): Money Market
Intermediate-term (1year < maturity < 10 years)
Long-term (maturity > 10 years)
Equity Markets
Common stocks: claims to share in assets and net income
No maturity date; periodic payments known as dividends
Trades conducted in central locations (e.g., New York Stock

Exchange, NYSE; London Stock Exchange, LSE)
Over-the-Counter Markets
o
Dealers at different locations buy and sell
Financial Market Instruments

What are the kinds of securities traded in financial
markets?
Money Market Instruments
Because of short term to maturity, debt instruments traded in the
money market do not have much fluctuation in their prices, and
hence are the least risky
Capital Market Instruments

Capital Market: Intermediate + Long Term Debt +
Equity
Examples: Bonds, mortgages
Debt and equity instruments with maturities greater than a year;

these have much greater fluctuations in their prices (compared to
money market instruments) and as such are considered more
risky
Examples: Money Market Instruments

US Treasury Bills
Issued by US govt, with 1, 3, and 6 month maturities.
Pay a set amount at maturity, and have no interest
payments; effectively pay interest by selling at a discount.
Examples: Money Market Instruments

Repurchase Agreements
Repos are effectively short term loans (usually with a
maturity of less than 2 weeks) for which T-bills serve
as collateral. The most important lenders in this
market are usually large corporations.
Negotiable Bank Certificates of Deposit

CDs are debt instruments sold by banks to depositors that
pays an annual interest of a given amount, and pays back
the original purchase price at maturity
Federal (Fed) Funds

These are typically overnight loans of reserves
between banks, of their deposits at the Federal
Reserve.
Commercial Paper
Short term debt instrument issued by large banks and well
known corporations (e.g. Microsoft, GM).
Table 1 Principal Money Market

Instruments
Examples: Capital Market Instruments
Stocks
These are equity claims on net income and assets of a corporation.
Issue of new stocks in any given year is typically quite small, although the
total value of stocks exceed that of any other type of security in the capital
markets.
Mortgages
Mortgage market is the largest debt market in the US
Residential mortgages are approximately 4 times the amount of commercial
and farm combined.
Corporate Bonds
Long term bonds issued by corporations with very strong credit ratings.
Typical corporate bond sends the holder an interest payment twice a year
and pays off the face value when the bond matures.
Some convertible corporate bonds allows the holder to convert them into a
specified number of shares of stock at any time up to the maturity date.
Examples: Capital Market Instruments
Table 2 Principal Capital Market

Instruments
US Government Securities
These are long term debt instruments issued by the US Treasury to finance
the deficits of the government.
US Government Agency Securities

Issued by various agencies such as Ginnie Mae, the Federal Farm Credit
Bank, etc, to finance such items as mortgages, farm loans or power
generating equipment.
Many of the securities are guaranteed by the federal government.
State and Local bonds

Also called municipal bonds, which are long term debt instruments issued
by the state and local governments to finance expenditures on roads,
schools, and other programs.
Interest payments from these bonds are exempt from federal income tax
and generally from the state taxes issuing the bond.
Consumer and Bank loans
Internationalization of Financial Markets

International Bond Market
Foreign bonds: bonds sold in a foreign country and
denominated in that countrys currency.
Eurobonds:
Now larger than U.S. corporate bond market
World Stock Markets

U.S. stock markets are no longer always the largest:
Japan sometimes larger
E.g. Dow Jones Industrial Average (U.S.); Financial
Times Stock Exchange (FTSE - London); Nikkei (Tokyo)
Common Confusions
Eurobond: bond denominated in a currency other than
that of the country in which it is sold
E.g. Bond denominated in Sterling, sold in the U.S.
Eurocurrencies: foreign currencies deposited in banks

outside the home country
E.g.: Eurodollar Market U.S. dollars deposited in foreign banks
outside the U.S.
Different to the Euro which is the national currency

adopted in Europe after monetary union in 2002.
Function of Financial Markets: Flow of Funds
Financial Intermediaries:
Indirect Finance
Financial
Intermediaries
Lender-Savers
Households
Firms
Government
Foreigners
Financial
Markets
Function of Financial Intermediaries
1. Engage in process of indirect finance
Borrowers-Spenders
Business-Firms
Government
Households
Foreigners
Direct Finance
Role of Financial Intermediaries
2. More important source of finance than

securities markets
3. Needed because of transactions costs and
asymmetric information
Primary Assets and Liabilities of Financial Intermediaries

Type of Intermediary
Primary Liabilities
Primary Assets
Deposits
Business and consumer loans,

mortgages, US Govt securities
and municipal bonds
Savings and Loans Institutions
Deposits
Mortgages
Mutual Savings Banks
Deposits
Mortgages
Credit Unions
Deposits
Consumer Loans
Life Insurance Companies
Premium from Policies
Corporate bonds and mortgages
Fire and Casualty Insurance Companies
Premium from Policies
Municipal bonds, corporate

bonds and stocks, US Govt
securities
Pension Funds, Government Retirement Funds
Employee and Employer

Contributions
Corporate bonds and stock
Commercial paper, stock, bonds
Consumer and business loans
Mutual Funds
Shares
Stocks and bonds
Money Market Mutual Funds
Shares
Money market instruments
Depository Institutions (banks)

Commercial Banks
1. Transaction Costs
2. Risk Sharing
3. Asymmetric Information
Contractual Savings Institutions
Investment Intermediaries
Finance Companies
Regulatory Agencies
Financial Intermediaries and Value of Their Assets

Value of Assets (Billions of $)
Type of Intermediary
1970
1980
1990
2007
2010Q1
Commercial Banks
517
1481
3334
11809.5
14438
Savings and Loans Institutions and Mutual Savings

Banks
250
792
1365
1815.0
1262.3
18
67
215
758.7
892.4
Depository Institutions (banks)
Credit Unions
Regulatory Agency
Subject of Regulation
Nature of Regulation
Securities and Exchange

Commission (SEC)
Organized Exchanges and

Financial Markets
Requires disclosure of
information; restricts insider
trading
Commodities Futures Trading

Commission (CFTC)
Futures Markets Exchanges
Regulates procedures for

trading in futures markets
Office of the Comptroller of the

Currency
Federally charted commercial

banks
Charters and examines the

books of federally chartered
commercial banks and imposes
restrictions on assets they can
hold
National Credit Union

Administration (NCUA)
Federally chartered credit

unions

books of federally chartered
credit unions and imposes
restrictions on assets they can
hold
State banking and Insurance

Commissions
State chartered depository

institutions

books of state chartered banks
and insurance companies;
imposes restrictions on assets
they can hold and imposes
restrictions on branching
Contractual Savings Institutions

Life Insurance Companies
201
464
1367
4952.5
4919.0
Fire and Casualty Insurance Companies
50
182
533
1381.0
1386.1
Pension Funds (Private)
112
504
1629
6410.6
5726.7
State and local Government Retirement Funds
60
197
737
3198.8
2793.9
Investment Intermediaries
Finance Companies
64
205
610
1911.2
1665.8
Mutual Funds
47
70
654
7829.0
7311.9
76
498
3033.1
2930.7
Money Market Mutual Funds
Regulatory Agencies
Regulatory Agency
Nature of Regulation
Federal Deposit Insurance

Corporation (FDIC)
Commercial banks, mutual savings

banks, savings and loans
associations
Provides insurance for each

depositor. Currently it is set to
$250000 per depositor, until
12/31/2013, whereas it will revert
back to the pre-crisis level of $100000
per depositor; examines the books of
insured banks and imposes
restrictions on assets they can hold
Office of Thrift Supervision
Federal Reserve System
Savings and Loans Associations
All depository institutions
Examines the books of savings and

loans associations and imposes
restrictions on assets they can hold
Regulatory Agencies
The new Dodd-Frank Banking reform bill that was passed during
June 2010 gives the following agencies additional power:
Regulatory Agency
New Powers
Federal Deposit Insurance

Corporation (FDIC)
Commercial banks, mutual savings

banks, savings and loans
associations
Will be able to unwind giant financial

firms in the same way it takes down
banks.
Federal Reserve System
All depository institutions
Fed will have powers to crack down on

interchange fees, which retailers pay to
banks to cover the operational cost of
transferring money. Fed can cap the fees
Consumer Financial Protection

Bureau
Consumer loans and credit cards
Establishes an independent Consumer

Financial Protection Bureau housed
inside the Federal Reserve. Fees paid by
banks fund the agency, which would set
rules to curb unfair practices in consumer
loans and credit cards. It would not have
power over auto dealers.
Government Accountability Office
Federal Reserve (excluding FOMC

and Monetary Policy)
Allows Congress to order the

Government Accountability Office to
review Fed activities, excluding monetary
policy. Audits would be allowed two
years after the Fed makes emergency
loans and gives financial help to ailing
financial firms.
Examines the books of commercial

banks that are members of the
system; sets reserve requirements for
all banks
Banking and Financial Institutions

Financial Intermediation
Helps get funds from savers to investors through
bond/equity/foreign exchange markets
Banks and Money Supply

Crucial role in creation of money
Financial Innovation

Money and Banking: Requirements Grades

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Money and Banking: Requirements Grades

Uploaded by

Copyright:

Available Formats

Professor Yamin Ahmad, Money and Banking ECON 354