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Financial
Analysis

Fall Semester 2021 Lecture 2

Prof. Sayuri Shirai Money
 Money
• Money
– Any medium that is universally accepted
in an economy (or country) both by sellers of
goods and services and by creditors as payment
for debts
 Money and Cash
• Generally, we tend to regard cash as money

• Cash is comprised of coins and banknotes

(central bank notes)

• But the coverage of money is broader than

cash.
 What is Money?
• You cannot generally buy food by using gold or
watches in the contemporary world.

• So gold or watches cannot be money.

• Money is something that serves as a medium

of exchange. Money must be accepted widely
by the society as a means of payment.
 Money
• Money: refers to the economic term for assets
that are widely used and accepted as payment.

• Money took various forms such as shells, leather,

wheat, animals, fish, and gold in the old days.

• Most prices are measured in units of money.

• Understanding money is important to understand

inflation.
Three Functions of Money

(1) Medium of exchange

(2) Unit of account

(3) Store of Value

 First Function of Money
(1) Medium of Exchange: money enables various
trade at low cost.
• In daily life, we exchange goods and services in the
market. To facilitate these exchanges, we settle
using money.
• Money improves efficiency in the economy through
specialization.
• Money facilitates exchange by reducing transaction
costs associated with means-of-payment
uncertainty.
• Permits specialization
 Barter Trade
• Barter: Simply a direct exchange without the
use of money
• Double coincidence of wants
• Barter trade refers to trade where goods and
services are exchanged directly for other goods and
services.
• It is not efficient because no one item serves as a
medium of exchange. If you want to get goods A in
exchange for goods B, it may be difficult to find a
seller who is willing to sell goods A and receive goods
B. (time and cost consuming).
 Second Function of Money
(2) Unit of Accounting: Money is the basic unit of measuring
economic value.
• Given that goods and services are mostly exchanged for
money, it is natural to express economic value in terms of
money. We report the value of a good or service in units of
money.

• For example, I pay $100 for a cell phone. I do not say I pay 5
books to buy a cell phone.

• If a county faces large and volatile inflation, money becomes

a poor unit of account because prices must be changed
frequently. In this environment, citizens in the country may
begin to prefer usage of hard currency (such as US dollar, euro,
yen, Swiss franc, British pound) or precious metals (such as
gold).
 Unit of Accounting
• A measure by which prices are
expressed
• The common denominator of the price
system
• A central property of money
 Third Function of Money
(3) Store of Value: refers to an item that holds value over
time. Money is a way of storing wealth.
• As money has a store of value, it can be used as a
standard for future payments.
• For example, suppose you find accidentally a $50 bill in
your bag left unused over 5 years. If you feel happy
because the $50 bill still has value, this means that the
country had limited inflation over the past 5 years.
Money had the value that could be stored.
• When you borrow money, you sign a contract pledging
to make a series of future payments to settle the debt.
These payments will be made using money. This means
that money acts as a store of value.
 Store of Value
• The ability to hold value over time

• A necessary property of money

• Money allows you to transfer value

(wealth) into the future.
 Fiat Money and Legal Tender
• Fiat money: refers to money that some authority
(generally a government) orders to be accepted as a
medium of exchange. It is the currency prevailing in
each country globally nowadays. It is not backed by
gold or any other tangible assets.

• It is a legal tender designated by the government

and issued by a central bank that the public are
willing to accept in exchange for goods and services,
pay taxes, and pay debt.
 Fiat Money and Legal Tender
• The value is backed by the credibility of a central
bank, which is regulated under the central bank act.
Money is not backed by gold, silver, etc. It is
backed by the confidence of those willing to
accept it.
• It is stable because a central bank attempts to
maintain price stability through monetary policy.
• The value of money is greater than the cost of
printing money.
Inflation

Turkey

US
 Price and Inflation
• General Price (P) = price level of a basket of goods and
services in an economy
– Most frequently used price is consumer price index (CPI). It is the
weighted average of representative goods and services consumed
by households
• Inflation is a measure of the rate at which the general price
level changes. It is expressed as a percentage
– It is positive if the general price increases over some period of
time. It means that a unit of currency effectively buys less than it
did in prior periods. The purchasing power of a country’s currency
declines.
– It is negative if the general price declines over some period of
time. It indicates an increase in the purchasing power.

Inflation (%) = (CPI t – CPI t-1) / CPI t-1 * 100

 Liquidity
• It refers to the degree to which an
asset can be acquired or disposed of
without much danger of any
intervening loss in nominal value and
with small transaction costs
• Money is the most liquid asset.
• In contrast, real estate is illiquid asset.
Degrees of Liquidity
 What are Transaction Deposits?
• Transactions Deposits
– Most liquid form of deposits
– Checkable and debitable account balances in
commercial banks and other types of financial
institutions, such as credit unions and mutual
savings banks
– Any accounts in financial institutions
on which you can easily transmit debit-card and
check payments without many restrictions
 Cash in US
• The Federal Reserve Act of 1913 authorized the
production and circulation of Federal Reserve
notes.
• The Bureau of Engraving and Printing (BEP) prints
these notes. Subsequently, they move into
circulation through the Federal Reserve System.

• Notes are obligations of both the Federal Reserve

System and the United States Government. On
Federal Reserve notes, the seals and serial
numbers appear in green.
• Coins are produced by the United States
Mint.

• The coins are then sold to Federal Reserve

Banks which in turn are responsible for
putting coins into circulation and
withdrawing them as demanded by the
country’s economy.
• Modern Monetary System
– A system in which currency is issued by the
government/central bank and its value rests on
the public’s confidence that it can be exchanged
for goods and services
– The Latin fiducia means “trust” or “confidence.”
– Cash and transactions deposits are money
because of their acceptability and predictability of
value.