Chapter 1

An Introduction to Money and the Financial System

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2008

Introduction
The Five Parts of the Financial System
The Five Core Principles of Money and Banking

1-2

Five Parts of the Financial System

1.

Money
To pay for purchases and store wealth

2.

Financial Instruments
To transfer resources from savers to investors and to transfer risk to those best equipped to bear it.

3. 4. 5.

Financial Markets
Buy and sell financial instruments

Financial Institutions.
Provide access to financial markets, collect information & provide services

Central Banks
Monitor financial Institutions and stabilize the economy

1-3

Five Core Principles of Money and Banking

1. 2. 3. 4. Time has value Risk requires compensation Information is the basis for decisions Markets determine prices and allocation resources 5. Stability improves welfare

1-4

Five Core Principles of Money and Banking

1. Time has value
Time affects the value of financial instruments Interest payments exist because of time properties of financial instruments

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Five Core Principles of Money and Banking

2. Risk requires compensation
In a world of uncertainty, individuals will accept risk only if they are compensated in some form.

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Five Core Principles of Money and Banking

3. Information is the basis for decisions
The collection and processing of information is the basis of foundation of the financial system.

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Five Core Principles of Money and Banking

4. Markets determine prices and allocate resources
The places where buyers & sellers meet are the core of the economic system

1-8

Five Core Principles of Money and Banking

5. Stability improves welfare.
A stable economy reduces risk and improves everyone's welfare.

1-9

 Do your best not to tell people your

Date of birth Birthplace Your mothers maiden name Your address

Guard your Social Security Number

Dont tell anyone unless you have to Remove it whenever you can
1-10

Sources of Financial News

Daily
Wall Street Journal Financial Times Bloomberg.com

Data
www.bls.gov www.bea.gov www.stls.frb.org

Weekly
The Economist Business Week

Personal Financial Information

www.choosetosave.org www.dinkytown.net www.wsj.com

1-11

Measuring Economic Activity

Gross Domestic Product:
The market value of final goods and services produced in a country during a year.

Real vs. Nominal GDP:

Need to distinguish changes in prices from changes in quantities Real GDP uses base-year prices Isolates change in quantities. Nominal GDP = Prices x Real GDP

1-12

Chapter 1
End of Chapter

McGraw-Hill/Irwin

The McGraw-Hill Companies, Inc., 2008