UNIVERSITY OF HARGEISA

Course title:
Money & Banking

Lecturer
By
Sadiq Mohamed Omer
© The McGraw-Hill Com
 Chapter One

Introducing Money, Banking, and

Financial Markets
 

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 Barter system
• The barter system is the oldest system of
trade which was prevalent or used many
centuries back. It refers to that system under
which goods or services were exchanged
directly with other goods and services and
there was no medium of exchange which is
the case in present times where the medium
of exchange is money. In order to
understand more about barter system lets
look at some of the advantages and
disadvantages of barter system  © The McGraw-Hill Com
• Barter is a system of exchange where
goods or services are directly exchanged for
other goods or services without using a
medium of exchange, such as money. It is
distinguishable from gift economies in many
ways; one of them is that the reciprocal (give
and take) exchange is immediate and not
delayed in time.
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•  It is usually bilateral, but may be multilateral
 (i.e., mediated through a trade exchange)
and, in most developed countries, usually
only exists parallel to monetary systems to a
very limited extent. Barter, as a replacement
for money as the method of exchange, is
used in times of monetary crisis, such as
when the currency may be either unstable
(e.g., hyperinflation or deflationary spiral) or
simply unavailable for conducting commerce.

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 Advantages

• Since direct barter does not require payment

in money, it can be utilized when money is in
short supply, when there is little information
about the credit worthiness of trade partners,
or when there is a lack of trust between
those trading.
• Barter is an option to those who cannot
afford to store their small supply of wealth in
money, especially in hyperinflation situations
where money devalues quickly
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• The first and foremost advantage of barter
system is that it’s the simplest system of
trade which involves no complications so if
you are a wheat seller and you want rice
and rice seller wants wheat then both rice
and wheat seller will exchange their
products without any hassles of the
modern day monetary exchange system.
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• Another benefit of barter system is that since
no money is involved people will produce and
consume only what they want and there is no
under or over production and also there is no
question of people hoarding the commodities
so as to sell them at higher price which is the
case in modern day monetary system where
due to presence of money people tend to
inflate prices by hoarding even when the
production is more than enough.

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• Another benefit of barter system is that
problem of foreign exchange and
international trade does not arise and also
there is less possibility of concentration of
wealth in the hands of few people as
different people specializes in different work
and nobody can control everybody’s
fortune(wealth) which is the case with
money where if one acquires money in
abundance then he or she tend to control
others and exploit them which is not possible
in case of barter system. © The McGraw-Hill Com
• The disadvantages of barter system were
Goods were limited, Need for Double
Coincidence of wants, Difficulty of Division
and Sub - division of Goods, Difficulty in
calculating the value of goods, Difficulty in
the case of services and Difficulty in Strong
Value. In barter system the goods were
limited.

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 Disadvantages
• The biggest disadvantage of barter system is
that it requires double coincidence of want so
for example if you are wheat producer and
you want apple but the apple producer does
not want to buy wheat rather he or she
wants rice then you will have to go to rice
producer first and buy rice from him or her
and then you can buy apple in exchange of
rice. Hence barter system leads to a lot of
wastage of time in finding the other party
and numerous exchanges in order to do a
trade. © The McGraw-Hill Com
• The limitations of barter are often explained
in terms of its inefficiencies in facilitating
exchange of comparison to money
• It is said that barter is “inefficient” because
There needs to be a double conscience of wants
• For barter to occur between two parties both
parties needs to have what the other wants

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• There is no common measure of value
• In a monetary economy money plays the
role of a measure of value of all goods so
their value can be assessed against each
other, this role may be absent in a barter
economy.

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• Indivisibility of certain goods
If a person wants to buy a certain amount of
another goods but only has for payment one
indivisible unit of another good which worth
more than what the person wants to optain.
a parter transaction can`t occur

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• Lack of standards for deferred
payments
This is related to the absent of common
measure of value, although if the debt is
denominated in units of the goods that
would eventually will be used in payment
it is not a problem

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• Difficulty in storing wealth
If a society relies exclusively on a
perishable goods, strong wealth for the
future may be impractical, how ever some
barter economy rely on durable goods like
cattle.

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• The history of money concerns the
development of means of carrying out
transactions involving a medium of
exchange. Money is any clearly identifiable
object of value that is generally accepted as
payment for goods and services and
repayment of debts within a market or
which is legal tender within a country.
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Financial markets are places or channels for
buying and selling stocks, bonds, and other
securities, such as the New York Stock
Exchange

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Five key categories of assets:
1. Money
2. Stocks
3. Bonds
4. Foreign exchange
5. Securitized loans

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Economists have a general definition of money:
Money is anything that people are willing to accept in
payment for goods and services or to pay off debts.
The money supply is the total quantity of money in the
economy

Currency consisting of dollars and coins clearly fits this

definition.

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 To define money merely (just) as currency is much too
narrow for economists because checks are also accepted
as payment for purchases, checking account deposits are
considered money as well.
 Wealth: is the total collection of pieces of property that
serve to store value. Wealth includes not only money but
also other assets such as bonds and stocks, cars, houses
etc.
 Income: is a flow of earnings per unit of time.

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 `
Functions of money
Money has three primary functions in any economy:
 As a medium of exchange
 A unit of account
 Store of value

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• Medium of exchange: in almost all market transactions in our
economy, money in the form of currency or checks is a medium of
exchange. It is used to pay for goods and services. The use of
money as a medium of exchange promotes economic efficiency by
eliminating much of the time spent in exchanging goods and
services.
The time spent trying change goods and services is called transaction
cost
In a barter economy transaction costs are high because people have
to satisfy a double coincidence of wants they have to find someone
who has a good or service they want and who also wants the good
or service they have to offer.

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• The need for money is strong that almost every society
uses it. 
For a commodity to function effectively as money it has to
meet several criteria.
 It must be easily standardized.
 Making it simple to ascertain its value.
 It must be widely accepted
 It must be divisible so that it is easy to make change
 It must be easy to carry
 It must not deteriorate quickly

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• Unit of account
The second role of money is to provide a unit of account
that is used to measure value in the economy. We
measure the value of goods and services in terms of
money as we measure weight in terms of kg

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• Store of value
Money also functions as a store of value; it is a repository
of purchasing power over time. A store of value is used
to save purchasing power from the time income is
received until the time it is spent. Thus function of
money is useful because most of us do not want to
spend our income immediately upon receiving it, but
rather prefer to wait until we have the time or the
desire to shop

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• Stocks, also called equities, are financial securities that
represent partial ownership of a corporation. When you
buy a share of Microsoft stock, you become a Microsoft
shareholder, and you own part of Microsoft, although
only a tiny part because it has issued millions of shares
of stock 
• Bonds When you buy a bond issued by a corporation or
a government, you are lending the corporation or the
government a fixed amount of money. The interest rate
is the cost of borrowing funds (or the payment for
lending funds), usually expressed as a percentage of the
amount borrowed Bonds typically pay interest in fixed
dollar amounts called coupons.
•  
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• Interest rate: the cost of borrowing funds (or the
payment for lending funds), usually expressed as a
percentage of the amount borrowed.
 
• Foreign exchange refers to units of foreign
currency. The most important buyers and sellers of
foreign exchange are large banks. Banks engage in
foreign currency transactions on behalf of investors
who want to buy foreign financial assets.

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• Financial markets refer to the markets in which
financial assets can be traded.
Financial markets provide a mechanism for those with
excess funds to purchase securities, such as stocks
and bonds, issued by those who need funds.
 

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• Financial markets generate prices whenever securities
are bought or sold.
• Financial institutions value financial assets whenever
making loans to businesses or consumers. Thus pricing
and valuation of financial assets are at the heart of the
financial markets. One of the objectives of financial
markets is to link the behavior of securities prices, such
as for stocks and bonds, to the performance of the
economy as a whole, as well as with the behavior of
financial institutions and markets.

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• Money plays a key role in the performance of the
economy. It not only facilitates transactions
among the millions of the economic players in the
economy. But it represents the principal
mechanism through which central banks attempt
to influence aggregate economic activity,
including economic growth, employment, and
inflation.

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• Money in the modern economy is sometimes
viewed as a lubricant that greases the wheels of
economic activity. Without money, the
transactions that make up our daily economic
routine would be unimaginably difficult.
 

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• A financial intermediary is an institution that
takes funds from one group of investors and
redeploys those funds by investing in financial
asset. Banks serve as the principal caretaker of
the economy`s money supply and along with
other financial intermediaries, provide an
important source of funds for consumers and
businesses.
 

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• Definition of bank
• Bank is a financial institution which deals in debts
and credits. It accepts deposits, lends money and
also creates money. It bridges the gap between the
savers and borrowers.
 
• Banking occupies one of the most important
positions in the modern economic world. It is
necessary for trade and industry. Hence it is one of
the great agencies of commerce. Modern banking is
crucial in developing modern business and
economics.
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• Banks play a particularly critical role in the
economy. Banks provide a place where individuals
and businesses can invest their funds to earn interest
with a minimum of risk. Banks in turn redeploy
these funds by making loans. In this regard banks
are similar to other financial intermediaries like
finance companies and life insurance, which also
acquire funds from individuals and businesses and
pass these funds to other individuals and businesses.

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