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The Economics of Money, Banking, and

Financial Markets The Financial Market
Twelfth Edition
• Markets in which funds are transferred from those who
have excess funds available to those who have a shortage
of available funds are called financial markets.
Chapter 1 - REVIEW
• Financial markets promote greater economic efficiency by
Why Study Money, Banking, channeling funds from savers to borrowers.
and Financial Markets?
• Well-functioning financial markets promote growth, while
poorly performing financial markets can be the cause of
poverty.

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The Bond Market and Interest Rates The Stock Market

• A security (financial instrument) is a claim on the issuer’s future • The stock market is the most widely followed financial
income or assets. market in every country.
• A bond is a debt security that promises to make payments periodically
for a specified period of time. • Common stock represents a share of ownership in a
corporation.
• An interest rate is the cost of borrowing or the price paid for the rental
of funds. • A share of stock is a claim on the residual earnings and
• The bond markets are important because they are the markets where assets of the corporation.
interest rates are determined.
• Stock prices are extremely volatile. → An increase in stock
• Compared to interest rates on long-term government bonds, interest
prices increases the size of people's wealth and may
rates on three-month Treasury bills fluctuate more and are lower on
average. increase their willingness to spend, everything else held
constant.

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Why Study Financial Institutions and Why Study Financial Institutions and
Banking? (1 of 3) Banking? (2 of 3)
• Financial intermediaries (institutions): institutions that • Financial innovation: the development of new financial
borrow funds from people who have saved and in turn products and services
make loans to people who need funds. – Can be an important force for good by making the
– Banks: accept deposits and make loans financial system more efficient
– Other financial institutions: insurance companies, – E-finance: the ability to deliver financial services
finance companies, pension funds, mutual funds and electronically
investment companies
• Banks, savings and loan associations, mutual savings
banks, and credit unions have been adept at innovating in
response to changes in the regulatory environment.

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Why Study Financial Institutions and

Banking? (3 of 3) Why Study Money and Monetary Policy?
• Financial crises: major disruptions in financial markets • Evidence suggests that money, defined as anything that is
that are characterized by sharp declines in asset prices generally accepted as payment for goods or services or in
and the failures of many financial and nonfinancial firms. the repayment of debts, plays an important role in
generating business cycles.
• Fear of a major recession causes stock prices to fall,
everything else held constant, which in turn causes • The gross domestic product (GDP) is the the market value
consumer spending to decrease. of all final goods and services produced in an economy in a
year.
• Recessions (unemployment) and expansions affect all of us.
• Monetary theory ties changes in the money supply to
changes in aggregate economic activity and the price level.

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Money, Business Cycles, and Inflation Money and Interest Rates

• The aggregate price level is the average price of goods • The price paid for the rental of borrowed funds (usually
and services in an economy expressed as a percentage of the rental per year) is
commonly referred to as the interest rate.
• A continual rise in the price level (inflation) affects all
economic players • An increase in interest rates might encourage saving
because more can be earned in interest income.
• Data show a connection between the money supply and
the price level → A continuing increase in the growth of the
money supply is likely followed by an increase in the price
level.

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Fiscal Policy and Monetary Policy The Foreign Exchange Market

• Monetary policy is the management of the money supply • The foreign exchange market: where funds are converted from one
and interest rates and is conducted by a nation’s central currency into another. → A company can borrow funds in both
domestic and foreign financial markets.
bank.
• The foreign exchange rate is the price of one currency in terms of
• Fiscal policy deals with government spending another currency. → Everything else constant, a stronger domestic
and taxation currency will mean that people will have more advantage when buying
foreign goods.
– Budget deficit is the excess of expenditures over
revenues for a particular year • Everything else held constant, a stronger domestic currency benefits
domestic customers and hurts domestic businesses.
– Budget surplus is the excess of revenues over
expenditures for a particular year • The foreign exchange market determines the foreign exchange rate.

– Any deficit must be financed by borrowing

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Copyright

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