Download Money and Banking

Unit IV The Financial Sector
Objectives:
 The functions of money
 Definition of Money Supply
 Financial assets
 The concept of time value of money
What are the characteristics of
a dollar bill that makes it a
good form of money?
 1.
Portable
 2. Stable
 3. Acceptable
 4. Durable
 5. Divisible
 6. Valuable
 7. Uniform
 8. Difficult to counterfeit
Barter: What’s the weakness?
Inefficient
Double
coincidence of wants
required for effective bartering
 Trade
requires people to find
someone who wants what they
have and has what they want.
Money facilitates trade
 Three
functions of money in an economy:
 1. Median of Exchange= any items that
sellers accept as payment.
 2. Standard of Value ( or unit of account)=
a way to measure the relative value of
goods by comparing their prices; make
economic decisions
 3. Store of Value= it can be saved, or
stored for later use; holds purchasing
power
Sources of Money’s Value
 Commodity
money: An item used as
money that also has value of its own (like
gold, silver or tobacco ).
 Representative money: An item that has
value because it “represents” something
else; can be exchanged for that
something else. (A sheet of paper that
can be redeemed for currency.)
 Fiat money: this money has value
because a government “fiat”, or decree
states that it has value (like currency=
coins and paper bills).
 U.S. dollars are fiat money and are not
backed by gold, silver or any commodity.
Definition of Money
 Difficult
to define because anything that
serves the function of money, can be
considered money.
 U.S. gov. defines what is included
in money when it measures the
Supply of money in the economy.
Monetary Aggregates:
 M0
tobacco
 M1
 M2
Definition of Money
 Liquidity
refers to how easy it is to convert an
asset into cash.
 M0- most liquid
 M2-least liquid
Definition of Money
 M0:
Coins and paper money, already
CASH, most liquid.
 MI: All of M0 plus demand deposits;
checking accounts, traveler’s checks
Checks can be paid “on demand” at any
time.
 M2: Includes M1 and near money, assets
that can easily be converted into cash
when needed, like savings accounts and
small time deposits, money market shares
Financial Markets
 Facilitate
the flow of funds from lenders to
borrowers
 Households invest their savings in financial
assets, which provide funds for investment
spending
 The financial system is important to the
econ: makes savings available for
investment which leads to long-run
growth.
Financial Markets
The
financial system
addresses three problems:
Transaction
Risk
liquidity
costs
What are financial assets?
 Any
paper claim that entitles the buyer to
future income from the seller.
 4 types




Loans
Stocks
Bonds
Bank deposits
Activity 4.1
A dollar today or a dollar next
year? Why?
 Money
today may be put in the
bank and earn interest for a year.
 So dollar today is worth more than
the dollar next year.
 Money has time value because
interest rates are positive.
Time value of money
 Let’s
say you earn 5% per year on your
savings account.
 $1 will grow to $1.05 after one year.
 Since the present value of $1.05 to be
received one year from now ( if interest
rates are 5%) is $1, then the present value
of $1 to be received one year from now
(again if interest rates are 5%)must be
some value less than $1.00
 The present value :PV=FV/(1+r) n
present value :PV=FV/(1+r)n
 PV
is present value
 FV is future value
 R is the rate of interest per period
 n is the number of compounding periods
(per year)
1
 Therefore, PV=$1.00/ (1.05)
 PV= $0.95
 Today’s value of $1.00 to be received one
year from now is the interest rate is 5%, is
$0.95

Activity 4.2