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Money and Banking CH. 10 & 11 ECONOMICS What is money? Anything that serves as a medium of exchange Functions Unit of account: Compare value of goods and services Store of value: Keeps value if stored/saved Unless there is inflation that devalues currency Inflation: Too much money in circulation, causes $ to lose values and prices to rise Barter: Direct exchange of one set of goods or services for another Disadvantages: Must find a person that wants what you have and has a something that would qualify as an even exchange https://www.youtube.com/watch?v=Dugn51K_6WA&index=11&list=PL8dPuua LjXtPNZwz5_o_5uirJ8gQXnhEO Inflation Rate in the US 2015: Currently 0% Characteristics of Viable Currency Durability: Survive wear and tear? Portability: Easy to carry around for daily use Divisibility: Can be broken down into smaller denomination Uniformity: All money is the same, unlike fish or stones, etc. Limited Supply: There is enough money in circulation, but not too much so that it loses value and creates inflation Acceptability: Everyone agrees that this currency has value Bitcoin: Current value 1 bitcoin = $362 https://www.youtube.com/watch?v=s4g1XFU8Gto Bitcoin Value and Exchange Rate Source of Value Commodity Money: Currency that has value in itself, useful not just as $ but in other ways Ex: wheat, salt, pepper, cows, stones, jewels, fish, etc. Ancient Egypt: Beer used to pay workers who built the Pyramids Representative Money: Has value because the holder can exchange it for something else with value (gold/silver) Specie: Coined money Paper receipts for gold was an early form of currency Fiat Money: Decreed by govt to be acceptable way to pay debt Current system History of Money in America American Revolution: Continentals Couldn’t redeem for gold because the govt didn’t have the power to collect taxes = unsuccessful The Gold Standard: After establishing the Constitution in 1789 Could redeem cash for gold until the 1930s (Ended officially in 1971) Whose faces are on our currency? Have there been any women? http://www.history.com/news/8-things-you-may-not-know-about-americanmoney History of Banking in America Local banks were informal: Collected small fee to keep your $ safe 1789: After Constitution, Debate between Federalist Hamilton and Anti-Federalist Jefferson Hamilton wanted a strong central bank to promote trade, and to monitor $ and private banks Jefferson fears wealthy will gain control of the bank and believes states should regulate it themselves 1791: 1st Bank of the US (20 year charter) Holds tax $ and issues representative $ Congress doesn’t actually have this power under the Constitution People had little confidence in the bank = collapse History of Banking 1816-1832: 2nd Bank of the US Sought to rebuild confidence in the banking system http://www.history.com/topics/bank-war 1837-1863: Free Banking Era Bank runs: People panic and rush to withdraw all $ until the bank shuts down Wildcat banks on the Western Frontier Fraud and counterfeiting: Producing fake currency Multiple currencies exist Civil War: Union issues greenbacks and this becomes the single national currency afterward History of Banking 1870s: The Gold Standard – paper currency is backed by gold and can be exchanged for it’s value One ounce = $20 Provides stability and confidence 1913: The Federal Reserve System Today’s currency: Federal Reserve Bank Notes 12 regional government/central banks that oversee member banks Federal Reserve Board appointed by the President Promote banking stability Provide short-term longs to private banks to prevent bank failure Control money supply Regulate inflation through interest rates Inflation and Interest Rates Federal Reserve banks lend money to private banks in order to insure your money: Keeping enough on hand to avoid bank failure Private banks pay interest to the Fed for the loan Consumers and businesses pay interest to the private banks for loans If there is inflation: There is too much money circulating in the system Value of currency decreases To get rid of inflation: The Federal Reserve can raise interest rates Less banks/consumers/businesses will take out loans to avoid fees This means they will also SPEND less money This leaves less money in circulation = fixes inflation Deflation is the opposite: Not enough money in the system Lower interest rates = more loans = more spending = more in circulation = fixes deflation History of Banking 1930s: Great Depression Many bank runs and failures New Deal: Reforms the system in 1933 FDIC: Federal Deposit Insurance Corporation Money insured up to $250,000 Banks were closely regulated through the 1960s 1970s and 80s: Deregulation of banks and “Savings and Loans” Interest rates sky rocket and banks give many risky loans 1989: Savings and Loans are regulated and put under FDIC https://www.youtube.com/watch?v=GPOv72Awo68&list=PL8dPuuaLjXtPNZwz5_o_5uirJ8gQXnhEO&index=12 Modern Economics Issues 1990s: Subprime mortgages become popular – predatory lending Lend to borrowers with bad credit and low ability to repay Higher interest rate comes with higher risk = bank profit Housing prices increase, many financial institutions invest in this system Bubble: Prices rapidly increase due to irrational decisions By 2005, 25% of mortgages were subprime Rise in foreclosures: Seize property from those who can’t pay Housing bubble burst: Real estate prices decline Lenders and investors lose $ and are forced to claim bankruptcy, default on debt, merge or accept a bailout 2008: Recession and Bailout (TARP) Financial Institutions who downsize cause 100,000s to lose jobs and make it difficult to get credit GW Bush Administration: Decides banks are “too big to fail” Approves $700 billion bailout of banks, auto industry and financial institutions Obama 2009: Approves $787 stimulus package to boost economy Included tax cuts and spending increases on infrastructure, healthcare, etc. http://projects.propublica.org/bailout/main/summary Glass-Steagall Act: Govt lends them money to keep them from collapsing, restart flow of credit http://www.investopedia.com/terms/g/glass_steagall_act.asp Whose fault was this? Should they be punished? After 1980s crisis, 839 bankers went to jail After 2008, 1 banker went to jail Currency Wars August 2015: China devalued their currency by 4.7% in a week Largest drop since 1994; makes their products cheaper 2nd largest economy in the world Growth around 7-10%, slowing down usually devalues currency Unsustainable growth: Most is investment (48%, compared to 10-15% in most countries) Most countries allow their currency’s value to be determined by world markets China has used US dollar to manage/tether their currency since mid-1990s World is urging China to use market value so everyone can benefit from their growth and to balance US trade deficit Not all bad: As others devalues, ours is stronger =currency appreciates Opposite is depreciation https://www.youtube.com/watch?v=i3RZoHZ0EgI https://www.youtube.com/watch?v=geoe-6NBy10&list=PL8dPuuaLjXtPNZwz5_o_5uirJ8gQXnhEO&index=15 Financial Markets ECONOMICS CHAPTER 11 Banking Today Money Supply: All the money available in the US economy Liquidity: The ability to be used as, or directly converted into cash M1: Money that people can gain access to easily and immediately M2: All assets in M1 and additional items of value that can be converted to cash easily Money Market Mutual Funds: Pools money from small savers to purchase short-term govt and corporate securities Allows you to save and write a limited number of checks, more interest than savings account Securities: Paper traded for value, where profit is anticipated through a third party Stock/Equity Securities: Gives ownership position to customer Bond/Debt Security: Gives customer loanership position Variable annuities, options, etc. http://www.investopedia.com/terms/s/security.asp Banking today Certificates of Deposit (CD): Offer a guaranteed rate of interest, but $ cannot be removed until a certain date (years) or you pay a penalty Fractional Reserve Banking: System that keeps only a fraction of its funds on hand and lends out the remainder Default: Failing to pay back a loan Mortgage: Specific loan used to buy real estate Principle: Amount of money borrowed Pay this back, along with interest Modern Banks Commercial Bank: Majority of banks; Offer wide range of services like checking accounts, loan services, etc. Some chartered by states and regulated by state and FDIC 1/3rd are national banks and part of the Federal Reserve System Savings and Loan Associations: Originally chartered to lend money for building homes in mid-1800s Members deposited funds into large group fund and then loaned enough to build houses Also called thrifts, now function like a regular commercial bank Modern Banks Mutual Savings Banks: Originally to serve people with smaller transactions Credit Unions: Cooperative lending associations often established by particular groups/employees of a firm or govt agency Formerly owned by depositors, now sell stock to raise capital Some open to entire community: Small and specialize in consumer loans with love interest rates, and some allow checking accounts Finance Companies: Make installment loans to consumers Spread the cost of major purchases over number of months, with generally high interest rates (Ex: car dealership) People who do this are more likely to fail to repay loans Saving and Investing Investment: Redirecting resources from being consumed today so that they may create benefits in the future Use of assets to earn income or profit Financial System: Network of structures and mechanisms that allows the transfer of money between savers and borrowers Financial Asset: A claim on the property or income of a borrower Savings account, govt or corporate bond, CDs, etc. Financial Intermediaries: Institutions that help channel funds form savers to borrowers (Chart pg. 279) Financial Intermediaries Mutual Fund: Organization that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets Hedge Fund: Private investment organization that employs risky strategies that often made huge profits for investors Little/No regulation from Securities and Exchange Commission (SEC) Life Insurance Companies: To provide financial protection for families, collect premiums and lend part to investors Pension Funds: Income that some retirees receive after working a certain number of years or reaching a certain age (or get injured) Withhold portion of salary, invest money, pay out later Risk and Diversification Diversify: Spread out investments to reduce risk Types of Risk (pg. 280) Credit Risk: Borrowers may not pay back the $ they have borrowed, or they may be late in making payments Liquidity Risk: You may not be able to convert the investment back into cash quickly enough for your needs Inflation Rate Risk: Inflation rates erode the value of your assets Time Risk: You may have to pass up better opportunities for investment Investment Portfolios: Collection of financials assets Prospectus: Investment report that provides information to potential investors Return: $ an investor receives above and beyond the sun of money initially invested Bonds: Sold by govt and corporations to fund projects, sold for certain term (period of time) Coupon Rate: Interest rate that a bond issuer will pay to the bondholder Maturity: Time at which payment to a bondholder is due Par Value: Bond’s stated value, to be paid to the bondholder at maturity Yield: Annual rate of return on a bond if the bond is held to maturity Bond Ratings: As with other investments, ratings are given to advise which bonds are the most sound investment Types: Treasury, municipal, corporate, inflation-indexed, savings bonds, junk bonds (pg. 289) The Stock Market Shares: A portion of stock Dividends: Part of corporations profits paid out to stockholders, usually quarterly Capital Gains: Difference between the selling price and purchase price that results in a financial gain for the seller Capital Loss: difference between the selling price and purchase price that results in a financials loss for the seller Stock Split: Division of each single share of a company’s stock into more than one share Stockbroker: Person who links buyers and sellers of stock Brokerage Firm: Business that specializes in trading stocks Stock Exchange Stock Exchange: A market for buying and selling stock NYSE: Since 1792, largest and most powerful in the country Blue Chip Companies: Largest, most financially sound, best-known firms listed on NYSE, with stock normally in high demand, long term profitably Over-the-Counter Market: Stocks aren’t always traded on exchange, but instead on the phone or internet or from a dealer or broker Nasdaq: National Association of Securities Dealers Automated Quotation (1971) System to help organize the OTC market, largest electronic market for stocks by broadcasting trading info to computer terminals throughout the world Futures and Options Futures: Contracts to buy or sell commodities at a particular date in the future at a price specified today Options: Contracts that give investors the right to buy or sell stock and other financials assets at a particular price until a specified future date Call Option: Contract for buying stock at a particular price until a specified future date Put Option: Contract for selling stock at a particular price until a specified future date Day Trading: Buy dozens of stocks a day, but only hold them for minutes at a time Measuring Performance Bull Market: Steady rise in the stock market over a period of time Bear Market: Steady drop or stagnation in the stock market over a period of time Dow Jones Industrial Average: Measure of stock performance, using value of a particular set of stocks to represent the whole market (30) in various areas, reported as number of points S&P 500: Standard & Poor’s 500 Gives broader picture of stock performance than Dow by tracking price changes of 500 stocks to measure the markets (from NYSE and Nasdaq) Speculation: Practice of making high-risk investments with borrowed money in hopes of getting a big return Crash and Black Tuesday (1929), Black Monday (1987 & 2008) https://www.youtube.com/watch?v=tEbZswU EnsU https://www.youtube.com/watch?v=2u007M sq1qo Stock Market Simulation Links Link to Class Game: Investing Basics: Stocks https://www.youtube.com/watch?v=Snsapamg8CU EBITDA: Earnings before interest, taxes, depreciation, and amortization http://studentstocktrader.com/play/31291-0 http://www.investopedia.com/terms/e/ebitda.asp Instructions and helpful hints can be found on the game site and on your instruction sheet (see link on Economics calendar)