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Chapter 1
Why Study Money,
Banking, and
Financial Markets?
Why Study Financial Markets?
1. Channel funds from savers to investors, thereby
promoting economic efficiency
2. Affect personal wealth and behavior of business firms
Why Study Banking and Financial Institutions?
1. Financial Intermediation
Helps get funds from savers to investors
2. Banks and Money Supply
Crucial role in creation of money
3. Financial Innovation
Why Study Money and Monetary Policy?
1. Influence on business cycles, inflation, and interest
rates
© 2004 Pearson Addison-Wesley. All rights reserved
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Issues to Address on Financial Markets
• What are bonds? What are stocks?
• What is the relation between bond prices and interest rates?
• Why rate of return can be negative for bonds with positive
coupon rate?
• What determines the interest rates?
• What explains the risk and term structure of the interest
rates?
• How are stocks priced?
• Is the financial market efficient?
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1-3
Bond Market
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Stock Market
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Banks and Other Financial Institution
• Banks are financial institutions that accept
deposits and make loans.
• Included under the term banks are firms such as
commercial banks, savings and loan associations,
mutual savings banks, and credit unions.
• Other financial institutions include insurance
companies, finance companies, pension funds,
mutual funds, and investment banks.
© 2004 Pearson Addison-Wesley. All rights reserved
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Questions to Address
• Why banks are the most important source of external funds
used to finance business?
• Why is the financial system among the most heavily
regulated sectors of the economy?
• How to read the balance sheet of commercial banks?
• How do banks manage their assets, liabilities and bank
capital?
• How to analyze interest risk facing banks?
• How has the competitive environment changed for banks?
• Why are there so many banks in the United States?
• How to use financial derivatives to hedge risk?
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Money and Business Cycles
• Money is store of value, unit of account and
medium of exchange.
• Business cycles are the upward and downward
movements of aggregate output produced in the
economy.
• Data: Every recent recession has been preceded by
a decline in the rate of money growth.
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Money and Business Cycles
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Money and Inflation
• The inflation rate is defined as the growth rate of
the aggregate price level.
• What explains inflation?
• Data: Inflation seems tied with increases in the
money supply across time and countries.
• Theory: Money’s role in creating inflation (27).
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Issues on Money
• How is the money supply determined?
• What are tools of monetary policy?
• What are the transmission mechanism of the
monetary policy?
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Money and the Price Level
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Money Growth and Inflation
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Money Growth and Interest Rates
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