Download Document

Chapter 1
Why Study
Money, Banking,
and Financial
Markets?
1
Why Study Financial Markets?
1. Financial markets channel funds from
savers to investors, thereby promoting
economic efficiency
2. Financial markets are a key factor in
producing economic growth
3. Financial markets affect personal wealth
and behaviour of business firms
2
The Bond Market & Interest Rates
•
A security (financial instrument) is a
claim on the issuer’s future income or
assets
•
An asset is any financial claim that is
subject to ownership
3
The Bond Market & Interest Rates
•
A bond is a debt security that
promises periodic payments for a
specified time
•
An interest rate is the cost of
borrowing or the price paid on the
rental of funds
Interest rate and the US subprime
mortgage crisis
•
4
The Bond Market & Interest Rates
5
The Stock Market
•
A stock represents a share of
ownership in a corporation
•
A stock is a security that is a claim on
the earnings and assets of that
corporation
6
Stock Market
7
Ten Largest Canadian Companies
by Market Cap
•
•
•
•
•
•
•
•
•
•
Royal Bank of Canada
Manulife Financial
Bank of Nova Scotia
Toronto-Dominion Bank
EnCana Corp.
Suncor Energy
Imperial Oil
Cdn. Natural Resources
CIBC
Bank of Montreal
8
Foreign Exchange Market
•
•
•
•
The foreign exchange market is where
one country’s currency is exchanged for
another
The exchange rate is the price of one
country’s currency in terms of another
Appreciation/depreciation is a rise/fall in
the value of a country’s currency
Recent exchange rate fluctuation of CND
9
Foreign Exchange Market
10
Banking and Financial
Institutions
• Financial Intermediaries - institutions that
borrow funds from people who have saved and
make loans to other people
• Banks - institutions that accept deposits and
make loans
• Other Financial Institutions - insurance
companies, finance companies, pension funds,
mutual funds and investment banks
• Financial Innovation- in particular, the advent of
the information age and e-finance
11
Money and Business Cycles
• Evidence suggests that money
plays an important role in generating
business cycles
• Evidence also suggests that monetary
policies are often a response to business
cycles
• Recessions (unemployment) and booms
(inflation) affect all of us
• Mckenzie and Fort St. John
12
Money and Business Cycles
13
• The decline of money supply is an
indication of recession, not the driving
force behind recession.
• Most Canadian recessions are caused by
recessions south of border.
• When was the last recession in Prince
George? Was it caused by any monetary
policy?
14
Money and Inflation
• The aggregate price level is the
average price of goods and services in
an economy
• A continual rise in the price level
(inflation) affects all economic players
• Data shows a connection between the
money supply and the price level
15
Money and the Price Level
16
Question
• Why inflation rates lower than growth rate
of money supply, especially after 1998?
17
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
Oil price in 2006 dollar
100.00
80.00
60.00
40.00
20.00
0.00
18
Money Growth and Inflation
19
Money and Interest Rates
• Interest rates are the price of money
• Prior to 1980, the rate of money growth
and the interest rate on long-term
bonds were closely tied
• Since then, the relationship is less
clear but still an important determinant
of interest rates
20
Money Growth and Interest
Rates
21
• The sharp turning point at 1998 was
during Asian financial crisis when money
flowed to North America, keeping Money
Growth Rate High and Interest Rate low.
• Another point when the direction of money
growth rate differ very much from interest
rate is at 1985, when oil price reach the
lowest point and Iran-Iraq was at war.
22
Monetary and Fiscal Policy
• Monetary policy is the management of
the money supply and interest rates
– Conducted by the Bank of Canada
• Fiscal policy is government spending
and taxation
– Budget deficit/surplus is the excess of
expenditures/revenue over
revenues/expenditures for a particular year
– Any deficit must be financed by borrowing
23
How We Study Money and
Banking
Basic Analytic Framework
• Simplified approach to the demand for assets
• Concept of equilibrium
• Basic supply and demand approach to
understand behaviour in financial markets
• Search for profits
• Transactions cost and asymmetric information
approach to financial structure
• Aggregate supply and demand analysis
24
How We Study Money and
Banking (Cont’d)
Features:
1.Case studies
2. Applications
3. Special-interest boxes
4. Financial News boxes
6. Web Exercises and References
25
Appendix: Definitions
• Aggregate Output
Gross Domestic Product (GDP) = Value of
all final goods and services produced in domestic
economy during year.
• Aggregate Income - Total income of factors of
production (land, capital, labour) during year
• Nominal = values measured using current
prices
• Real = quantities measured with constant
prices
26
Appendix: Definitions
• Aggregate Price Level
GDP Deflator = Nominal GDP/Real GDP
Consumer Price Index = (CPI) price of a “basket” of
goods and services
Inflation rate = growth rate of the aggregate price
level (percent change from previous period)
27
Note on the definition of inflation
• Inflation rate often underestimate the cost
of housing because new houses only
represent a small percentage of housing
purchases and even smaller percentage of
potential house buyers. Inflation rate is
especially not helpful in indicating the
difficulty of first time house buyers.
28
Homework
• 2, 4, 6, 10
29