chapter 1 why study money, banking, and financial markets?

Chapter 1

Why Study Money, Banking, and Financial Markets?

© 2004 Pearson Addison-Wesley. All rights reserved 1-2

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 SupplyCrucial role in creation of money

3. Financial Innovation

Why Study Money and Monetary Policy?1. Influence on business cycles, inflation, and interest rates


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?


Bond Market


Stock Market


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.


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?


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.


Money and Business Cycles


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).


Issues on Money

• How is the money supply determined?• What are tools of monetary policy?• What are the transmission mechanism of the

monetary policy?


Money and the Price Level


Money Growth and Inflation


Money Growth and Interest Rates

chapter 1 why study money, banking, and financial markets?

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