Financial Markets Banking and Monetary Policy Exam 1 Notes LECTURE 1 Economic units and markets o Consuming units households Own the factors of production capital and labor o Producing units firms and governments Own the means of production but must rent the factory of production from households Supply goods and services Economic Markets o Good or product market o Financial market deal with the factor of timing Firms cannot afford to produce if nothing is being consumed o You need contracts in a sophiscated financial system Consequences of dysfunctional financial markets o 2007 2009 financial crisis credit market froze high quality businesses froze market lost 1 trillion dollars firms responded by reducing investments and reducing employment economy fell unemployment rose Net Savings in the US Economy o Net savings by sector in 2012 Households 470 billion Businesses 719 billion Governments 1 22 trillion negative o Aggregate net savings 33 trillion Economic functions of Financial institution o Savings wealth enables individuals to exchange current consumption for future consumption Savings economic flow variable that is measured over an interval Wealth an economic stock variable that is measured at a point in o Credit liabilities enables individuals to increase current consumption at the expense of future consumption Total liabilities an economic stock variable measured at any point time in time o Net worth or net wealth value of ones assets minus value of total liabilities U S Household balance sheet o Aggregate value of households total assets 79 5 trillion o Aggregate value of households total liabilities 13 5 trillion o Household net worth 66 billion o U S Population 315 million o Household net worth per capita 210 000 o Household net worth for a family of 3 630 000 Liquidity function enables individuals to convert their wealth into consumption at low costs o Marketability ease with which a buyer of an asset can be found o Liquidity high marketable asset but one where the cost of converting the Payment function permits the ownership of the economic good or asset to asset into cash is low change hands Risk protection function enables households to insure against unexpected expenses such as hospitalization or income of wealth due to theft or death Policy function enables government to conduct its monetary and fiscal policies but buying selling and issuing financial assets Partitioning the financial market o Money vs capital markets money market is a financial market for short term assets typically with maturities of one year or less Capital market for longer term assets such as stock and bonds o Primary vs secondary market primary market is one where financial assets are initially introduced and secondary market is where existing assets are traded o Open vs negotiated market in open market assets are freely bought and sold to 3rd party whereas in a negotiated market the financial contract is between two parties o Spot vs forward futures and options markets sport market ownership of assets changes hands immediately Forward futures and options market contracts specify the terms under which the change of ownership will take place in the future if at all LECTURE 2 4 basic categories of financial assets o Money equities debt securities derivatives Derivatives financial asset that derives value from real asset Money a collection of assets with o Medium of exchange purchase good and service o Store of value allows the asset holder to carry their wealth with time o Unit of account establishes a standard of value for all goods and services in the economy such as the Dollar in the United States o MI includes all financial assets that can be used as a medium of exchange Currency 1 107 1 billion Federal reserve notes liabilities of that federal reserve more than 90 Coin liabilities of US treasure department 75 90 is held overseas Demand deposit accounts DDAs non interest bearing checking Other checkable deposits OCDs interest bearing checking accounts 940 9 billion Don t have checking fees accounts 462 4 billion Travelers checks 3 7 billion Usually have a per check fee The Federal Reserve defines the monetary aggregate and tracks their value because They provide information on changes that are taking place in financial markets and among financial institutions Changes in the monetary aggregates tend to help forecast the economy Money supply increase 3 6 months lag GDP Increase 12 18 month lag inflation increase REVIEW QUESTION 1 1 Highly liquid asset a Has a high marketability and pays a relative high rate fo return for a given b Has low marketability and pays a relatively high rate of return for a given c Has a high marketability and pays a relatively low rate of return for a d Has low marketability and pays a relatively low rate of return for a given level of risk level of risk given level of risk level of risk 2 A 3 month treasury bill with 2 months left to maturity is traded in a market that is a Spot and primary b Negotiated and futures c Money and open money market because it s a treasury bill d Capital and secondary US monetary aggregates was fairly strong o Prior to 1980 the statistical relationship between M1 GDP and inflation o After 1980 with all of the changes in the US payments system with debit cards smart cards and interest transactions etc the relationship broken down and became relatively unreliable o The Federal Reserve switched its focus to the broader monetary aggregate M2 as its principal measure of the US money supply despite the fact that the relationship between M2 GDP and inflation has also weakened in recent years M2 includes all of the assets in M1 plus the principal short term savings assets of households seasonally adjusted dats for the week ending April 15 2013 M1 2 514 1 billion Savings accounts money market deposit accounts MMDAs 6 806 3 billion Small time deposits certificates of deposits 100 000 593 5 billion interest o Less liquid has a higher rate of return Has higher Retain Money Market Mutual Funds MMMFs for accounts 100 000 622 3 billion o Like a savings account no capital gains Pay taxes on the interest not the investment when you withdraw Can withdraw at any time Equities represent ownership shares in publicly held firms 2 types Total value of M2 assets 10 536 2 o Common Stock entitles owners to Voting rights for the Board of Directors Dividends that can vary from quarter to quarter and can be cancelled o Preferred Stock No voting rights Cannot vote