Chapter 1

1. Chapter 1 Why Study Money, Banking, and Financial Markets?

2. When I see the title to chapter 1 I say to myself, “Why not!” I believe the reason you are studying the topics implied in the question is because you are a business major or a person with an interest in the economic system and how the system operates. As with many books, in our text we will see that early on a great deal of what is done is defining terms and introducing ideas. Should you read the book? YES! I see my role here as giving you some assistance in learning. But, I need you to participate. Let’s get started! Right in the book the author defines financial markets as markets in which funds are transferred from people who have an excess of available funds to people who have a shortage. At a basic level, I take this idea to mean that some folks are willing to part with their money for a while and let others use the money. Financial markets are a way to facilitate the bringing together of these folks.

3. Two types of financial markets are bond markets and stock markets. A bond is a debt security or financial instrument that is essentially a promise that periodic payments will be made for a specified period of time. The issuer of a bond is borrowing from others (so the issuer has a shortage of funds). The author suggests that the bond market is important because in this market the interest rate is determined. Let’s note there are many interest rates (rates on home mortgages, credit cards, student loans,…), but in a general way we use the term interest rate and we recognize the different rates tend to move in the same direction when there is change. An interest rate is the cost of borrowing or the price paid for the rental of funds. The author suggests that interest rate is usually expressed as a percentage of the rental of $100 per year. As an example, say the rate is 12%. This means the borrower would be charged $12 during the year for every $100 borrowed.

4. A common stock, or stock, represents a share of ownership in a corporation and as a security, or financial instrument, is a claim on the earnings and assets of the corporation. Corporations that have a shortage of funds may issue news shares of stock as a way to get funds. As such, the corporation is asking for new owners. The stock market, in general, is where claims on corporations are traded!!!! The author suggests the stock market is important because when looking at the value of stocks a corporation can get an idea of how much it could get in funds for each share of stock issued. So, corporations and government organizations use stocks or bonds to get funds to do the things they do. For example, Wayne State College as a government organization uses bonds to finance major renovations or new construction on campus. Let’s note that you and I may own shares of stock or borrow to get a house or a car. Thus, where we live or work, financial markets have an impact on the quality of our life! I believe your study of these markets is important as a safeguard in ensuring the highest quality of life!!!!!!

5. Financial intermediaries are financial institutions that borrow funds from people who save and in turn make loans to others. These institutions include banks , insurance companies, mutual funds, finance companies and investment banks. Banks accept deposits and make loans. Here banks includes commercial banks, saving and loan associations, mutual savings banks, and credit unions. A financial crises is a major disruption in financial markets and characterized by sharp declines in asset prices and failures of many financial and nonfinancial firms. Financial innovation is the development of new financial products and services. Hey, remember we are getting warmed up to many topics and I what you to learn terminology. We will look at many of these ideas later in more detail.

6. Money, or the money supply, is anything that is generally acceptable in payment for goods and services or in the repayment of debt. The author suggest that money has an influence on interest rate movement. Remember before the author suggested that the interest rate is determined in the bond market. So, money must have an impact on the bond market. We see this later. Monetary policy is the management of money and interest rates. The central bank of a country manages monetary policy. The central bank in the United States is called the Federal Reserve System. (The FED, as we may call the Federal Reserve System, was born on Dec. 23, 1913. So, the FED is a little over 100 years old. Note the country started with the Declaration of Independence in 1776 and yet we didn’t have a central bank in its current form until 1913! But, we did have the First and the Second Banks of the United States as central banks. The details are part of US history!!!!)

7. The author mentions that fiscal policy deals with government spending and taxation. A budget deficit means government spending > tax revenue in a time period such as a year and a budget surplus reverses the inequality sign. Note a deficit or surplus is a yearly concept, but the government debt is the accumulation of all past deficits that have not been paid off. In our economic system it has been commonly accepted that there should be some degree of economic growth, low inflation, and low unemployment. How these are viewed may be explored later, but modern economies have monetary and fiscal polices concocted with the idea of influencing the economic performance of output, prices and employment.

8. Since we live in a world of increasing interaction among citizens of various countries we may consider foreign exchange markets where the currency of one country is converted into the currency of another country. The foreign exchange rate, the price of one country’s currency in terms of another’s, is determined in the foreign exchange market. Let’s consider an example where we have the dollar and the currency of many countries in Europe called the euro. Say that at one point in the time that 1 euro costs $0.85, or 85 cents. Without worrying at this time why, say the dollar price of 1 euro becomes $1.50. Here when the dollar price of 1 euro rises (from $0.85 to $1.50), the dollar is said to have depreciated or become weaker and the euro has appreciated or become stronger. When the dollar weakens we want less stuff from other countries and foreign travel is more expense to us (even when the euro price of an Italian hotel has not changed, for example). We will import less while at the same time US goods and services become a better buy and we will likely have increased exports.

9. Here I want to expand the idea of an exchange rate. We can either use the convention of units of foreign exchange per dollar, or we can refer to the dollars per unit of foreign exchange. Consider the following table with a fictitious example of exchange between the dollar ($) and the euro (€): Year Euros per dollar dollars per euro 2010 1€ $1 2011 2€ $0.50 2012 0.5€ $2 Note that each column number can converted to the other column number by: Other column number = 1/each column. For example, in 2011 0.50 = 1/2 or 2 = 1/.5. Notice as we move from 2010 to 2011 that the dollar buys more euros, or we could say the euro buys less dollars. Either way we end up saying the dollar has appreciated or strengthened and the euro has depreciated or weakened. But, from 2011 to 2012 the dollar buys less euros, or the euro buys more dollars. In this case the dollar has weakened or depreciated and the euro has appreciated or become stronger. Either way of expressing the exchange rate is okay, but be sure you know which way a given data set of exchange rates is presented.

10. The author shows us how to get data from various places. I want to show you this and show you the updated way in the newer version of Excel. Go to www.federalreserve.gov Toward the middle of the top part click “Economic Research & Data” Toward the middle of the bottom part under “Data Releases” click “Selected Interest Rates –H.15” Toward the middle of the middle part click “Historical Data” Scroll down to “Treasury constant maturities” and “Nominal” and further down to “10- year” and way on the right click on “Annual” Click on “OK” on the Excel pop-up box

11. Highlight all the data and then right click and scroll to copy Open a new page by clicking on the circle with the plus sign

12. When you get to the new sheet go to cell A4 and right click and scroll to Paste Special…. And scroll to Paste Values and get to the second one And you will see this option is Values and Number Formatting (A) The author says after you do this past copy the data on the new sheet and go back to the original data sheet and paste on top of the old data. He claims you have to do this to be able to use the data. See the next slide to see the data.

13. In Excel when you click on “INSERT” and then on “Recommended Charts” On the pop-up screen click on the “All Charts” tab and find the X Y Scatter option. OOPS – make sure you highlight the data in cells A6:B57 before doing the above. Then click on an option that will connect the dots.

14. In Excel you can click on the title and type a new title like “Interest Rate on 10-year Treasury Note.” So, in Excel we can manipulate data into graphs (and other things as well!).

15. Okay, stay with me on this slide. Perhaps I will be getting too philosophical here. I like to watch sports and news channels. Many commercials deal with pets that are abused, children with cancer and wounded soldiers. I see athletes visit hospitals and assist people who are less fortunate than I am and I see the Pope and other religious leaders express concern about how we live. I wrap all these ideas into what I would call our standard of living or quality of life. The study of money and banking is important mainly because ultimately in a world of economic scarcity we want to get an acceptable standard of living if we can. Understanding how the system works is an import part of getting the standard of living we desire! Wouldn’t it be great to wipe out poverty, cancer, war, ignorance?