Money and Banking

1) make sure the system stays sound 2) to provide information

2 reasons for regulation of the financial system

Importance of Financial Institutions (3)

Financial intermediaries: Financial crises: Financial innovation

the initial yield to maturity

If a bond is held to maturity, the return = what?

PV goes down when interest rate goes up; vise versa

What happens to the present value when the interest rate goes up or down?

below

Yield is greater than coupon rate when bond price is ____ par value

Percentage change formula

[(ending-beginning)/beginning]*100

Bond Market

a bond is a debt security that promises to make payments periodically for a specified period of time plus interest

Foreign bond

a bond sold in a foreign country and denominated in that country's currency: ex. US company (GM) bond sold in London in pounds sterling: purchasers in London are buying a foreign bond

negative return if interest rates rise

a bond with a high initial yield can have a what?

Simple Loan

a credit market instrument providing the borrower with an amount of funds that must be repaid to the lender at the maturity date along with an additional payment (interest) one time loan

Discount bond

a credit market instrument that is bought at a price below its face value and whose face value is repaid at the maturity date. It does not make any interest payments-always going to purchase this at a price less than face value-ex. T-bills-one payment

Coupon bond

a credit market instrument that pays the owner of the bond a fixed interest payment every year until the maturity date when a specific final amount is repaid

Fixed Payment Loan

a credit market instrument that provides a borrower with an amount of money that is repaid by making a fixed payment periodically for a set # of years, ex. mortgage, car loan

Money markets

a market in which only SHORT-TERM DEBT is traded: anything that has a maturity of less than one year: T-bills, etc

Stock Market

a share of stock is a share of ownership in a corporation

Money

anything that is generally accepted in payment for goods and or services or in the repayment of debts

Short-term debt

debt that matures in less than a year: ex. Treasury bill

Intermediate-term debt

debt that measures in one to ten years: ex. car loan

Long-term debt

debt with a maturity date of ten years or longer: ex. mortgage

Fiscal policy

decisions about govt spending and taxation to try and get out of recession

Risk Sharing

financial intermediaries help individuals to diversify and reduce risk: spread it out Asymmetric information; one party to a negotiation has more information than the other party to the negotiation: the borrower knows more information than the lender: anytime we have insurance, we have this problem

Primary market

financial market in which new issues of a security are sold to initial buyers: the first time it is sold: the corporation acquires new funds here

Secondary Market

financial market in which securities that have been previously issued can be resold: the owner of the security receive funds here: resold on this market

Fisher equation

i= i(real) + π^e: π^e: expected rate of inflation

decrease in bond prices and a capital loss for bonds not held to maturity

if an increase in interest rates, this means what for bond prices and bonds?

Financial intermediaries

institutions that channel funds from savers to investors

Financial crises

major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and non-financial firms

Over-the-counter market

no one specific location: dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices: all done electronically: ex. NASDAQ

Rate of return

payments to the owner of a security plus the change in the security's value, expressed as a fraction of its purchase price

Growth rate

percentage change in a variable

The Importance of Financial Markets (3)

promotes economic efficiency by channeling funds from savers to investors (individuals that will put funds to productive use): affects the personal wealth of consumers: affects the behavior of businesses

Price level

the average price of goods and services in an economy

Inflation

the continual increase in the price level: don't want inflation (BAD!)

Par (face) value

the final specified amount that is paid to the owner of a coupon bond at the maturity date

Yield to maturity

the interest rate that equates the present value of a debt instrument's future payments to today's value: PV= FV/[(1+i)^n]

the longer the time to maturity...(rate of return)

the larger the change on the rate of return when the interest rate changes

Capital Market

the market in which LONGER-TERM DEBT and EQUITY INSTRUMENTS are traded: no maturity date

Gross Domestic Product (GDP)

the market value of all final goods and services produced in a country during a specified time period (usually a year)

moral hazard

the problem that happens after the transaction

nominal interest rate

what you see on your contract; on the market

Real GDP

GDP calculated using constant prices: look at the output to see if changed (growing?): use the base year prices

Nominal GDP

GDP calculated using current prices: producing more than we did before means we are growing

when you are importing and traveling

When do you want to have a strong dollar?

When you are exporting

When do you want to have a weak dollar?

par

When the bond is at ____, yield equals coupon rate.

U.S. Treasury

Who is responsible for paying govt bills and collecting receipts?

Congress

Who is responsible for setting the govt budget and conducting fiscal policy?

the Federal Reserve

Who is responsible for the monetary policy?

Eurobond

a bond denominated in a currency other than that of the the country in which it is sold: does not have to be in terms of "euros"..could be "yen": ex. GM bond sold in London in dollars

Consol (perpetuity)

a bond with no maturity date and no repayment of principal that pays fixed coupon payments forever

Coupon rate

the percentage of the par value that is paid in interest to the bondholder on a regular basis-once it is set, it will never change-set when it is first sold-similar to the current rates in the economy

Coupon payment

the periodic interest payment the holder of the coupon bond receives. It is calculated by multiplying the coupon rate times the par value

adverse selection

the problem that happens before the transaction

Transactions costs

the time and money spent carrying out financial transactions: financial intermediaries can reduce this through economies of scale

Business cycle

the up and down movement of aggregate output in the economy: will measure GDP: recession, trough (lowest peak), recovery, expansion (more than what you were at before the recession)

real interest rate

this is what is driving the borrowing

Present value

todays value of a payment to be received in the future when the interest rate is "i"; todays dollar is more valuable than the dollar in the future

Interest rate risk

The possible reduction on returns associated with charges on interest rates

that your economy is doing well

A strong dollar is an indication of what?

that your economy is doing poorly: U.S. had a weak dollar during recession which benefited us

A weak dollar is an indication of what?

Function of Financial Markets

Channel funds from savers to borrowers: improves economic efficiency

To reduce transactions costs

Function of Financial Intermediaries (transfer from lenders to borrowers)

Before the recessions, there is a decline in the money growth rate: Just because the money growth rate goes down, doesn't mean there will be a recession

How does the money growth rate relate to the business cycle?

interest rate risk (all bonds including Treasury have this risk)

Long-term bonds have greater what?

Financial Markets

Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage

negatively

Price and yield are ______ related.

less

Prices and returns for long-term bonds are more or less valuable than those for shorter term bonds?

GDP

Quantity*Price

current yield

The consol (perpetuity) formula used as the yield to maturity for a long-term coupon bond

the larger the bonds price change when the interest rate changes

The longer the time to maturity...(bonds)

Eurodollar

US dollars deposited in foreign banks outside the US borders or in foreign branches of US banks: leaving it in terms of dollars when it is deposited to another foreign bank or foreign branch of US bank

we have to borrow money (deficit): I collect more revenue than I pay (surplus)

What do we do if we have a budget deficit? surplus?

Investment bank: ex. Goldman Sachs

What financial institution helps with the primary market?

Direct finance

borrowers borrow funds directly from lenders in financial markets by selling them securities: lenders choose the borrowers: the savers choose who they give money to: ex. Purchasing a bond issued Ford Motor Company

Exchange

buyers and sellers of securities meet in one central location to conduct trades: ex. New York Stock Exchange (NYSE)

Equity

claims to share in the net income and the assets of a business: an owner of a corporation: get profits which are dividends; all bills have to be paid first

Debt

contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when a final payment is made: ex. bonds

Financial innovation

different than what it used to be due to technology and changed rules: can be good: need to understand and regulate it

Maturity date (term)

the date when the loan expires or when the final payment must be paid

Monetary policy

the management of the money supply and the interest rates

Foreign Exchange Market

the market where one currency is converted into another currency

Indirect finance

using a financial intermediary to channel funds from savers to borrowers: the savers dollars are still being used but the savers aren't choosing who the borrower is going to be; someone else is choosing that (credit union-charges interest): ex. Purchasing shares in a mutual fund