AP Econ Unit 4 Financial Markets and Monetary Policy

loanable funds market

channel funds from savers (who supply) to borrowers (who invest)

federal reserve

created in 1913 in response to panic of 1907 to prevent future financial crises, not really public institution or private

four bak regulation features

deposit insurance, capital requirements, reserve requirements, discount window

liquid vs illiquid

liquid: can be quickly converted into cash without much loss of value (money the most, stocks and bonds second, less= houses, painting, baseball card) illiquid: can't be quickly converted into cash without much loss of value

discount loans

loans from the fed to private banks

structure of the fed

public side=board or governors, private side=12 private regional fed banks

tangible, intangible, and human capital

t: investment in plant and equiipment i: research and development hc: investment in schooling, training on the job

budget balance

the difference between tax revenue and government spending

investment bank

trades in financial assets and is not covered by deposit insurance

financial risk

uncertainty about future outcomes that involve financial losses and gains

direct finance

when borrowers go directly to savers for funds (like firms sell a stock or bond directly tot public)

indirect finance

when savers lend funds to financial intermediaries, which then loan these funds to borrowers

collateralized loan

¡The house acts as "collateral" in exchange for the money borrowed to finance the purchase of the house

an increase in prices does not make everyone poorer

If the price of every good goes up, and wages and income also go up, no one is worse off

Initial Public Offering (IPO)

The first public offering of a corporation's stock/share

stock

a share of ownership in a company

M1

currency, demand deposits, traveler's checks, and other checkable deposits

real income/wage

income/wage divided by the price level (adjusts for inflation)

bond broker

licensed person who investors can buy bonds from

deposits with federal reserves, counted as a reserve?

money that bank owns held at fed, counts as reserves

public v private investors

public: a big company sells bonds directly to buyers; could be done through IPO (Initial Public Offering private: borrow money from friend

reserve ratio

the fraction of deposits that banks hold as reserves

interest rate

the price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year (face value-price at inception)/price at innception

monetary base

the sum of currency in circulation and bank reserves

national savings

the sum of private savings and the budget balance, is the total amount of savings generated within the economy

money supply

the total value of financial assets in the economy that are considered money

factors that shift MD

1) Changes in the aggregate price level 2) Changes in real GDP 3) Changes in banking technology 4) Changes in banking institutions/regulations

fed can alter the money supply by

1) Changing the discount rate : a higher discount rate discourages banks from borrowing reserves and a lower discount rate encourages banks to borrow from the Fed 2) Change the Reserve Requirement 3) Through FOMC, change the Federal Funds Rate

elements of bonds

1) Repayment or Maturity Date 2) Amount due at repayment: Face Value or Par Value 3) Coupon Rate or Interest rate: periodic interest payments to be paid to the bond owner

bond

IOU issued by borrower, firms will issue bonds to the public in order to borrow money and use those funds for investment (indirect financing)

Certificates of Deposit (CDs)

Savings accounts that guarantee a depositor a set interest rate (usually higher than normal) over a specified interval as long as the funds are not withdrawn before the end of the period—six months or one year for example

federal funds rate

The interest rate on overnight loans between private banks in federal funds market (influences other interest rates in the economy and spending/investing decisions made by consumers and producers)

excess reserve

a bank's reserves over and above its required reserves

fractional reserve banking

a banking system that keeps only a fraction of funds on hand and lends out the remainder

bank deposit

a claim on a bank that obliges the bank to give the depositor his or her cash when demanded

physical asset

a claim on a tangible object that gives the owner the right to dispose of the object as he or she wishes

bank

a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance borrowers' investment spending on illiquid assets

commodity money

a good used as a medium of exchange that has intrinsic value in other uses

central bank (sometimes called a reserve bank)

a government institution that issues currency, overseas and regulates the banking system, controls the monetary base, and implements monetary policy (the bank's bank)

loan

a lending agreement between an individual lender and an individual borrower

store of value

a means of holding purchasing power over time from present to future not always money, can be transfers of stocks and bonds if prices rise then money is not a good store of value bc its value can fall over time

unit of account

a measure used to set prices and make economic calculations

fiat money

a medium of exchange whose value derives entirely from its official status as a means of payment

commodity-backed money

a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods (cash backed by quantities of silver and gold)

financial asset

a paper claim that entitles the buyer to future income from the seller

bank run

a phenomenon in which many of a bank's depositors try to withdraw their funds due to fears of a bank failure

liability

a requirement to pay money in the future

medium of exchange

an asset that individuals acquire for the purpose of trading goods and services rather than for their own consumption

quantitative easing

an expansionary monetary policy that involves central banks purchasing longer-term government bonds and other private financial assets

financial intermediary

an institution that transforms the funds it gathers from many individuals into financial assets

monetary aggregate

an overall measure of the money supply

money

any asset that can easily be used to purchase goods and services functions: medium of exchange, unit of account, store of value

reserve requirements

are rules set by the Federal Reserve that determine the required reserve ratio for banks.

Federal Open Market Committee (FOMC)

consist of 7 members of board of governors and five regional bank presidents, president of new york regional bank is always on FOMc and the other 4 seats rotate between the 11 other regions, chair of board of governors is usually chair of FOMC, make decisions about monetary policy

monetary policy (made by what?)

decisions concerning the money supply (made by the FOMC)

federal funds

deposits that private banks hold on reserve at the fed (Banks keep reserves at the Fed because the Fed clears federal funds loans, loans between banks)

rating agencies

evaluate the default risk of all borrowing entities and give a grade showing the likelihood of defaulting

mutual fund

fund that pools the savings of many individuals and invests this money in a variety of stocks, bonds, and other financial assets

future value

future value of some current amount of money is the amount to which it will grow as interest accumulates over a specified period of time

if inflation rate is higher, borrowers if inflation rate is lower, lenders

gain at the expense of lenders lenders gain at the expense of borrowers

government bonds, counted as a reserve?

gov borrows money from bank (not counted as a reserve)

deposit insurance

guarantees that a bank's depositors will be paid even if the bank can't come up with the funds, up to $250,000 amount per account

expected real interest rate

nominal interest rate - expected inflation rate

mortgage payment composed of four parts

principle (total amount of money borrowed to buy the home), interest, taxes, insurance

the fed's functions

providing financial services to depository institutions, supervising and regulating banks and other financial institutions, maintaining stability of financial system, conducting monetary policy

savings-investment spending identity

savings and investment spending are always equal for the economy as a whole

money demand curve

shows the relationship between the quantity of money (you keep as cash) demanded and the nominal interest rate (slopes downward)

present value

the amount of money today that would be needed, using prevailing interest rates, to produce a given future amount of money

Owner's Equity

the amount remaining after the value of all liabilities is subtracted from the value of all assets (put in liabilities side)

bank reserves

the currency banks hold in their vaults plus their deposits at the Federal Reserve

budget deficit

the difference between tax revenue and government spending when government spending exceeds tax revenue

budget surplus

the difference between tax revenue and government spending when tax revenue exceeds government spending

transaction costs

the expenses of negotiating and executing a deal

nominal interest rate

the interest rate actually paid for a loan (real interest rate + inflation rate) can't be negative

real interest rate

the interest rate corrected for the effects of inflation (nominal interest rate - inflation rate) can be negative because the money can lose it's value because of inflation

interest rate on reserves

the interest rate that the Federal Reserve pays on reserves held by banks

secondary market

the market in which previously issued securities are traded among investors

net present value

the present value of current and future benefits minus the present value of current and future costs

Open-Market Operations (OMOs)

the purchase and sale of U.S. government debt (bonds) by the Fed, doesn't always directly affect the money supply but starts the money multiplier (open market sale can cause reserves to fall, less loans, less money supply)

board of governors

the seven-member board that oversees the Federal Reserve System, appointed by president and approved by senate, serve 14 year terms, chair appointed more frequently (every 4 years). oversee everything

required reserve ratio

the smallest fraction of deposits that the Federal Reserve allows banks to hold

role of department of the treasury

•Production of coin and currency, the disbursement of payments to the American public, revenue collection, and the borrowing of funds necessary to run the federal government. •Implement economic sanctions against foreign threats to the U.S., provide information on financial threats, and improv the safeguards of the financial systems. •Collect taxes, duties and monies paid to and due to the U.S. : largest division is the Internal Revenue System •Pay the bills of the U.S.; •Manage Government accounts and the public debt; •Supervise national banks and thrift institutions; •Advise on trade and tax policy; •Enforce Federal finance and tax laws; •Investigate and prosecute tax evaders, counterfeiters, and forgers

M2

All of M1 + savings deposits, money market funds, certificates of deposit, and other time deposits (debit cards pull from checking/savings accounts so they count, credit cards don't bc they're loans)

wealth

The total value of money and other assets, minus outstanding debts

12 fed reserve banks

each serve a region of country known as federal reserve district, owned by private commercial banks in their district, run by board of directors chosen from local banking and business community

capital inflow

equal to the total inflow of foreign funds minus the total outflow of domestic funds to other countries

primary market

direct connection between savers and borrowers

opportunity cost of cash

doesn't gain interest and earn you more money (is more convenient though so can be more valuable than the interest gained in an account)

implementation regime

how the fed implements monetary policy

options for savers

stuff in mattress, savings account, buy land/invest in real estate, invest in stocks of bonds, buy gold/invest in collectibles

counted as money

1) Currency: paper bills and coins in the public sphere 2) Demand Deposits: wealth held in a checking account that can be access on demand by a check or debit card 3) Savings account: can't write a check but can be easily transferred to the checking account 4) Some money market mutual funds have check writing privileges

financial markets goals

1. raising capital 2. Storing, protecting, making profitable use of excess capital 3. insuring against risk

discount window

Allows banks to quickly borrow money from the Federal Reserve in an emergency

capital requirement

Bank regulators require banks to hold a certain amount of capital; ensure that banks will be able to pay off their depositors without having to resort to government provided deposit insurance

bank capital

Banks get financial resources not only from accepting deposits but also from issuing equity and debt

commercial bank

accepts deposits and is covered by deposit insurance

discount rate

interest rate on the discount loans made from the Fed to private banks.

treasury securities

the bonds sold by the U.S. government to pay for the national debt

money multiplier

the ratio of the money supply to the monetary base. It indicates the total number of dollars created in the banking system by each $1 addition to the monetary base deposits * (1/RR) reciprocal of reserve ratio (If the reserve ratio is 1/10 (i.e. 10% of assets), then the money multiplier is 10)

default risk

the risk that the borrower will not pay the face value of a bond on the maturity date