EC223

money market instruments

-Government of Canada T-Bills: most liquid -Commercial Paper: unsecured short-term debt instrument issued by large banks and corporations -->interest rate reflects risk and is low relative to those on other corporate fixed-income securities and slightly higher than rates on government of Canada T-bills -Repurchase Agreements (repos): short term loan for which treasury bills serve as collateral -Overnight funds: loans by banks to other banks -->responds to the credit needs of the deposit taking institutions

types of financial intermediaries - contractual savings institutions

-acquire funds at periodic intervals -can predict with reasonable accuracy how much they will have to pay out in benefits in the coming years -the liquidity of assets is not as important a consideration for them as it is for depository institutions -tend to invest their funds primarily in long-term securities such as corporate bonds, stocks, and mortgages -life insurance companies -property and casual insurance companies -pension funds and government retirement funds

e-money: Bitcoin

-advantage: functions well as a medium of exchange. lower transactions costs and increased privacy -disadvantage: not a good unit of account or store of value: sizable volatility of the price of Bitcoins, uncertain security from theft and fraud: e.g. Mt Gox -raises a number of legal and regulatory concerns including its potential for facilitating money laundering and its status in the regulation of foreign exchange trading -Blockchain could be the future epayment system

cheques

-allow transactions to take place without the need to carry around large amounts of currency -improved the efficiency of the payments system -->payments back and forth cancel each other; without cheques, this would involve the movement of a lot of currency -->reduces the transportation costs associated with the payments system and improves economic efficiency -->loss from theft is greatly reduced -->they provide convenient receipts for purchases -problems: -->it takes time to get cheques from one place to another, serious problem if you are paying someone in a different location who needs to be paid quickly -->it usually takes several business days before a bank will allow you to make use of the funds from a cheque you deposited -->all the paper shuffling required to process cheques is costly

function of financial intermediaries - risk sharing

-asset transformation: financial intermediaries create and sell assets with risk characteristics that people are comfortable with -->ex. sell chequing accounts to invest into riskier portfolios -diversification: investing in a collection (portfolio) of assets whose returns do not always move together

function of financial intermediaries - mitigate asymmetric information problems

-asymmetric information: one party doesn't know enough about the risks in comparison to another party -adverse selection: -->before the transaction -->financial intermediary avoids selecting the risky borrower by gathering information (ex. credit rating) about potential borrower -moral hazard: -->after the transaction -->ensure borrower will not engage in activities that will prevent him/her to repay the loan (ex. by signing a contract with restrictions)

functions of money - medium of exchange

-barter economy: the economy without money, in which goods/services are exchanged directly for other g/s -eliminated the trouble of finding a double coincidence of needs (reduces transaction costs) -promotes specialization -a medium of exchange must be: easily standardized, widely accepted, divisible, easy to carry, not deteriorate quickly

types of financial intermediaries - depository institutions

-chartered banks: raise funds by issuing deposits -->use these funds to make commercial, consumer, and mortgage loans and to buy Canadian government securities and provincial and municipal bonds -trusts and mortgage loan companies -->in the past, these institutions were constrained in their activities but these days TMLs provide most of the services provided by chartered banks -credit unions and caisses populaires -->very small cooperative lending institutions organized around a particular group: union members, employees of a particular firm, and so forth

equity (stock) market

-common stocks: shares in corporation -dividends: periodic payments -capital gain: increase in price -disadvantage: shareholder is residual claimant -advantage: confers ownership rights on the equity holders

fiat money

-currency has evolved into fiat money, paper currency decreed by governments as legal tender (meaning that legally it must be accepted as payment for debts) but not convertible into coins or precious metal -major problems: paper currency and coins easily stolen, can be expansive to transport if there are large amounts

classification of financial market

-debt and equity -primary and secondary -money market and capital market

Debt (bond) market

-debt: a contract between a borrower (who issues bond) and lender (who owns it) -maturity: number of years until the debt instrument's expiration --> short term (maturity < 1 year) --> intermediate term (maturity between 1 and 10 years) --> long term (maturity > 1 year)

growth rates of monetary aggregates

-does it matter which measure of money is considered? yes -aggregates can move in different directions in the short run -conclusion: the choice of monetary aggregate is important for policymakers

investment intermediaries

-finance companies: raise fund by issuing CP, stocks and bonds, lend the money to consumers and small businesses -mutual funds: raise funds by selling shares, use fund to purchase stocks and bonds -money market mutual funds MMMF: raise fund by selling shares, use the fund to purchase money market instruments

e-money

-money that exists only in electronic form -debit card -smart card and e-cash

primary market

-new issues of a security are sold to initial buyers by the corporation or government agency borrowing the funds --> not well known to the public --> investment bank assists in the initial sale of securities by underwriting securities --> purchase a big part of the securities

secondary markets - exchanges

-organize exchanges: buyers and sellers of securities meet in one central location to conduct trades (TSX, NYSE, Winnipeg Commodity Exchange) -Over the counter market: network of dealers at different locations who have an inventory of securities stand ready to buy and sell securities -->small stocks, bonds, currencies, derivatives and structures products, government bonds -->more competitive than organized exchange because dealers can see what prices each other are setting

paper currency

-paper convertible into coins or a quantity of precious metal

commodity money

-precious metals or other valuable commodity -problem: hard to transport

regulation of financial markets

-primary reasons for regulation: increase information to investors, increase efficiency of financial markets -ensure the soundness of intermediaries -->restrictions -->disclosure, periodic inspection -->deposit insurance

secondary market

-securities previously issued are bought and sold -functions -->increase the liquidity of instruments -->determine the price of security that the issuing firm sells in the primary market -brokers and dealers are crucial for well functioning secondary markets -->brokers: agents who match buyers and sellers of securities -->dealers: buying and selling securities at stated prices (principal, markup, Nasdaq)

examples of secondary markets

-stock exchange -bond market -foreign exchange market -futures market -options market

capital market instruments

-stocks -mortgages: loans to households or firms to purchase housing, land, or other real structures, where the asset serves as collateral -->largest debt market in Canada -mortgage backed securities: bond-like debt instrument which is backed by bundle of individual mortgages -corporate bonds: issued by corps with strong credit rating -->size of corporate bond market is smaller than that of stock market, but volume is larger -consumer and bank commercial loans

money as a weighted average

-the Bank of Canada's money supply measures simple-sum indices, the index - M = x1+x2+xn -where xj is one of the n monetary components of the monetary aggregate M

function of financial intermediaries - reduce transaction costs

-time and money spent in carrying out financial transaction -economies of scale: loan contract can be used for many loans and specialized software/expertise for risk management

money markets

-trade in short term debt instruments (maturity < 1 year)

function of financial markets

-transfer funds from people that have surplus funds to those that have a shortage of funds -promote efficient allocation of capital -improve consumer's wellbeing: allows consumers to time purchases

function of money - store of value

-used to save purchasing power over time -other assets also serve this function -money is the most liquid of all assets but loses value during inflation -->liquidity: relative ease and speed with which an asset can be converted into money -->liquidity spectrum: currency, chequing account, savings acc, government bond, stocks and corporate bonds, houses and arts -hyperinflation: inflation rate exceeds 50% per month

function of money - unit of account

-using money as a unit of account reduces the number of prices -reduces transaction cost, and facilitate comparison of value

measuring money

-which particular assets can be called "money" -construct monetary aggregates using the concept of liquidity

measuring money con't

M1+ = currency + chequable deposits M1++ = previous + non chequable deposits at depository taking institutions M2 = currency + bank deposits+fixed term deposits M2+ = previous + deposits at TMLs and CUCPs M2++ = previous + certain retain debt instruments M3 = M2 + non-personal term deposits + foreign currency bank deposits

assets and liabilities of a financial intermediary

assets: loans, investment, stocks purchased, bonds purchased liabilities: deposits, CP, stocks issued, bonds issued

capital market

trade in longer term debt (maturity > 1 year) and equity