Transcript Document

Chapter 1
Why Study
Money, Banking,
and Financial
Markets?
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Why Study Financial Markets?
1. Financial markets channel funds from
savers to investors, thereby promoting
economic efficiency
2. Financial markets are a key factor in
producing economic growth
3. Financial markets affect personal wealth
and behaviour of business firms
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The Bond Market & Interest Rates
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A security (financial instrument) is a
claim on the issuer’s future income or
assets
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An asset is any financial claim that is
subject to ownership
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The Bond Market & Interest Rates
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A bond is a debt security that
promises periodic payments for a
specified time
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An interest rate is the cost of
borrowing or the price paid on the
rental of funds
Interest rate and the US subprime
mortgage crisis
•
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The Bond Market & Interest Rates
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The Stock Market
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A stock represents a share of
ownership in a corporation
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A stock is a security that is a claim on
the earnings and assets of that
corporation
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Stock Market
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Ten Largest Canadian Companies
by Market Cap
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Royal Bank of Canada
Manulife Financial
Bank of Nova Scotia
Toronto-Dominion Bank
EnCana Corp.
Suncor Energy
Imperial Oil
Cdn. Natural Resources
CIBC
Bank of Montreal
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Foreign Exchange Market
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The foreign exchange market is where
one country’s currency is exchanged for
another
The exchange rate is the price of one
country’s currency in terms of another
Appreciation/depreciation is a rise/fall in
the value of a country’s currency
Recent exchange rate fluctuation of CND
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Foreign Exchange Market
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Banking and Financial
Institutions
• Financial Intermediaries - institutions that
borrow funds from people who have saved and
make loans to other people
• Banks - institutions that accept deposits and
make loans
• Other Financial Institutions - insurance
companies, finance companies, pension funds,
mutual funds and investment banks
• Financial Innovation- in particular, the advent of
the information age and e-finance
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Money and Business Cycles
• Evidence suggests that money
plays an important role in generating
business cycles
• Evidence also suggests that monetary
policies are often a response to business
cycles
• Recessions (unemployment) and booms
(inflation) affect all of us
• Mckenzie and Fort St. John
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Money and Business Cycles
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• The decline of money supply is an
indication of recession, not the driving
force behind recession.
• Most Canadian recessions are caused by
recessions south of border.
• When was the last recession in Prince
George? Was it caused by any monetary
policy?
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Money and Inflation
• The aggregate price level is the
average price of goods and services in
an economy
• A continual rise in the price level
(inflation) affects all economic players
• Data shows a connection between the
money supply and the price level
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Money and the Price Level
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Question
• Why inflation rates lower than growth rate
of money supply, especially after 1998?
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Oil price in 2006 dollar
100.00
80.00
60.00
40.00
20.00
0.00
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Money Growth and Inflation
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Money and Interest Rates
• Interest rates are the price of money
• Prior to 1980, the rate of money growth
and the interest rate on long-term
bonds were closely tied
• Since then, the relationship is less
clear but still an important determinant
of interest rates
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Money Growth and Interest
Rates
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• The sharp turning point at 1998 was
during Asian financial crisis when money
flowed to North America, keeping Money
Growth Rate High and Interest Rate low.
• Another point when the direction of money
growth rate differ very much from interest
rate is at 1985, when oil price reach the
lowest point and Iran-Iraq was at war.
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Monetary and Fiscal Policy
• Monetary policy is the management of
the money supply and interest rates
– Conducted by the Bank of Canada
• Fiscal policy is government spending
and taxation
– Budget deficit/surplus is the excess of
expenditures/revenue over
revenues/expenditures for a particular year
– Any deficit must be financed by borrowing
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How We Study Money and
Banking
Basic Analytic Framework
• Simplified approach to the demand for assets
• Concept of equilibrium
• Basic supply and demand approach to
understand behaviour in financial markets
• Search for profits
• Transactions cost and asymmetric information
approach to financial structure
• Aggregate supply and demand analysis
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How We Study Money and
Banking (Cont’d)
Features:
1.Case studies
2. Applications
3. Special-interest boxes
4. Financial News boxes
6. Web Exercises and References
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Appendix: Definitions
• Aggregate Output
Gross Domestic Product (GDP) = Value of
all final goods and services produced in domestic
economy during year.
• Aggregate Income - Total income of factors of
production (land, capital, labour) during year
• Nominal = values measured using current
prices
• Real = quantities measured with constant
prices
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Appendix: Definitions
• Aggregate Price Level
GDP Deflator = Nominal GDP/Real GDP
Consumer Price Index = (CPI) price of a “basket” of
goods and services
Inflation rate = growth rate of the aggregate price
level (percent change from previous period)
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Note on the definition of inflation
• Inflation rate often underestimate the cost
of housing because new houses only
represent a small percentage of housing
purchases and even smaller percentage of
potential house buyers. Inflation rate is
especially not helpful in indicating the
difficulty of first time house buyers.
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Homework
• 2, 4, 6, 10
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