Core Principals
1. Time has value
2. Risk requires compensation
3. Information is the basis for decision making
4. Markets determine price and resource allocation
5. Stability improves welfare
As the risk gets higher, how does that effect the size of the payment?
As the risk gets higher, the payment gets higher
The Foundation of the financial System
Collection and processing of information
The core of the economic system
Markets
Channels resources and minimizes the cost of gathering information and making transactions
Markets
What effect does a stable economy have on risk and welfare?
reduces risk and increases everyone's welfare
Main roles of a central bank
stabilize the economy
What other core principal is related to Stability improves welfare?
Risk requires compensation
What are the parts of the financial system?
1. Money
2. Financial instrument
3. Financial markets
4. Financial institutions
5. Government Regulatory Agencies
6. Central banks
Transfers resources from savors to investors to transfer the risk to those who are best equipped to bear it
Financial instruments
Another name for financial instruments
securities
Allow for the buying and selling of financial instruments easily
Financial Markets
The New York Stock exchange is an example of what?
Financial Market
Has the change of financial markets to primarily electronic markets increased or decreased the cost of processing financial transactions?
decreased
Stocks, mortgages, and insurance policies are examples of what?
Financial instrument
Banks, security firms, and insurance companies are examples of what?
Financial institution
What part of the financial system controls the availability of money and credit to promote low inflation, high growth, and stability of financial systems?
Central Banks
What is the central bank of the US?
The federal reserve
What are the functions of money?
1. Means of payment
2. Unit of Account
3. Store of value
Which function of money is the most important?
Means of Payment
What is the future of money being a means of payment?
Disappearing due to ease of electronic transactions
What is the future of money being a unit of account?
Likely to remain the same since it will always be needed to quote values and prices because it is efficient.
Financial institutions use which types of liquidity?
1. Market liquidity - ability to sell assets for money
2. Funding Liquidity - ability to borrow money to buy securities or make loans
What is the future of money being a store of value?
Disappearing due to liquidity of many financial instruments
Today's paper money because its value comes from government decree, or fiat.
Fiat Money
M1
-narrowest definition of money
-only includes the most liquid assets
-no longer a useful measure of money
-Ex: currency in hands of public, traveler's checks, demand deposits
M2
-is a broader definition
-includes all of M1 plus assets not used as a means of payment
-ex: saving deposits
-Most commonly quoted monetary aggregate
Is M2 useful for tracking inflation anymore?
No
primary cause of inflation
Too much money
Inflation makes money more or less valuable?
less valuable
Figure out what it would cost to buy the same basket of goods and services today/Compute the percentage change in the cost of the basket of goods
Consumer Price Index (CPI)
CPI formula
100 x (cost of basket in current year/cost of basket in base year)
written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under specified conditions.
Financial instrument
Functions of Financial Instrument
1. Means of Payment (Like money)
2. Stores of value (Like money)
3.Allow for the transfer of risk (Not like money)
Is financial instruments acting as a means of payment good or bad compared to money?
Are NOT a very good means of payment since you can't currently buy things with stock like with money
Is financial instruments acting as a means of stores of value good or bad compared to money?
Better than money since you can pay off in future if you don't have the money now
Financial instruments that act as means of payment
employees taking stock options as a payment for working
Financial instruments that act as a means of a stores of value
bank loans, bonds, home mortgages, stocks, asset backed securities
Financial instruments that act as a means of transferring risk
insurance contracts, Futures contracts, Option, Swaps