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by: Bethany Conn


Bethany Conn
GPA 3.71

Charles Cook

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Charles Cook
Class Notes
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This 22 page Class Notes was uploaded by Bethany Conn on Tuesday October 13, 2015. The Class Notes belongs to ECON 2035 at Louisiana State University taught by Charles Cook in Fall. Since its upload, it has received 8 views. For similar materials see /class/223018/econ-2035-louisiana-state-university in Economcs at Louisiana State University.




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Date Created: 10/13/15
1 8242010 Mon y Banking g Financiai Markei Why Study Money Banking and Financial Markets 0 To examine how financial markets such as bond stock and foreign exchange markets work 0 To examine how financial institutions such as banks and insurance companies work 0 To examine the role of money in the economy OOVVO v J V barrage 8242010 Financial Markets Markets in which funds are transferred from people who have an excess of available funds to people who have a shortage of funds The Bond Market and Interest Rates 0 A security financial instrument is a claim on the issuer s future income or assets 0 A bond is a debt security that promises to make payments periodically for a specified period of time 0 An interest rate is the cost of borrowing or the price paid for the rental of funds r 4 i A A r15 3 you sz aormrw mrx 22f 39 prvmlxgotrs more 01 rugpmj xt 2c army L 1439 p393 e pt i a mtaagr 8242010 FIGURE 1 Interest Rates on Selected Bonds 1950 2008 interest Rate 93923 20 Corporate Baa Bonds us Government LongTenn gonds neasury Biiis o v i i 1 i I i a s 1950 1955 1960 was 1970 1975 1930 1985 1990 1995 2000 2005 2010 Sources Federal Reserve Bulletin wwwfederalreservegovreleasesHlSdatahtm xx 1 quotiquot i is fi good Kiriquot Ezy 313 ff The Stock Market Common stock represents a share of ownership in a corporation 0 A share of stock is a claim on the earnings and assets of the corporation A sotquot i a meme 1 You own Corp Ft bO i L 0 G Let x a mt93 Stock I On hi 3 3 Or wing Hquot an Elfg a 5 IiiHitquot 0 taka 134 rm z 8242010 FIGURE 2 Stock Prices as Measured by the Dow Jones Industrial Average 1950 2008 Dew Jeans lmslrml may 15500 o i r i 135C 1355 mm 595 197 1975 mac 1935 mo was 2000 2005 240 Source Dow Jones Indexes http nanceyahooicomu Financial Institutions and Banking 0 Financial Intermediaries institutions that borrow funds from people who have saved and make loans to other people Banks accept deposits and make loans Other Financial Institutions insurance companies finance companies pension funds mutual funds and investment banks 0 Financial Innovation in particular the advent of the information age and e nance C met r bow3v cm savers at oiisrr wrikvwifc EWHOVMQY Lida than onlln b 09mlmy lD 8242010 Financial Crises 0 Financial crises are major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms 4m a m wt 5 1 s f 395 z a was rvulrvquot ew v A slowmg Cr Lia m C xferww r J 90m 1V0 D t r vg f cg Money and Business Cycles Evidence suggests that money plays an important role in generating business cycles Recessions unemployment and expansions affect all of us Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level i w r 6699 I x W A r exmnae n I V 2 C 397 oLHerra ma q 8242010 FIGURE 4 Aggregate Price Level and the Money Supply in the United States 1950 2008 inwxlmu 1007 3m 7 Aggregm We Lew e39 991mm 25 I meysupply Am G l i z m 1955 1950 m 1970 1975 1950 1935 1990 ms m 2905 20m SOUI39C95 Q ie i PEEL wwwfederalreservegovreleasesh6histh6hist10txt Mowvts 609de glam l glZlgv GD km xed Money andxlnflation o 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 IV Mattien 3 46 A m price Qmm L gem r lt AS WGlfx Ab 4X gr f9 3 34 dis a gt5 Xv a 551x Slag somalwwa is aw 6 B 8242010 FIGURE 5 Average Inflation Rate Versus Average Rate of Money Growth for Selected Countries 1997 2007 Avemge inilauon Rale 1 so 7o Belarus 60 9 so 40 Romania Ecuador 39 an 32 Uruguay Venezuela 20 1 Colombia mussia m I Mexico United Kingdomla C 9 5 31 United Statesma xpem 2 l I x x a fsojzo so 40 so so 70 so so mo g Argentina Avemgeamnayemwmaazem Switzerland Source International Financial Statistics FIGURE 6 Money Growth M2 Annual Rate and Interest Rates Long Term US Treasury Bonds 1950 2008 Interest lame Grown R2329 Rats Wu 63 annual rate 13 1 a i i I 6 a I a 1950 3955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2105 200 Sources Federal Reserve Bulletin p A4 Table 110 wwwfederalreservetgovreisaseshShisthshistlttxt 8242010 Money and Interest Rates 0 Interest rates are the price of money Prior to 1980 the rate of money growth and the interest rate on longterm Treasury bonds were closely tied 0 Since then the relationship is less clear but the rate of money growth is still an important determinant of interest rates 0 i i i i f We m vx we v 1le mot DJtamf5 H l Pm ca O J mm run 2 m a arig j w r FIGURE 7 Government Budget Surplus or Deficit as a Percentage of Gross Domestic Product 1950 2008 Perceni of GDP 3 m mwpwmgo l I l l l i l l l i l 1950 1955 1960 1965 1970 1975 i980 1985 1990 7995 2000 2005 2010 Source www 39 39 8242010 Monetary and Fiscal Policy Monetary policy is the management of the money supply and interest rates Conducted in the US by the Federal Reserve System Fed 0 Fiscal policy deals with government spending and taxation Budget deficit is the excess of expenditures over revenues for a particular year Budget surplus is the excess of revenues over expenditures for a particular year Any deficit must be financed by borrowing FIGURE 8 Exchange Rate of the US Dollar 1970 2008 index March 1973 100 l I 4 q l 4 x 1 r x 4 i 4 1970 1975 1980 1955 1990 1995 Source Federal Reserve wwwfecleraIreservegovreleasesH105ummaryindexbcmtxt 8242010 The Foreign Exchange Market 0 The foreign exchange market is where funds are converted from one currency into another 0 The foreign exchange rate is the price of one currency in terms of another currency 0 The foreign exchange market determines the foreign exchange rate FIGURE 3 Money Growth M2 Annual Rate and the Business Cycle in the United States 1950 2008 Money Gmwzn Raie my i5 Money Growl 7M 5 t 1 f 50 955 19 1955 1970 1575 19 w if z a l x l 1955 19 1995 2000 2005 2010 Note Shaded areas represent recessions Source Federal Reserve Bulletin p A4 Table 110 39 39 r l39 8242010 International Finance Financial markets have become increasingly integrated throughout the world 0 The international financial system has tremendous impact on domestic economies How a country s choice of exchange rate policy affect its monetary policy How capital controls impact domestic financial systems and therefore the performance of the economy Which should be the role of international financial institutions like the IMF How We Will Study Money Banking and Financial Markets 0 A simplified approach to the demand for assets 0 The concept of equilibrium 0 Basic supply and demand to explain behavior in financial markets 0 The search for profits 0 An approach to financial structure based on transaction costs and asymmetric information 0 Aggregate supply and demand analysis 8242010 FIGURE 9 Federal Reserve Board Website n 5 Selected Interest Rates Weekly V mm I W W W Release Dates m u meMmyvmh mym Wmisa inwbx thcan cdatz will I W MMy gamlly a MILE 39 m as in ms m for m following Ms W Cumnt mm M W mumst W W W mm W FIGURE 10 Excel Spreadsheet with Interest Rate Data FIGURE 11 Excel Graph of Interest Rate Data Recyvswxi m hm 1 x m V iapw w 1 W 8242010 8252010 i S E tquot 0 Money j Finan Maria Enormqu Susaaw mi ofove Q mc wua E ti39la fic J a ogevt wa 42 Shir trite via Capr rm A waallr ng Crhner Memoi or p mggigm 2 ne t3 pfod39oce more weed kw Function of Financial Markets Perform the essential function of channeling funds from economic players that have saved surplus funds to those that have a shortage of funds Direct finance borrowers borrow funds directly from lenders in financial markets by selling them securities Wm ivmr re 0 bug 51ml ww iom car quot Q M mow j jx i 2 03365 iq gi if 1 mm w a 5 lie 2 8252010 Function of Financial Markets Promotes economic efficiency by producing an efficient allocation of capital which increases production Directly improve the well being of consumers by allowing them to time purchases better FIGURE 1 Flows of Funds Through the Financial System 8252010 Structure of Financial Markets 0 Debt and Equity Markets Debt instruments maturity v giwm W i3 l39wirz Equities dividends gtiCK WloUe dmdemdg patinavibes or i v wu o aa aw Cl93 a 1447ka 0 Primary and Secondary Markets V 3 Investment Banks underwrite securities in primary markets bog m r no x swim Memm xed Brokers and dealers work in secondary markets A v gmqg 3333 wgs was heat a if f ii tlol Q33 slum Cl winter pl Dwid m g are onle Paid li me COFQSYVQEl lQm more 1 at mfwria mgr Magma 29mins everwee 9692 5 W ii i l M t v Y C Woe dem licosel nm 3 33 C bllli blowv PWd 0 Ere bome owea believe in d d b Structure of Financial Markets 0 Exchanges and Over the Counter OTC 1 Markets VMQQ Magma l d 39 g if EXChan9953 NYSE Chicago Board of Trade 39 agrees 1a deter JG 1 price bale 51 r gt OTC Markets Foreign exchange Federal fundcs Nam m groom cam ail or 0 Money and Capital Markets smegma Pi lb g Money markets deal in shortterm debt instruments Capital markets deal in longerterm debt and equity instruments Mom mm at 9 means ragtime to less tram nanwee geqh big SSE1 t 35 egirxigh i itthm lasagna 3 GEEEarle newts m greater we t 3 i CIRAlexi 36 8252010 Table 1 Principal Money Market Instruments Ovaxquot Maj in team Jk Ari VH i PM are Sm 3394 H Table 2 Principal Capital Market Instruments kin 6W Ob quot i Do 3 3 a s N A T i2r i 1343 V92be it i x 1 3 23 gt n Ems10m i as 0 c extW39P i 8252010 Internationalization of Financial Markets Glossary Foreign Bonds sold in a foreign country and denominated in that country s currency Eurobond bond denominated in a currency other than that of the country in which it is sold Km w mm m dam magma Eurocurrencies foreign currencies deposited in 2 banks outside the home country Eurodollars US dollars deposited in foreign banks outside the Us or in foreign branches of US banks World Stock Markets Help finance federal government also Function of Financial Intermediaries Indirect Finance Lower transaction costs time and money spent in carrying out financial transactions Economies of scaleasob quot airt vacreams Amman Liquidity services can go 133in 4m Lousci vice vei ea Reduce the exposure of investors to risk Risk Sharing Asset Transformation Diversification 8252010 Function of Financial Intermediaries Indirect Finance a Deal with asymmetric information problems before the transaction Adverse Selection try to avoid selecting the risky borrower Gather information about potential borrower after the transaction Mgggl azard ensure borrower will not engage in activities that will prevent himher to repay the loan 0 Sign a contract with restrictive covenants Function of Financial Intermediaries Indirect Finance 0 Conclusion Financial intermediaries allow small savers and borrowers to benefit from the existence of financial markets 63 Gill12 i J 8252010 Table 3 Primary Assets and Liabilities of Financial Intermediaries Table 4 Principal Financial Intermediaries and Value of Their Assets 8252010 Regulation of the Financial System 0 To increase the information available to investors Reduce adverse selection and moral hazard problems Reduce insider trading SEC Regulation of the Financial System 0 To ensure the soundness of financial intermediaries Restrictions on entry chartering process Disclosure of information Restrictions on Assets and Activities control holding of risky assets Deposit Insurance avoid bank runs Limits on Competition mostly in the past Branching 0 Restrictions on Interest Rates 8252010 Table 5 Principal Regulatory Agencies of the US Financial System V OW


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