UNIT 4

3/4/16

Money

·      Uses of money

-Medium exchange- Barter and trading

-Unit of Accounting-It establishes economic value

-Store of Value- money holds its value over a period of time whereas products may not.

·      Types of money

-Commodity money- it gets its value from the type of material from which it is made (ex. Gold and silver coins)

-Representative money- Paper money that is backed by something tangible

-Fiat money- money because the government says so.

·      Characteristics of money

-Divisible- breaking down money

-Portable- carry

-Uniform- a dollar is a dollar

-Acceptable- everywhere we go

-Scarce

-Durable

·      Money supply

Liquid- easy to change to cash

-M1 money- Currency, checkable deposits (demand deposits), travelers check. 75% of money comes from this. Most liquid.

-M2 money- Consists of M1 money, savings accounts, and deposits made by banks outside the USA.

-M3 money- Consists of M2 and certificate of deposits, better known as CDs.

CD- Money in a bank for x amount of time. Get interest, but pulled out early you are charged.

3/9/16

·      Time Value of Money

-Is a dollar today worth more than a dollar tomorrow?

Yes, because of inflation.

This reason is the reason for charging and paying interest.

·      Let v= Future value of money

·      P= Present value of $

·      R=real interest rate (nominal rate- inflation rate)

Expressed as a decimal

N= Years

K= number of times interest is credited per year

·      The simple interest formula

V=( 1 + r) ^n *p

·      The compound interest formula

V= (1 + r/K) ^ nk *p

·      Demand for money has an inverse relationship between nominal rates and the quantity of money demanded

·      What happened to the quantity demanded of money when interest rates increase?

-Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.

·      What happens to the quantity demanded when interest rates decrease?

-Quantity demanded increases. There is no incentive to convert cash into interest earning assets.

·      The money demand shifters:

Change in price level

Change in income

Changes in taxation that affects investment

·      Increasing money supply, interest rate decrease, investment increases, AD Increase

·      Decreasing money supply, interest rate increase, investment decreases, AD decrease

·      Financial Sector:

·      Financial assets- Something that you own.

·      Liabilities-Something you owe

Financial assets

Financial Liabilities

·      Interest Rate- cost to borrow money

·      Stocks- a share of a company you buy

·      Bonds- lend money to the government and promise to pay you back with interest.

Stocks

Bonds

What do Banks do

·      A bank is a financial intermediary

-uses liquid assets (i.e. bank deposits) to finance the investments of borrowers

-Process is known as Fractional Reserve bank

A system in which depository institutions hold liquid assets less than the amount of deposits.

-can take the form of:

1. currency in bank vaults

2. Bank reserves- deposits held at the federal reserve.

·      T- Account (balance Sheet)

·      Assets (amounts owned)

-items to which a bank holds legal claim

-the uses of funds by financial intermediaries

·      Liabilites (Owed)

-The legal claims against

Liabilities (owe)

Assets(own)

3/10/16

·      Reserve requirements:

-the fed requires banks to always have some money readily available to meet consumer’s demand for cash.

-the amount is set but the Fed, is the required reserve ration

-the required reserve ratio is the % of demand deposits (checking account balances) that must not be loaned out

-Typically the required reserve ration= 10%

·      Type of multiple deposit expansion questions:

-Type 1: calculate the initial change in excess reserves (Amount a single bank can loan from the initial deposit)

-Type 2: calculate the change in loans in the banking system

-Type 3: calculate the change in the money supply (sometime 2&3 have the same result) Ex. No Fed involvement

·      Monetary ratio: 1/ reserved requirement

·      Total change in deposits in the bank (Maximum change in money supply) - ER X MM + Deposit

3/21/16

3 tools of monetary

1.     Reserve requirement: only a small percent of your bank is in the safe. The rest of your money has been loaned out. This is called “Fractional Banking”. Fed sets amount of banks must hold. Reserve requirement (reserve ratio) is the % of the deposits that the bank must hold in reserve and not loan out. When FED increases money supply it increases the amount of money held in bank deposits.

-statement 1: if there is a recession what should FED do to reserve requirement? Decrease reserve ratio 1) Banks hold less money and have more excess reserves. 2) banks create more money by loaning out of access. 3) money supply increases interest rates fall AD goes up

-Statement 2: if there’s an inflation what should FED do to the reserve requirements? Increase reserve ratio

2.     Discount rate: discount rate is the interest rate that the FED charges commercial banks.

EX: to increase money supply the FED should decrease discount rate. To decrease money, supply the FED should increase the discount rate.

3.     OMO (open market operations): FEDS buy / sell government bonds (securities). This is most important and widely used monetary policy.

-to increase money supply FEDs should buy government securities

- to decrease money supply FEDs should sell government securities.

Federal Fund rate: Where FDIC member’s banks loan each other overnight funds.

Prime Rate: the interest rate that banks give to their credit worthy customers.

3/29/16

·      When a customer deposits cash or withdraws cash from their demand deposit acct., it has no effect on money supply.

Single Bank ex. Chase	Banking System  ex. Chase, wells, B.O.A.
-loan money from excess reserves	- ER X Multiplier *total money supply ^

It only changes:

·      The composition of the money 

·      Excess reserves

·      Required reserves

When the FED buys or sells bonds ER is created