Module 22-23

Assets, Wealth, & Liabilities

• A household’s wealth is the value of its accumulated savings.

• Financial assets are paper claims, physical assets are tangible claims.

  • A financial asset is a paper claim that entitles the buyer to future income from the seller.

  • A physical asset is a claim on a tangible object that gives the owner the right to dispose of the object as he or she wishes.

• A liability is a requirement to pay income in the future.

   

• Transaction costs are the expenses of negotiating and executing a deal.

  • Financial intermediaries tries to lower this^

• Financial risk is uncertainty about future outcomes that involve financial losses and gains.

Financial System

• Reducing transaction costs ─ the cost of making a deal.
• Reducing financial risk ─ uncertainty about future outcomes that involves financial gains and losses.
• Providing liquid assets ─ assets that can be quickly converted into cash (in contrast to illiquid assets, which can’t).
  
  • Ranked in order of liquidity
  • Cash
    • Checking accounts
    • A share of AT&T stock
    • A government bond
      
    • A person's house

There are four main types of financial assets: 

• loans
  
• bonds
  
• stocks
  
• bank deposits

In addition, financial innovation 
has allowed the creation of a 
wide range of loan-backed 
securities.

• A financial intermediary is an institution that transforms the funds it gathers from many individuals into financial assets.
  
  • A mutual fund is a financial intermediary that creates a stock portfolio and then resells shares of this portfolio to individual investors.
    
  • A life insurance company sells policies that guarantee a payment to a policyholder’s beneficiaries when the policyholder dies.
  • A bank deposit is a claim on a bank that obliges the bank to give the depositor his or her cash when demanded.
  • A bank is a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investments or investment spending needs of borrowers.
• A pension fund is a type of mutual fund that holds assets in order to provide retirement income to its members.

Example: Banks

Money

Money is anything that is accepted as payment for goods and services.

Three roles

• Medium of exchange.
  • Money can be used to acquire goods and services rather than used for its own consumption.
• Store of value.
  • Money can hold its purchasing power over time.
• Unit of account.
  • Use money as a way of assigning value or worth.

Types of Money

• Commodity money is a good used as a medium of exchange that has its own physical use.
• Commodity-backed money is a medium of exchange who's value is guaranteed by a commodity/physical valuable good.
• Fiat money is a medium of exchange whose value is derived entirely from its status as a means of payment.
• M1 - Most liquid type of money; you can spend it right away.
  • Cash, coin, demand/checking accounts, traveler's checks.
  • Debit -> pays off debt
  • Credit -> incurs debt
• M2 - Less liquid type of money; you cannot spend it right away.
  • Includes M1 and near money
    • Near money - Financial assets that aren't directly usable as a medium of exchange, but can be readily converted.
    • Ex. Savings accounts, CDs (certificate of deposits).

Money Supply

• Monetary Aggregate - An overall measure of the money supply.
• Near-money - Financial assets that can't be used directly as a medium of exchange, but can be readily liquified.

Banking

Checkable deposits are an asset to the lender, and a liability on the bank.

• Required reserves
  • 10% of your money the bank has to keep.
• Excess reserves
  • What is used to grow the money supply.

When the government raises the reserve ratio, it forces banks to hold more money - contractionary.

When the government lowers the reserve ratio, it enables banks to loan out more money - builds the money supply.

One of the key components of monetary policy, Reserve Ratio.

Money Multiplier 

Every time a bank creates a new loan, new money is created in the economy---because it creates money that does not exist before that. The money will eventually have to be loaned back.

The amount of money created with an initial deposit.

\(Money Multiplier = 1/Rr\)

The key to our economy are loans.

Fed

Created in 1913 in response to the panic of 1907.

It oversees all banks today; it regulates banks and ensures they are fiscally responsible. Housed in Washington reserve.

It was made to provide banks with liquidity; it controls the money supply. "The banks of the banks."

Three tools to conduct monetary policy - monetary is the preferred method

• Expand or contract the money supply
  • Reserve requirement
  • Open mark operations - Most widely used
  • Discount rate - Sometime used