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Module 22-23

  • Types of financial assets
  • Financial intermediaries
  • Role of money

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Assets, slip^

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: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.
    • Worth?
      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
    • Not directly spendable, but can easily be exchanged.

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
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