Chapter 1

Financial Market

- Market in which funds from ppl who have excess of available funds are channeled to ppl who
have shortage- promotes economic efficiency
- Well-functioning FM, produce high economic growth
- Poor performing FM, reason why countries remain poor
- FM activities have effects on personal wealth, business behavior and consumers and
performance of the economy

Bond Market and Interest Rates

**Security- a financial instrument, claim on issuers future income or assets

**Bond- debt security, promise to make payments periodically for period of time

Bond Market- important in economic activity as it enables corporations and gov’t to borrow to finance
activities.

**Interest rate- cost of borrowing, price paid for rental of funds, usually expressed as a %.

- TYPES: mortgage IR, car loan rates and bond IR

-affects ppl spending and saving decisions and business’ investment decisions

- lump interest rates

The Stock Market

**Common stock- represents share of ownership in a corporation. Its issuance is a way to raise funds to

finance activities

-a security, claim on earnings and assets of the corporation

Stock Market- where shares of stock are traded, the most widely followed FM, called “the market”

- important factor in business investment decisions , price of shares affect amount

raised by selling newly issued stock to finance investment spending

Financial Institution and Banking- make FM works, channel funds

Structure of the Financial System

**Financial Intermediaries- institutions that borrows funds from ppl who have saved and in turn make

loans to others
Financial Crises- declines in asset prices, failure of financial and non-financial firms

Banks and other Financial Institutions

Banks-

Financial Innovation- development of new financial products and services

Money and monetary Policy

Money- anything that is accepted as payment for goods or repayment of debts

- linked to changes in economic variables

-has a role in generating business cycle- the upward and downward movement of AO in the

Economy

- decline in money growth is usually followed by a recession

Money and Business cycles

**Aggregate output (AO)- total production of goods and services

**Aggregate Income- total income of factors of production

**Unemployment rate- % of the available labor force unemployed

**Recessions- periods of declining aggregate output

**Aggregate price level-“price level”, average price of goods and services in the economy

1. GDP deflator- nominal GDP divided by real GDP

2. PCE or Personal Consumption Expenditures- nominal PCE divided by real PCE
3. Consumption Price Index (CPI)

**Inflation- continual increase in the price level

-continuing increase in money supply can be a factor in causing inflation

**Inflation rate- rate of the change of the price level, measured as percentage change per year

*Countries with highest inflation rates have the highest money growth rates

*Positive association exist between money growth rate and inflation

“Inflation is always and everywhere a monetary phenomenon” – Milton Friedman (Nobel laureate)

Money and Interest Rates

*Money plays role in interest rate fluctuations

Conduct of Monetary Policy

Monetary Policy- management of money and interest rates

Central Bank- organization responsible for conduct of nation’s monetary policy

*In US, central bank is the Federal Reserve System “The Fed”

Fiscal and Monetary policy

Fiscal policy- involves decisions about the government spending and taxation

Budget deficit- excess in gov’t expenditures over tax revenues, gov’t finance through borrowing

-lead to higher inflation, money growth, interest rates

Budget surplus- tax revenues exceed expenditures, leads to lower gov’t burden

GDP- real measure of AO, market value of all the final goods and services produced in a country during
the yr

*Nominal and Real

-EXCLUDES: purchases of goods produced in the past

Purchases of stocks or bonds

Intermediate goods, used in producing final goods

International finance

Foreign Exchange Market- is where the conversion of a currency of a country to the currency of another

country takes place

- instrument in moving funds between countries

Foreign exchange rate- price of one country’s currency in terms of another’s

-changes, affects cost of imports

International Financial System

*Increase in capital flows heightens IFS impact on domestic economies

Review dollar stronger

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