Chapter 1 y Financial Markets People and firms that trade financial assets.

o Financial Assets Currencies and securities  Securities Bonds and Stocks Bond a fixed income-security o Bonds pay coupons and face value once bond reaches maturity.  Maturity Life of a bond Zero-Coupon Bond do not have coupon payments o Sold at a discount from face value o Interest rate- annualized percent difference between face value and purchase price Default Risk a payment won t be made Stocks ownership shares in corporations o Residual claim on corporate income streams  Returns are uncertain  Stock owners vote on corporate policies Savers lenders Investors borrow to increase economic capacity Diversifying holding variety of assets, reducing risks Mutual Fund diversified collection of bonds Asymmetric information when one party knows more than the other o Adverse Selection the idea that most borrows are high risk o Moral Hazard risk that borrower will use loan not for its intended purpose Banks financial intermediary, channel funds from savers to investors o Indirect Finance channel funds through intermediary o Reduces asymmetric information through screenings and covenants  Covenants how investor should behave contract o Investment Bank issues new securities for companies Economic Growth an increase in real GDP, standard of living, and productivity o Less developed countries invest less o Developed nations encourage Bank deposits

y y

y y y y y

y y

Unit Banking Single location bank with no branches o No economies of scale/diversification and is a local monopoly Microfinance providing small loans to poor people to start a business o Loans for people not served by banks Centrally Planned government chooses investments and financial markets don t exist. o Soviets attempted to increase short-run productivity. Ignored important long-term investments in attempt to catch up to West. Nominal GDP total value of goods and services in a given period Aggregate Price Level a weighted average of the price of goods and services Consumer Price Index (CPI) change in price level of consumer goods GDP deflator average of prices for all goods produced Inflation percent change in prices over time Real GDP = nominal GDP / aggregate price level

y y y y y y

y y y y

Chapter 2

Money Class of assets used to buy goods and services o Medium of exchange, unit of account, stores value Income Annual earnings Barter trading without using money o Requires a double coincidence of want both want something of equal value o Difficult to store wealth o Storing Wealth some goods can t be saved, yet money is easily stored o Countries with inflation problem hold stable foreign currencies. Commodity Money money with intrinsic value (ie gold) Fiat Money Money with no intrinsic value (ie legal tender) Dollarization using another countries currency as its own o Currency Board national currency backed by foreign currency o Currency Union Countries band together to make one currency (ie Euro)  Reduces costs Monetary Aggregates measure of money supply M1 primary measure of money, measure of the medium of exchange, includes: o Currency in circulation outside of banks o Checkable deposits (Checking accounts) o Nonbank s travelers checks (including stored value cards) Credit Card- not money, consumer uses credit card to borrow money and makes payments at later date Payment System- how seller receives funds for goods and services o Check21 digital imagining of checks, less costly to handle checks now o Electronic funds transfer Liquidity how easily an asset is converted to money o Liquid assets higher returns than money  Easily traded for money o Money is the most liquid

y y y

y y

o Most liquid assets have lowest yield  Less liquid assets pay higher rates of interest  More earnings = less liquidity Securities are less liquid than bank deposits, and savings deposits are more liquid than CDs due to withdrawal limitations.

M2 includes M1 plus liquid assets o Savings deposit includes money market deposit account (acts like savings account) o Small time deposits Certificate of deposits less than 100,000  Withdrawal restrictions, less liquid than saving deposit o Retail Money Market Mutual Funds shares in funds that buy short term bonds  Highly liquid Sweep Program Moving checking deposits to money market deposit account to avoid reserve requirements o Distorts M1 money comes out of checking to savings o M2 unaffected Federal Reserve Clears checks, processes electronic payments o Monetary policies management of money supply and interest rates o Lender of Last Resort o Safeguard the banking system In response to 9/11, the Fed o Disrupted payment system o Allowed banks to have negative flow of money  Facilitates operational economy o Emergency Loans  Temporarily suspended regulations against lend to security dealers o Increase money to stimulate economy and keep interest rates stable  Increased M1 and M2 dramatically o New Credit/Liquidity Programs o Increased asset holdings