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Summary of the chapters discussed during the lectures: H1-H8, H10, H13-H19, H24. Includes images with explanations from the book.
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Samenvatting / Summary FIMT The Economics of Money, Banking & Financial Markets (European edition)
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Chapter 1 Why study money, banking and financial markets?Why study financial markets?
Financial markets: markets in which funds are transferred from people who have an excess of
available funds to people who have a shortage.
--> Crucial to promoting greater economic efficiency by channeling funds from people who do
not have a productive use for them to those who do.
Well-functioning financial markets are a key factor in producing high economic growth, and poorly
performing financial markets are one reason that many countries in the world remain desperately
poor.
The bond market and interest rates
A security (also called a financial instrument) is a claim on the issuer’s future income or assets (any
financial claim or piece of property that is subject to ownership).
A bond is a debt security that promises to make payments periodically for a specified period of time.
The bond market is especially important to economic activity because it enables corporations and
governments to borrow to finance their activities and because it is where interest rates are
determined.
An interest rate is the cost of borrowing or the price paid for the rental of funds. Interest rates are
important on a number of levels:
• Personal level: high interest rates could deter you from buying a house or a car because the
cost of financing it would be high.
o It could encourage you to save because you can earn more interest income by
putting aside some of your earnings as savings.
• General level: interest rates have an impact on the overall health of the economy because
they affect not only consumers’ willingness to spend or save but also businesses’ investment
decisions.
o Higher interest rates might cause a company to postpone building a new plant that
would provide more jobs.
The stock market
A common stock represents a share of ownership in a corporation. It is a security that is a claim on
the earnings and assets of the corporation. Issuing stock and selling it to the public is a way for
corporations to raise funds to finance their activities.
The stock market is also an important factor in business investment decisions, because the price of
shares affects the amount of funds that can be raised by selling newly issued stock to finance
investment spending.
The foreign exchange market
When funds are transferred from one country to another, they have to be converted from the
currency of the country of origin into the currency of the country they are going to. This convention
takes place in the foreign exchange market: currency is bought and sold using another currency.
--> The price at which one curr3ency is exchanged for another is known as the foreign exchange rate.
A rise in the exchange rate represents an appreciation and a fall is depreciation.
1
,Why study financial institutions and banking?
Without banks, financial markets would not be able to move funds from people who save to people
who have productive investment opportunities.
Structure of the financial system
Financial intermediaries: institutions that borrow funds from people who have saved and in turn
make loans to others.
Financial crises
Financial crises: major disruptions in financial markets that are characterized by sharp declines in
asset prices and the failures of many financial and non-financial firms.
Banks and other financial institutions
Banks are financial institutions that accept deposits and make loans.
Why study money and monetary policy?
Money, also referred to as the money supply, is defined as anything that is generally accepted in
payment for goods or services or in the repayment of debts.
Money and business cycles
Aggregate output: total production of goods and services.
Unemployment rate: the percentage of the available labor force unemployed.
Money plays an important role in generating business cycles: the upward and downward movement
of aggregate output produced in the economy. When output is rising, it is easier to find a good job;
when output is falling, finding a good job might be difficult.
Recessions: periods of declining aggregate output.
Monetary theory: the theory that relates changes in the quantity of money to changes in aggregate
economic activity and the price level.
Money and inflation
The average price of goods and services in an economy is called the aggregate price level, or the
price level.
Inflation, a continual increase in the price level, affects individuals, businesses and the government.
The inflation rate is the rate of change of the price level, usually measured as a percentage change
per year.
Conduct of monetary policy
Because money can affect many economic variables that are important to the well-being of the
economy, politicians and policymakers throughout the world care about the conduct of monetary
policy: the management of money and interest rates.
The organization responsible for the conduct of a nation’s monetary policy is the central bank.
2
,Fiscal policy and monetary policy
Fiscal policy involves decisions about government spending and taxation.
A budget deficit is the excess of government expenditures over tax revenues for a particular time
period, while a budget surplus arises when tax revenues exceed government expenditures.
The government must finance any deficit by borrowing which leads to a higher government debt
burden while a budget surplus leads to a lower government debt burden.
Why study international finance?
The globalization of financial markets has accelerated at a rapid pace in recent years. Financial
markets have become increasingly integrated throughout the world.
Fluctuations in the foreign exchange rate markets have major consequences for the economy.
The international financial system
The tremendous increase in capital flows among countries heightens the international financial
system’s impact on domestic economies.
3
, Chapter 2 An overview of the financial system
Function of financial markets
Financial markets perform the essential economic function of channeling funds from households,
firms and governments that have saved surplus funds by spending less than their income to those
that have a shortage of funds because they wish to spend more than their income.
In direct finance, borrowers borrow funds directly from lenders in financial markets by selling them
securities, which are claims on the borrower’s future income or assets. Securities are assets for the
person who buys them but liabilities for the individual or firm that sells them.
Financial markets allow funds to move from people who lack productive investment opportunities to
people who have such opportunities.
Structure of financial markets
Debt and equity markets
A firm or an individual can obtain funds in a financial market in two ways:
• Issue a debt instrument, such as a bond or a mortgage, which is a contractual agreement by
the borrower to pay the holder of the instrument fixed amounts of euros at regular intervals
until a specified date, when a final payment is made.
o The maturity of a debt instrument is the number of years until that instrument’s
expiration date
o A debt instrument is short-term if its maturity is less than a year and long-term if its
maturity is longer than one year
• Issuing equities which are claims to share in the net income and the assets of a business.
o Equities often make periodic payments (dividends) to their holders and are
considered long-term securities because they have not maturity date.
The main disadvantage of owning a corporation’s equities rather than its debt is than an equity
holder is a residual claimant; that is, the corporation must pay all its debt holders before it pays its
equity holders.
The advantage of holding equities is that equity holders benefit directly from any increases in the
corporation’s profitability or asset value because equities confer ownership rights on the equity
holders.
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