Financial Markets & Institutions - Summary lectures and reading
Summary of Financial Markets and Institutions EBE year 3 track Finance
Summary Lectures Financial Markets and Institutions
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Msc Finance
Financial Markets & Institutions
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Summary Financial Markets and Institutions
Book: The Economics of Money, Banking, and Financial
Markets. 12th global edition (F. Mishkin)
Chapter 1: Why study money, banking, and financial markets?
Preview:
- This chapter will provide a road map of the book by outlining many exiting
issues and exploring why they are worth studying
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
- e.g. bond and stock markets; channelling funds from people who do not have
a productive use for them to those who do.
® Debt Markets and Interest Rates:
- security (or financial instrument): a claim on the issuer’s future income or
assets
- assets: any financial claim or piece of property that is subject to ownership
- bond: a debt security that promises to make periodic payments for a specified
period of time
- debt markets (or bond markets)…
1. enable corporations and governments to borrow money to finance their
activities
2. determine interest rates
- interest rate: the cost of borrowing or the price paid for the rental of funds
(many types of interest rates exist: mortgage loan rates, car loan rates,
interest rates on many types of bonds etc.)
- why are interest rates important?
1. personal level: high interest rates might deter you from buying a house or
a car because the cost of financing would be high; conversely, high
interest rates may encourage you to save because you can earn more
interest on your savings
2. general level: interest rates have an impact on the overall health of the
economy because they effect consumers’ willingness to spend or save
and businesses’ investment decisions
® The Stock Market:
- Common stock (or 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
- Stock prices are extremely volatile, consequently they affect the size of
people’s wealth and, as a result, their willingness to spend
- The stock market is 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
, Why study financial institutions and banking?
- Banks and other financial institutions are what make financial markets work.
Without them, 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 system is complex, compromising many different types of private
sector financial institutions (banks, insurance companies, investment banks
etc.), all of which are heavily regulated by the government
- Financial intermediary: institutions that borrow funds from people who have
saved and in turn make loans to people who need funds
® Banks and Other Financial Institutions:
- Banks: financial institutions that accept deposits and make loans; it includes
firms such as commercial banks, savings and loan associations, mutual
savings banks, and credit unions etc.
- Banks are the largest financial intermediaries in the economy, however in
recent years other financial institutions have been growing at the expense of
banks (insurance companies, finance companies, pension funds, mutual
funds etc.)
® Financial Innovation:
- Financial innovation: the development of new financial products and
services
- E-finance: ability to deliver financial services electronically
- Financial innovation can lead to higher profits but can also sometimes result
in financial disasters
® 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
nonfinancial firms
Why study money and monetary policy?
- Money (or money supply): anything that is generally accepted as payment for
goods or services or in the repayment of debts. It is linked to changes in
economic variables that affect all of us and are important to the health of the
economy.
® Money and Business Cycles:
- Aggregate output: total production of goods and services
- Unemployment rate: percentage of the available labour force unemployed
- Business cycles: the upward and downward movement of aggregate output
produces in the economy
- Recessions: period of declining aggregate output
- Money growth has declined before almost every recession, indicating that
changes in money growth might be a driving force behind business cycle
fluctuations (figure 3, page 58)
- However, declines in the rates of money growth are often not followed by a
recession
- Monetary policy: the theory that relates the quantity of money and monetary
policy to changes in aggregate economic activity/output and inflation
® Money and Inflation:
- Aggregate price level (or price level): the average price of goods and
services in an economy (more than sixfold from 1970 to 2017)
,- Inflation: a continual increase in the price level, affects individuals,
businesses, and the government (top of political and economic agendas)
- What explains inflation?
1. Price level and the money supply generally rise together (figure 4, page
59), so continuing increase in money supply causes continuing increase in
price level, and thus inflation
2. A positive association can be seen between the ten-year averages of
inflation rate and the growth rate of the money supply. The countries with
the highest inflation rates are also the ones with the highest money growth
rates
- Inflation rate: the rate of change of the price level, usually measured as a
percentage change per year
® Money and Interest Rates
- Money plays an important role in interest-rate fluctuations (figure 6, page 61)
® Conduct of Monetary Policy:
- Monetary policy: the management of money and interest rates
- Central bank: the organization responsible for the conduct of a nation’s
monetary policy (in the US it is the Federal Reserve System/”the Fed”)
® Fiscal Policy and Monetary Policy:
- Fiscal policy: involves decisions about government spending and taxation
- Budget deficit: an excess of government expenditures with respect to tax
revenues for a particular time period, typically a year
- Budget surplus: arises when tax revenues exceed government expenditures
- The government must finance any budget deficit by borrowing, whereas a
budget surplus lead to a lower government debt burden (figure 7, page 62)
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. Companies are borrowing in other countries and vice
versa. Financial institutions have operations throughout the world.
® The Foreign Exchange Market:
- For funds to be 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
- Foreign exchange market: where this conversion takes place and where the
foreign exchange rate is determined
- Foreign exchange rate: the price of one country’s currency in terms of
another’s currency (figure 8, page 63)
- A change in the exchange rate has a direct effect on consumer because it
affects the cost of imports
- E.g. a weaker dollar leads to more expensive foreign goods; when this
happens, Americans increase the consumption of domestic goods
- Conversely, a strong dollar means that US goods exported abroad will cost
more in foreign countries, and hence foreigners will buy less of them
- A strong dollar benefits American consumers by making foreign goods cheap,
but hurt American businesses and eliminates some jobs by cutting both
domestic and foreign sales: thus, major consequences for economies
® The International Financial System:
, - The tremendous increase in capital flows among countries has heightened the
international financial system’s impact on domestic economies
Chapter 2: An Overview of the Financial System
Preview:
- Well-functioning financial markets and financial intermediaries are crucial to
economic health. Financial markets and financial intermediaries serve the
basic function of getting people together so that funds can move from those
who have a surplus of funds to those who have a shortage of funds
- This chapter focuses on the major financial intermediaries and the
instruments that are traded in financial markets, as well as how these markets
are regulated.
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