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economics 210
1. Financial markets channel funds from savers to investors, promoting economic efficiency and growth. 2. The document discusses various financial markets and instruments, including the bond market, stock market, and foreign exchange market. 3. It also covers topics like banking and financial institutions, monetary and fiscal policy, and the role of regulation in financial markets.
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economics 210
- 1. Why Study FinancialMarkets? Financial markets channel funds from savers to investors, thereby promoting economic efficiency 2. Financial markets are a key factor in producing economic growth 3. Financial markets affect personal wealth and behaviour of business firms 1.
- 2. The Bond Market& Interest Rates A security (financial instrument) is a claim on the issuer’s future income or assets An asset is any financial claim that is subject to ownership 1.
- 3. The Bond Market& Interest Rates A bond is a debt security that promises periodic payments for a specified time An interest rate is the cost of borrowing or the price paid on the rental of funds 1.
- 4. The Bond Market& Interest Rates 1.
- 5. The Stock MarketA stock represents a share of ownership in a corporation A stock is a security that is a claim on the earnings and assets of that corporation 1.
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- 7. Foreign Exchange Market1. The foreign exchange market is where one country’s currency is exchanged for another The exchange rate is the price of one country’s currency in terms of another Appreciation/depreciation is a rise/fall in the value of a country’s currency
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- 9. Banking and FinancialInstitutions Financial Intermediaries - institutions that borrow funds from people who have saved and make loans to other people Banks - institutions that accept deposits and make loans Other Financial Institutions - insurance companies, finance companies, pension funds, mutual funds and investment banks Financial Innovation - in particular, the advent of the information age and e-finance 1.
- 10. Money and BusinessCycles Evidence suggests that money plays an important role in generating business cycles Recessions (unemployment) and booms (inflation) affect all of us Monetary Theory ties changes in the money supply to changes in aggregate economic activity and the price level 1.
- 11. Money and BusinessCycles 1.
- 12. Money and InflationThe aggregate price level is the average price of goods and services in an economy A continual rise in the price level (inflation) affects all economic players Data shows a connection between the money supply and the price level 1.
- 13. Money and thePrice Level 1.
- 14. Money Growth andInflation 1.
- 15. Money and InterestRates Interest rates are the price of money Prior to 1980, the rate of money growth and the interest rate on long-term bonds were closely tied Since then, the relationship is less clear but still an important determinant of interest rates 1.
- 16. Money Growth andInterest Rates 1.
- 17. Monetary and FiscalPolicy Monetary policy is the management of the money supply and interest rates Conducted by the Bank of Canada Fiscal policy is government spending and taxation Budget deficit/surplus is the excess of expenditures/revenue over revenues/expenditures for a particular year Any deficit must be financed by borrowing 1.
- 18. How We StudyMoney and Banking Basic Analytic Framework Simplified approach to the demand for assets Concept of equilibrium Basic supply and demand approach to understand behaviour in financial markets Search for profits Transactions cost and asymmetric information approach to financial structure Aggregate supply and demand analysis 1.
- 19. How We StudyMoney and Banking (Cont’d) Features: 1.Case studies 2. Applications 3. Special-interest boxes 4. Financial News boxes 6. Web Exercises and References 1.
- 20. Appendix: Definitions AggregateOutput Gross Domestic Product (GDP) = Value of all final goods and services produced in domestic economy during year. Aggregate Income - Total income of factors of production (land, capital, labour) during year Nominal = values measured using current prices Real = quantities measured with constant prices 1.
- 21. Appendix: Definitions AggregatePrice Level GDP Deflator = Nominal GDP/Real GDP Consumer Price Index = (CPI) price of a “basket” of goods and services Inflation rate = growth rate of the aggregate price level (percent change from previous period) 1.
- 22. An Overview ofthe Financial System Primary Function of the Financial System is Financial Intermediation The channeling of funds from households, firms and governments who have surplus funds (savers) to those who have a shortage of funds (borrowers). 2.
- 23. An Overview ofthe Financial System 2.
- 24. Classifications of FinancialMarkets Debt Markets Short-term (maturity < 1 year) – the Money Market Long-term (maturity > 10 year) – the Capital Market Medium-term (maturity >1 and < 10 years) 2.
- 25. Classifications of FinancialMarkets Equity Markets - Common stocks Primary Market - New security issues sold to initial buyers Secondary Market - Securities previously issued are bought and sold 2.
- 26. Classifications of FinancialMarkets (Cont’d) Secondary Markets Exchanges Trades conducted in central locations (e.g., Toronto Stock Exchange and New York Stock Exchange) Over-the-Counter Markets Dealers at different locations buy and sell 2.
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- 28. Financial Market Instruments (Cont’d) Other Money Market Instruments Certificates of deposit Repurchase agreements Overnight funds 2.
- 29. Financial Market Instruments (Cont’d) 2.
- 30. Financial Market Instruments (Cont’d) Other Capital Market Instruments Canada savings bonds Provincial and municipal bonds Government agencies securities 2.
- 31. Internationalization of FinancialMarkets International Bond Market Foreign bonds - sold in a foreign country and denominated in that country Eurobonds – denominated in a currency other than the country in which it is sold Eurocurrencies – foreign currencies deposited in banks outside the home country 2.
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- 33. Function of FinancialIntermediaries Financial Intermediaries Engage in process of indirect finance Are needed because of transactions costs and asymmetric information 2.
- 34. Function of FinancialIntermediaries (Cont’d) Transactions Costs 1. Financial intermediaries make profits by reducing transactions costs. 2. They reduce transactions costs by developing expertise and taking advantage of economies of scale. 2.
- 35. Function of FinancialIntermediaries (Cont’d) Risk Sharing Create and sell assets with low risk characteristics and then use the funds to buy assets with more risk (also called asset transformation) Lower risk by helping people to diversify portfolios 2.
- 36. Asymmetric Information Adverse Selection Before transaction occurs Potential borrowers most likely to produce adverse outcomes are ones most likely to seek loans and be selected 2.
- 37. Asymmetric Information (Cont’d) Moral Hazard After transaction occurs Hazard that borrower has incentives to engage in undesirable activities making it more likely that loan won’t be paid back 2.
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- 39. Size of FinancialIntermediaries 2.
- 40. Regulation of FinancialMarkets 2.
- 41. Regulation of FinancialMarkets Primary Reasons for Regulation Increase information to investors - Decreases adverse selection and moral hazard problems - Securities commissions force corporations to disclose information 2.
- 42. Regulation of FinancialMarkets (Cont’d) Primary Reasons for Regulation (continued) 2. Ensuring the soundness of intermediaries Prevents financial panics Restrictions on entry/assets/activities, disclosure, deposit insurance, limits on competition 2.