Money and Banking Study Guide Chapter 1-5

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Chapter 1- Why study Money, Banking and Financial Markets?

Why are Financial Markets Important?
Financial markets are 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, vice versa. Financial markets and intermediaries have the basic function of getting people together by moving funds from those who have a surplus of funds to those who have a shortage of funds.

The Importance of Interest Rates
On a personal level, high interest rates can deter you from buying a house or a car because the cost of financing would be too high. Conversely, they could encourage you to save because you earn more interest by putting your money aside in savings. ON a more general level, interest rates affect the overall health of the economy because they affect not only consumers’ willingness to spend but also businesses’ investment decisions. High interest rates for example might cause a corporation to postpone building a new plant that would provide more jobs.

The Importance of Stocks
On a personal level the fluctuations in stock prices affect the size of people’s wealth and as a result may affect their willingness to spend. On a general level, it affects business investment decisions since the price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending. A higher price for a firm’s shares means that it can raise a larger amount of funds, which it can use to buy production facilities and equipment. A higher price means it can raise a larger amount of funds, which it can use to buy production facilities and equipment.

Role of Financial Intermediaries
Financial intermediaries are institutions that borrow funds from people who have saved and in turn make loans to others. Banks are included in this category. They accept deposits and make loans. These include commercial banks, savings and loan associations, mutual savings banks and credit unions. Investment banks are, insurance companies, mutual funds etc. are a different category.

Money growth and Inflation
Inflation may be tied to continuing increases in the growth rate of the money supply. Countries with the highest inflation are those with the highest money growth rates.

Questions:
- Quantitative easing is done by the Federal Reserve buying more bonds. This is how they decrease the interest rate. Therefore, since the Federal reserve said they will be keeping the interest rate close to zero for the next two years, is this not considered QE3?

- How many shares of stock are too much? Can’t a company infinitely raise money than? Like when does it become a problem in terms of ownership? When 51% is in the hands of the public? Are stock profits considered cash flow for a company?

Chapter 2- An Overview of the Financial System

Indirect Finance vs. Direct Finance
In direct finance borrowers borrow funds directly from lenders in financial markets by selling them securities that are claims on the borrower’s future income or assets. In indirect finance, lender-savers provide funds to financial intermediaries, who provide funds to borrower and spenders, as well as into financial markets. This financial intermediary borrows funds from the lenders savers and then using these funds make loans to borrower-spenders. This process is called financial intermediation. It is more feasible for them to do this because of their economies of scale and ability to shy off transaction costs. Also it provides liquidity services, and risk sharing. This process of risk sharing is also sometimes referred to as asset transformation, because in a sense, risky assets are turned into safer assets for investors.

Firm and Individual Ways to Obtain Funds
First way is to issue a debt instrument such as a bond or a...
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