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Introduction

• This document is a compilation of study notes for students.
• The notes are based on various pages of a document, likely a textbook or lecture notes.
• They cover topics including money, banking, financial markets, monetary policy, and financial crises.

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

• Objectives of the chapter include recognizing the importance of financial markets in the economy, describing financial intermediation and innovation, identifying the links between monetary policy, business cycles, and economic variables, and explaining exchange rates in a global economy.
• Financial markets are where funds are transferred from those with excess funds to those needing them.
• Financial markets promote economic efficiency.
• Well-functioning financial markets are a key component to economic growth.

Financial Markets

• Financial markets transfer funds from those with excess funds to those who need them.
• They promote efficiency.
• A security is a claim on the issuer's future income or assets—it can be a debt security (like a bond) or an equity security (like stock).
• Bonds are a promise to make periodic payments for a set time.

Financial Institutions

• Financial intermediaries are institutions that borrow funds from savers and lend to borrowers with productive opportunities.

Money and Monetary Policy

• Evidence suggests money plays a role in generating business cycles.
• Monetary theory associates changes in money supply with changes in economic activity and the price level.
• The aggregate price level is the average price of goods and services in an economy.

Interest Rates

• Interest rates are the price of money.
• Before 1980, there was a strong relationship between money growth and interest rates on long-term treasury bonds.
• Since 1980, that relationship has been less clear.

Chapter 2: An Overview of the Financial System

• Objectives include comparing and contrasting direct and indirect finance, identifying the structure and components of financial markets, listing and describing different types of financial market instruments, and recognizing the international dimensions of financial markets.
• Direct finance involves borrowers borrowing directly from lenders in financial markets by selling securities.
• Indirect finance involves intermediaries like banks who borrow from savers to lend to borrowers.
• Financial markets allocate capital efficiently, increasing production.
• Well-functioning financial markets improve consumer well-being.

The Economy as a Circular Flow (diagram)

• Households save funds and send those to the financial sector.
• The financial sector then invests those funds into businesses or firms.
• Firms use these funds to operate & produce and pay back financial sector
• Financial sector also gives money to households if they borrowed or investors

Structure of Financial Markets

• Debt Markets: Include instruments like bonds and mortgages with a commitment to repay a fixed amount at maturity.
  • Short-term debt instruments (< 1 year)
  • Long-term debt instruments ( ≥ 10 years)
• Equity Markets: Include instruments such as common stocks, representing ownership claims on a company.

Financial Market Instruments (examples)

• Treasury Bills
• Negotiable bank certificates of deposit (CDs)
• Commercial paper
• Repurchase agreements

Capital Market Instruments (examples)

• Stocks
• Mortgages
• Corporate Bonds
• Government Securities

Internationalization of Financial Markets

• International financial markets are highly integrated.
• The international financial system significantly impacts domestic economies.

Function of Financial Intermediaries

• Intermediaries connect borrowers and lenders, reducing transaction costs.
• Economies of scale reduce transaction costs per unit of transactions.
• Risk sharing allows investment diversification.
• Asymmetric Information leads to adverse selection and moral hazard.

Chapter 3: What is Money?

• Money is anything generally accepted as payment for goods and services or for repaying debts
• Functions of money include:
  • Medium of exchange: facilitates transactions
  • Unit of account: measures value
  • Store of value: saves purchasing power over time.
• Types of money include:
  • Commodity Money: gold, silver
  • Fiat Money: paper currency issued by governments
  • Checks
  • Electronic money: e-money

Measuring Money

• M1: Narrowest definition, includes currency in circulation, checking account deposits, and traveler's checks
• M2: Broader definition, includes M1, plus savings deposits, money market deposit accounts, and money market mutual fund shares.

Chapter 4, Part 1: Quantity Theory, Inflation, and the Demand for Money

• This chapter explores the Quantity Theory of Money.
• The theory shows how the price level is determined by the amount of money in circulation, relative to output.
• The Velocity of money is the average number of times per year each dollar is used to buy final goods and services.

Chapter 4, Part 2: Quantity Theory, Inflation, and the Demand for Money

• Three motives for holding money: Transactions motive, Precautionary motive, and Speculative motive
• Money demand is negatively related to nominal interest rate.
• Money demand is positively related to real income.

Chapter 5: The Meaning and Behavior of Interest Rates

• Interest rates are the price of money.
• Present Value: the current worth of future cash flows using an appropriate discount rate.
• Yield to Maturity: The interest rate that makes the present value of all future cash flows equal to the bond's current price.
• Real interest rates account for inflation.

Chapter 6, Part 1 & 2: Banking and the Management of Financial Institutions

• Four types of credit market instruments: Simple loans, Fixed-payment loans, Coupon bonds, Discount bonds
• Objectives include summarizing balance sheet features and identifying general principles of bank management.
• Asset management: Finding borrowers with low defaults, diversifying investments, adequate liquidity.
• Liability management: Acquiring funds at low cost / diverse funding sources
• Capital adequacy management: Maintaining sufficient capital to prevent failure.
• Credit risk management, screening borrowers. Adverse selection & moral hazard.

Chapter 7: Central Banks

• Central banks control monetary policy, regulating money supply and interest rates.
• They serve as lender of last resort to commercial banks.
• They manage government finances, advise on economic policy, and are custodians of commercial banks’ cash reserves.
• Various tools include open market operations, discount policy, and reserve requirements.

Chapter 8: Tools of Monetary Policy

• Tools for controlling money supply and interest rates include: open market operations, discount policy, and reserve requirements.
• Open market operations are buying or selling of government securities. buying securities increases money supply, and vice versa

Chapter 9: The Conduct of Monetary Policy: Strategy and Tactics -

• Monetary policy aims to fulfill multiple goals (e.g., price stability, high employment, stable exchange rate and economic growth).
• A nominal anchor, a variable like inflation rate or money supply, helps tie monetary policy goals.

Chapter 10: Financial Crises

• Key characteristics and stages of financial crises like Great Depression and 2007-2009 Crisis are included.
• Key aspects are:
  • Initial phase: credit boom and burst, asset price bubbles.
  • Banking crisis: failures of financial institutions.
  • Debt deflation: decline in prices.

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