Unit 6 – Money, Banking, and the Fed
Chapter 14.1 – The evolution, functions, and characteristics of money
- Federal Reserve System (Fed) – private owned, publicly controlled central bank of the united states
- Federal reserve note – paper currency issued by the Fed in use today
The evolution of money
- Barter economy – moneyless economy that relies on trade or barter
- Exchange of goods and services would be more difficult because the products some people have to offer are not always acceptable or easy to divide for payment.
- Commodity money – money that has an alternative use as an economic good, usually referring to actual goods (can be consumed)
- Fiat money – money by government decree, such as metallic coins
- A commonly accepted commodity money was tobacco
- Continental dollars, a form of fiat paper currency with no gold nor silver backing; along with the large volume, it virtually worthless by the end of revolution
- Specie – money in the form of gold or silver coins
- Coins were the most desirable form of money, because they were limited supply
- Monetary unit – standard unit of currency in a country’s money supply
Characteristics and functions of money
- Money must be portable, or easily transferred from one person to another, to make the exchange of money for products easier
- Money must be reasonably durable so it does not deteriorate when it is handled
- Money should be easily divisible into smaller units so that people can use only as much as they need for a transaction
- If something is to serve as money, it must available, but only in limited supply
- Moneys roles in the economy
- Medium of exchange – money or other substance generally accepted as payment for goods and services
- Measure of value – a function of money that allows it to serve as a common way to express value
- Store of value – a function of money that allows people to preserve value for future use
- Money can be in forms of Federal Reserve notes, metallic coins issued by US Bureau, or
- Demand deposit account (DDA) – account from which funds can be removed by writing a check and without having to gain prior approval from the depository institution
- Definitions of money supply
- M1 – component of the money supply relating to money’s role as a medium of exchange
- M2 – component of the money supply relating to money’s role as a store of value
Chapter 11.1 – savings and the financial system
- Saving – absence of spending that frees resources for use in other activities or investments
- Savings – the dollars that become available for investors to use when others save
Saving and economic growth
- The saved money was borrowed by businesses to produce new goods and services, etc.
- Money can be saved through savings account, buy a bond, or …
- Certificate of deposit – document showing that an investor has made an interest bearing loan to a financial institution
- Financial assets – a stock or other document that represents a claim on the income and property of a borrower, such as a CD, bond, treasury bill, or mortgage
- Stocks, or ownership claims on a corporation, are another type of financial asset
- Financial system – network of savers, investors, and financial institutions working together to transfer savings for investment uses
- System consist of funds that a saver transfers to a borrower, financial assets that certify conditions of the loan, organizations that bring the surplus funds and financial assets together
- Financial intermediary – institution that channels savings to investors
Households, businesses financial intermediaries* governments, businesses
*examples: commercial banks, savings and loan associations, saving banks, mutual savings banks, credit unions, life insurance companies, mutual funds, pension funds, finance companies
- Government and businesses are the biggest borrowers
Chapter 14.2 – the development of modern banking
The development of banking in America
- Unregulated banking led to abuses, and problems with the money supply
- During the civil war, supply of money were left to private banks
- State bank – bank that receives its charter from the state in which it operates
- Problems with currency
- Each bank issued its own currency
- Banks were tempted to issue too many notes because they can print more money
- Counterfeiting became a major problem
- 1861, congress authorized the printing of $60 million with no gold nor silver backing
- Legal tender – fiat currency that must be accepted for payment by decree of the government
- 1863, congress enacted the national currency act, creating the national banking system consist of national banks
- National bank – commercial bank chartered by the national banking system, they issued their own notes called…
- National currency – currency backed by government bonds and issued by commercial banks in the national banking system
- Gold certificate – paper currency backed by gold and issued between 1863 and 1934
- Silver certificate – paper currency backed by, and redeemable for, silver from 1878 to 1968
Chapter 14.1 – the evolution, functions, and characteristics of money
- Federal Reserve System (Fed) – privately owned, publicly controlled central bank of the united states
- Federal Reserve notes – paper currency issued by the Fed in use today
Chapter 14.2 – the creation of the Fed
- National banking system used to financial the civil war
- Checking accounts grew popular
- Minor recession had caused major problems for banks and other lending institutions
- Central bank – bank that can lend money to other banks in times of need
- All banks required to be a part of Fed, and shares stocks of the system
- Bank run – sudden rush by depositors to withdraw all deposited funds, generally in anticipation of bank failure or closure
- Bank holiday – brief period during which all banks or depository institutions are closed to prevent bank runs
- 1933, congress passed legislation to strengthen the banking industry
- Banking act of 1933, also created federal deposit insurance corporation (FDIC)
- Fractional reserve system – system requiring financial institutions to set aside a fraction of their deposits in the form of reserves
- Legal reserves – currency and deposits used to meet the reserve requirement
- Reserve requirement – formula used to compute the amount of a depository institution’s required reserves
- Member bank reserve (MBR) – reserves kept by member banks at the fed to satisfy reserve requirements
- Excess reserves – financial institution’s cash, currency, and reserves not needed for reserve requirements
Structure of the Fed
- Fed components had not changed since the Great Depression
- Member bank – bank belonging to the federal reserve system
- Fed directed by seven members board of governors
Advisory councils
Federal, consumer, thrift institution
Board of governors
Composition: 7 members appointed by the president to 14 years terms
Function: supervises and regulates the Fed
Federal open market committee (FOMC)
Composition: 7 members of the Board of governors, and 5 presidents of district banks
Function: decides monetary policy
Other Fed Responsibilities
- Maintaining the money supply and the payment system, regulating and supervising banks, preparing consumer legislation, and serving as the federal government’ bank
- Currency – paper component of the money, supply, today consisting of federal reserve notes
- Coins – metallic forms of money such as pennies, nickels, dimes, and quarters
- Payments system involves money supply, electronic transfer of funds, checks, online banking
- Fed is responsible for establishing specific guidelines, monitoring, inspecting, and examining various banking agencies
- Bank holding companies – company that owns and controls one or more banks
- Regulation Z – provision extending truth in lending disclosures to consumers
- Fed maintain accounts and provide financial service to federal government and its agencies
Chapter 14.1 – Modern Money
- Demand deposit account (DDA) – account from which funds can be removed by writing a check and without having to gain prior approval from the depository institution
- M1 – component of the money supply relating to money’s role as a medium of exchange
- M2 – component of the money supply relating to money’s role as a store of value
- Modern money is portable, durable, divisible, and limited availability and stable in value
Chapter 14.2 – fractional reserves and deposit expansion
- Fractional reserve system – system requiring financial institutions to set aside a fraction of their deposits in the form of reserves
- Legal reserves – currency and deposits used to meet the reserve requirement
- Reserve requirement – formula used to compute the amount of a depository institution’s required reserves
- Member bank reserve (MBR) – reserves kept by member banks at the Fed to satisfy reserve requirements
- Excess reserves – financial institution’s cash, currency, and reserves not needed for reserve requirements
Chapter 11.1 – Basic investment considerations
- Investors invest consistently over long periods of time
- Ignore any investment that seems too complicated, investment that seems too good to be true probably is
- Risk – situation in which the outcome is not certain, but the probabilities can be estimated
- Increase risk equal to increase return
- Objective for investing also contribute in the consideration
Chapter 11.2 – Financial assets and their markets
Bonds as financial assets
- Bond – contract to repay borrowed money and interest on the borrowed money at regular future intervals
- Increasingly bonds are taking on international flavor, with companies in one country issuing bond in another
- Coupon rate – stated interest on a corporate, municipal, or government bond
- Maturity – life of a bond or length of time funds are borrowed
- Par value – principal of a bond or total amount borrowed
- Bonds as a financial asset
- Current yield – bond’s annual coupon interest divided by purchase price; measure of a bond’s return
Financial assets and their characteristics
- Certificates of deposit (CDs) are one of the one of the most common forms of investments available
- Corporate bonds are an important source of corporate funds
- Junk bonds – bond that carries an exceptionally high risk of nonpayment and a low rating
- Municipal bonds – bond, often tax exempt, issued by state and local government
- Tax exempt – not subject to tax by federal or state governments
- Savings bond – low denomination, non-transferable bond issued by the federal government
- Paper bonds are available in denominations.
- Paperless bonds are purchased directly from the treasury
- Beneficiary – person designated to take ownership of an asset if the owner of the asset dies
- Treasury note – US government obligation with a maturity of 2 to 10 years
- Treasury bond – US government bond with a maturity of 10 to 30 years
- Treasury bills – short term united states government obligation with a maturity of one year or less in denominations of $1,000
- Individual retirement accounts (IRAs) – retirement account in the form of a long-term time deposit, with annual contributions not taxed until withdrawn during retirement
Markets for financial assets
- Capital market – market in which financial capital is loaned and/or borrowed for more than one year
- Money market – market in which financial capital is loaned and/or borrowed for one year or less
- Primary market – market in which only the original issuer can sell or repurchase a financial asset
- Secondary market – market in which financial assets can be sold to someone other than the original issuer
Stocks and efficient markets
- Equities – stocks that represent ownership shares in corporations
- Stockbroker – person who buys or sells securities for investors
- Value of the stock depends on the number of outstanding shares to be traded and a company’s profitability influence the price
- Efficient market hypothesis (EMH) – argument that stocks are always priced about right because they are closely watched
- Portfolio diversification – strategy of holding different investments to protect against risk
- Mutual fund – company that sells stock in itself and uses the proceeds to buy stocks and bonds issued by other companies
- Net asset value (NAV) – the market value of a mutual fund share found by dividing the net value of the fund by the number of shares issued
- 401k plan – tax deferred investment and savings plan that acts as a personal pension fund for employees
- This plan is popular because it provides a simple, consistent, and relatively safe way for employees to save
Stock markets and their performance
- Stock or securities exchange – physical place where buyers and sellers meet to exchange securities
- Oldest, largest, and most prestigious of the organized stock exchanges is the NY stock exchange
- Over the counter market – electronic marketplace for securities not listed on organized exchanges such as NYSE
- Most important OTC market is the national association of securities dealers automated quotation, world’s largest electronic stock market
- Dow jones industrial average (DJIA) – measure of stock market performance based on 30 representative stocks
- Standard & poor’s 500 – measure of stock market performance based on 500 stocks traded on the NYSE, AMEX, and OTC market
- Bull market – period during which stock market prices move up for several months or year in a row
- Bear market – period during which stock market prices move down for several months or years in a row
