Introduction
The system of financial institutions and markets produces and distributes financial services to the public. Among its most important services is a supply of credit that allows businesses, households, and governments to invest and to acquire assets they need to carry on daily economic activity. The financial system of money and capital markets determines both the amount and cost of credit available. In turn, the supply and cost of credit affect the health and growth of the global economy and our own economic welfare.
This course examines the complex relationship between financial markets (such as those for bonds, stocks, and foreign exchange) and financial institutions (banks, insurance companies, mutual funds, and other institutions) how markets and institutions interact. The impact of this complex financial web is explored. The relationships between money, banking, financial markets and institutions has a powerful impact on many aspects of our individual lives, politics, and world affairs.
This lesson introduces money, banking, and financial markets, provides a general overview of the financial system, and explains what money is and how it is measured. Chapter 1 introduces why the study of money, banking, and financial markets is worthwhile. Chapter 2 gives a general overview of the financial system and Chapter 3 explains what money is and how money is measured.
Lesson Learning Objectives
By the conclusion of this Lesson you should be able:
• Describe how financial intermediation and financial innovation affect banking and the
economy
• Identify the basic links between monetary policy, the business cycle, and economic
variables
• Explain the importance of exchange rates in a global economy
• Identify the structure and components of financial markets
• List and describe the different types of financial market instruments and the different
types of financial intermediaries
• Identify the reasons for, and list the types of, financial market regulations
• Describe what money is and list and summarize the functions of money
Assignments
The following Assignments should be completed and submitted to the course faculty via the learning platform for evaluation and grading. Submit your responses to these questions in one WORD document. List the question first, and then your response.
Be sure to properly site your sources, both in-text and with a reference list at the conclusion. If you use an online source to support your answers, you must provide a properly formatted link to the source. You should use APA citation format and make sure your sources are credible. In most cases, your responses should be no more than 200 words.
Short Answer Questions
1. Why are financial markets important to the health of the economy?
2. If history repeats itself and we see a decline in the rate of money growth, what might
you expect to happen to:
a. Real output?
b. The inflation rate?
c. Interest rates?
3. When the dollar is worth more in relation to currencies of other countries, are you more
likely to buy American-made or foreign-made jeans? Are U.S. companies that
manufacture jeans happier when the dollar is strong or weak? What about an American
company which is in the business of importing jeans into the United States?
4. Describe who issues each of the following money market instruments:
a. Treasury bills
b. Certificates of deposit
c. Commercial paper
d. Repurchase agreements
e. Fed funds
5. A significant number of European banks held large amounts of assets as mortgage-
backed securities derived from the U.S. housing market, which crashed after 2006. How
does this demonstrate both a benefit and a cost to the internationalization of financial
markets?
6. Why did cavemen not need money? Why do modern humans, in most cultures and
environments, need money?
7. Was money a better store of value in the United States in the 1950s than in the 1970s?
Why or why not? In which period of time would you have been more willing to hold
money?
8. It is not unusual to find a business that displays a sign saying, “no personal checks,
please.” On the basis of this observation, comment on the relative degree of liquidity of
a checking account versus currency.
Professional Development Questions
1. Go to the St. Louis Federal Reserve FRED database and find data on the three-month treasury bill rate (TB3MS), the three-month AA nonfinancial commercial paper rate (CPN3M), the 30-year treasury bond rate (GS30), the 30-year conventional mortgage rate (MORTG), and the NBER recession indicators (USREC).
a. In general, do these interest rates behave during recessions and during
expansionary periods?
b. In general, how do the three-month rates compare to the 30-year rates? How do the treasury rates compare to the respective commercial paper and mortgage rates?
c. For the most recent available month of data, take the average of each of the three-month rates and compare it to the average of the three-month rates from January 2000. How do the averages compare?
d. For the most recent available month of data, take the average of each of the 30-year rates and compare it to the average of the 30-year rates from January 2000. How do the averages compare?
2. Suppose you have just inherited $10,000 and are considering the following options for investing the money to maximize your return:
Option 1: Put the money in an interest-bearing checking account that earns 2%. The FDIC insures the account against bank failure.
Option 2: Invest the money in a corporate bond with a stated return of 5%, although there is a 10% chance the company could go bankrupt.
Option 3: Loan the money to one of your friend’s roommates, Mike, at an agreed-upon interest rate of 8%, even though you believe there is a 7% chance that Mike will leave town without repaying you.
Option 4: Hold the money in cash and earn zero return.
a. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (HINT: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event.)
b. Suppose Option 3 is your only possibility. If you could pay your friend $100 to find out extra information about Mike that would indicate with certainty whether he will leave town without paying, would you pay $100. What does this say about the value of better information regarding risk?
