economics 210


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economics 210

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