1. Chapter 1: Intro to Money & theChapter 1: Intro to Money & the
Financial SystemFinancial System
• 5 Core Principles of Money & Banking
 Time has value
 Risk requires compensation
 Information is the basis for decisions
 Markets set prices and allocate
resources
 Stability improves welfare

2. in the news…in the news…
• Subprime lending market meltdown
 impact on mortgage markets
 Impact on financial institutions
 impact on the stock market
 impact on the economy

3. • The U.S. dollar
 parity with the Canadian $!
 Revaluation of the Chinese yuan?
• Federal Reserve Chair Ben
Bernanke
 Reduction of federal funds rate
• Largest since 1984
 A re-emergence of stagflation?

8. 1. Time has value1. Time has value
• $100 today vs. $100 in one year
 Are you indifferent?
• Forensic economics
• Value of a financial instrument
depends on SIZE and TIMING of
payments

9. Example: HGTVExample: HGTV
• My House is Worth What?
 House purchased 2001: $225,000
 Renovations over 5 years: $41,000
 Estimated current value: $350,000
 Profit: $84,000…..Really?
• NO! not really!

10. 2. Risk requires compensation2. Risk requires compensation
• Risk comes from uncertainty
• Risk is unavoidable
• We don’t like it.

11. • To take on risk, we demand
compensation
 Subprime mortgage rates > prime
mortgage rates
• We pay to avoid certain risks
 Auto, life insurance
 Low rates on checking, savings
accounts

12. • The value of a financial asset
depends on the
 size,
 timing, and
 CERTAINTY
of its payments.

13. 3. Information is the basis for3. Information is the basis for
decisionsdecisions
• Rational decisions use all available info
• Asymmetric info can impede markets
• Financial institutions play a big role in
gathering info
• Financial regulation demands disclosure
of certain info

14. 4. Markets set prices and allocate4. Markets set prices and allocate
resourcesresources
• Eco 101!
• Markets set a price that rations
scarce resources
 Prices send a signal
• Financial market prices allocate
funds

15. 5. Stability improves welfare5. Stability improves welfare
• Back to #2—we do not like
uncertainty
• Financial stability feeds economic
growth and standards of living
 Role of institutions, Federal
Reserve