The document provides an overview of financial markets and the characteristics and functions of money, including its role as a medium of exchange, store of value, unit of account, and standard of deferred payment. It discusses different definitions of the money supply, distinctions between narrow and broad money, and introduces Bitcoin as a digital currency, highlighting its value volatility and acceptance. Additionally, the document examines factors affecting the supply and demand for money, as well as the roles of money, capital, and foreign exchange markets in the economy.

1. Introduction to Financial Markets and
Money
Financial Economics

2. Financial Markets and Monetary Policy
Financial Economics

3. What is Money?
Financial Economics

4. Characteristics and Functions of Money
1. Durability i.e. it needs to last
2. Portable i.e. easy to carry around, convenient, easy to
use
3. Divisible i.e. it can be broken down into smaller
denominations
4. Hard to counterfeit - i.e. it can’t easily be faked or
copied
5. Must be generally accepted by a population
6. Valuable – generally holds value over time

5. The Key Functions of Money
1. Medium of exchange: money allows goods and services to
be traded without the need for a barter system. Barter
systems rely on there being a double coincidence of wants
between the two people involved in an exchange
2. Store of value: this can refer to any asset whose “value” can
be used now or used in the future i.e. its value can be
retrieved at a later date. This means that people can save
now to fund spending at a later date.
3. Unit of account: this refers to anything that allows the value
of something to be expressed in an understandable way, and
in a way that allows the value of items to be compared.
4. Standard of deferred payment: this refers to the expressing
of the value of a debt i.e. if people borrow today, then they
can pay back their loan in the future in a way that is
acceptable to the person who made the loan.

6. Definitions of the money supply
• Notes and coins:
• Notes and coins in circulation outside the Bank of England
• The Bank of England (BoE) makes sure it creates enough banknotes to
meet the public’s demand for them
• M0
• Notes and coin plus central bank reserves
• MZM
• Notes and coin plus all sight deposits held by the non-bank private
sector
• M2
• Notes and coin plus all retail deposits (including retail time deposits)
held by the non-bank private sector
• M4
• Notes and coin, deposits, certificates of deposit, securities with a
maturity of less than five years held by the non-bank private sector.

7. Distinction between narrow money and broad money
• Narrow Money
• The narrow money definition of the money supply is a measure
of the value coins and notes in circulation and other money
equivalents that are easily convertible into cash such as short
term deposits in the banking system
• Broad Money
• Broad money is a measure of the total amount of money held by
households and companies in the economy
• Broad money is made up mainly of commercial bank deposits —
which are essentially IOUs from commercial banks to
households and companies — and currency — mostly IOUs from
the central bank

8. Is Bitcoin Real Money?
• Bitcoin is a digital currency that was launched by a secretive entrepreneur
in October 2008, with the aim of being “a new electronic cash system that
is fully peer-to-peer with no trusted third party”.
• Bitcoins are created by users (a.k.a. “miners”) who allow the Bitcoin
system to use their computing power to process Bitcoin transactions
• These miners are also rewarded with the some of the transaction fees paid
by those who use Bitcoin.
• A few retailers, especially online, accept Bitcoin, partly because the
transaction fees are lower than those of credit cards.
• However, Bitcoin’s value has been volatile
• Fewer retailers than expected have signed up to accept Bitcoin because
any transactions made in Bitcoin are not protected by financial regulation.
• Bitcoin is special it is made possible by special cryptographic techniques so
that it can not be faked
• Each Bitcoin can only be spent by the same person just once.
• The peer-to-peer nature of Bitcoin bypasses the need for banks, allowing
people to lend to or borrow directly from others.

9. The Global Price of Bitcoin
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10. Factors Affecting Supply of Money
• “Open market operations” – this is effectively the same as
Quantitative Easing. The Central Bank buys government
bonds, effectively creating money
• The “reserve requirement” imposed on banks – this is
the % of deposits made by customers at the bank that the
bank must keep hold of rather than lending it out
• The policy interest rate set by the Bank of England – the
rate of interest will influence how many households and
businesses are willing and able to borrow. Most money in
a modern economy is created by commercial bank lending
so the rate of interest ultimately does have a bearing on
the supply of money

11. Factors Affecting Demand for Money
• The rate of interest on loans
• The number / value of monetary transactions that we
expect to carry out
• The extent to which we also want to hold other financial
assets, such as bonds, property, saving (this is also
influenced by the rate of interest) – this is known as the
speculative motive for holding money
• Changes in GDP
• The extent to which it is possible to use debit cards /
credit cards i.e. the pace of financial innovation
• The extent to which we might have to pay out large
unexpected payments, for example, for i.e. the
precautionary motive
• The rate of anticipated inflation

12. UK Savings and Lending Interest Rates
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Household deposit and lending interest rates
£10,000 unsecured loan Two-year, fixed-rate mortgage, 90% loan to value
Two-year, fixed-rate mortgage, 75% loan to value New fixed-rate time deposit

13. Money, capital & foreign exchange markets
Money
Market
Market for short term loan finance for businesses
and households
Money is borrowed and lent normally for up to 12
months
Includes inter-bank lending i.e. the commercial
banks providing liquidity for each other
Includes short term government borrowing e.g. 3-
12 month Treasury Bills – to help fund the
government’s budget (fiscal) deficit

14. Money, capital & foreign exchange markets
Capital
Market
Market for medium-longer term loan finance
Capital markets are the markets where
securities such as shares and bonds are issued
to raise medium to long-term financing
Includes raising of finance by the government
through the issue/sale of medium term - long
term government bonds for example 10 year
and 20 year bonds (loans)

15. Money, capital & foreign exchange markets
Foreign
exchange
market
A market where currencies (foreign exchange) are
traded. There is no single currency market – it is
made up of the thousands of trading floors
Gains or losses are made from the movement of
exchange rates – speculative activity in the
currency market is often high
The spot exchange rate is the price of a currency
to be delivered now, rather than in the future.
The forward exchange rate is a fixed price given
for buying a currency today to be delivered in the
future

16. Role of financial markets in the wider economy
To facilitate saving by businesses and households
To lend to businesses and individuals
To facilitate the exchange of goods and services
To provide forward markets in currencies and commodities
To provide a market for equities
A financial market is any exchange that facilitates the trading of
financial instruments, such as stocks, bonds, foreign exchange, or
primary commodities such as oil and gas.