Money:
Uses of Money
Medium of Exchange- barter & trade
Unit of Account- establishes economic value
Store of Value- money holds its value over a period of time, whereas products may not
Types of Money
Commodity Money- it gets its value from the type of material from which it is made (Ex. gold & silver coins)
Representative Money- it is paper money backed up by something tangible that gives it value
Fiat Money- is money because the government says so
Characteristics of Money
Divisible- can be split (dollars into coins)
Portable- taken anywhere
Uniform- a dollar is a dollar
Acceptable- accepted by all
Scarce- limited
Durable
Money Supply
M1 Money- (75%) it is the most liquid (easy to convert to cash)
Currency: cash & coins
Checkable Deposits/Demand Deposits
Traveler’s Checks
M2 Money- consists of M1 Money, savings accounts, and deposits held by banks outside the U.S.
M3 Money- consists of M2 Money & certificate of Deposits (better known as CDs- money kept in the bank, collecting interest for x amount of time)
3/9/16
Time Value of Money
Is a dollar today worth more than a dollar tomorrow?
Yes
Why?
Opportunity cost & inflation
This is the reason for charging and paying interest
Let:
v= future value of $
p= present value of $
r= real interest rate (nominal rate- inflation rate) expressed as decimal
n= years
k= number of times interest is credited per year
The Simple Interest Formula:
v=(1+r)^n×p
The Compound Interest Formula:
v= (1+r/k)^nk×p
The Money Market
Demand for money has an inverse relationship between nominal interest rates and the quantity of money demanded
What happens to the quantity demanded of money when interest rates increase?
Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities
What happens to the quantity demanded when interest rates decrease?
Quantity demanded increases. There is no incentive to convert cash into interest earning assets.
The Demand of Money
What happens if price level increases?
Money Demand Shifters
Changes in price level
Changes in income
Changes in taxation that affects investment
Increasing the Money Supply
Decreasing the Money Supply
Financial Liability- something you owe
Financial Asset- something you own
Interest Rate- the cost of borrowing money
Stocks
Bonds
Share of a company; stockholders
Lending money to the govt & they promise to pay it back with interest
What Banks Do
A bank is a financial intermediary
Uses liquid assets (i.e. bank deposits) to finance the investments of borrowers
Process is known as Fractional Reserve Banking
A system in which depository institutions hold liquid assets less than the amount of deposits
Can take the form of:
Currency in the bank vaults
Bank Reserves- deposits held at the Federal Reserve
T-Account (Balance Sheet)
Statements of assets and liabilities
Assets (amount owned)
Items to which a bank holds legal claim
The uses of funds by financial intermediaries
Liabilities (amount owed)
Legal claims against a bank
Sources of funds for financial intermediaries
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