Econ Section 1
Three Tasks of the Financial System
1. Reduce transaction cost. (cost of making a deal)
2. To reduce financial risk- provides opportunity tp diversify financial portfolios.
3. Provides liquid assets- assests that can quickly be turned into cash.
Four Main Types of Financial Assests
4. Bank Deposites
Financial Intermidiaries (4)
1. Mutual Funds- Creates a stock portfolio- resales shares to individual investors.
2. Pension Funds- type of mutual funds that holds assests to provide retirement income.
3. Life insurance- Governtees payments to beneficiaries when the policy holder dies.
4. A Bank- provides liquid assests based on the bank deposites to finance the spending needs of borrowers
The Efficient Market Hypothesis
The price of an asset will always reflect "market fundamentals" (supply and demand)
What is Money?
Any asset that can easily be used to purchase goods and services.
Consists of cash or assets that are highly liquid
Function of Money (3)
1. Medium of Exchange- money facilitates the exchange of goods by eliminating the need for the double confidence of wants.
2. Store of value- money holds purchasing power over time.
3. Unit of Account- money represents the standard by which we express the value of goods.
Types of Money (3)
1. Commodity Money- the medium of exchange is a good. ex- gold or silver
2. Commidity Banked Money- paper currency which is backed by a commodity.
3. Flat Money- money whose value derives entrivly from its status as offical currency.
Measure of Money
1. M1- currency in circulation + checkable bank deposites + travelers checks
2. M2- M1 + savings deposites + small denomination time deposites + money market mutual funds. (a little less liquid)
Is a financial intermediary that uses its deposites to make loans to borrowers.
A main way in which commercial banks earn profit.
Two Primary Funtions of Commercial Bank
1. To hold demand deposites and honor check drawn upon them.
2. To lend money- important because it facilitates investment in the public sector.
Fractional Reserve Banking and Money Supply
FRB- refers to the fact that banks are only required to hole a portion of their deposites.
The rest can go to loans
1. Deposite Insurance- federal deposite insurance corporation insures deposites up to 250,000.
2. Capital requirements- banks require to hole capital that is at least 7% of total assests.
3. Reserve Requirement set by the fed
4. The discount window- the fed provides low interest rate loans to banks that are in trouble.
Federal Reserve System
Is our central bank of the us.
Established in 1913 with the passage of the federal reserve act.
Functions of the Fed
1. Control money supply
2. Serve as lender at last resort
3. Provide check clearing facilities for the banking system.
4. Issue Currency
5. Requlate financial institutions
Structure of the Fed
12 federal reserve districts across the us.
A district bank in each district.
Federal Open Market Committee (FOMC)
Board of governors + 5 district bank presidents.
President of NY fed is always on FOMC.
Other 4 slots rotate yearly between the other 11.
Determines Monetary policy.
Board of Governors
14 year term
Staggered every 2 years
Federal Advisory Council
12 private bankers
One from each district
Advise the fed.
Purpose of Monetary Policy
Fed controls over the money supply
Goals- Price stability and full employment
Three tools of Monetary Policy
1. Reserve Requirements
-Lowering the RR increases money supply. VV
Open Market Operations
- the FOMC buys and sells bonds in the open market
-FOMC buuys bonds the money supply increases VV
3. Discount Rate
-Rate at which the fed loans lower banks money.
-fed lowers the DR, increas in money supply VV
Econ Section 1