Wednesday, March 9, 2016

UNIT 4: Money, Time value of money, What banks do and Functions of FED.

                                                                    Money
1.      Uses of money
-          Medium of exchange (trade/barter).
-          Units of accounts: establishes economic worth in the exchange process for example: giving something to someone in order to reduce price.
-          Store of value: money holds its value over a period of time whereas products may not.
2.      Types of money
-          Commodity money: it gets its value from the type of material from which it was made. An example would be gold coins and silver coins.
-          Representative money: paper money backed by something tangible, that gives it value. Example would be(“I owe you”)
-          Fiat money: it is money because the government says so. “used in the united states”.
3.      Characteristics of money
·         There are six characteristics of money:
-          Durable- paper money and coins both last.
-          Portable
-          Divisible (can be broken down in many ways)
-          Uniform (identical)
-          Scarce
-          Acceptable (Everywhere you go)

                                         Money supply

1.      M1 money supply: consists of currency (coins and cash), it also consists of checkable deposits (demand deposits) and travelers checks.
    75% of the money we use comes from M1 money. Out of all three money supply it is the “liquid” (easy to break down).
2.      M2 money: consists of M1 money + savings + deposits built by banks outside of the United States. Saving accounts are not “liquid” (not easy to break down).
3.      M3 money: consists of M2 money + certificates of deposit that are held by private institutions
                              (Pay bank penalty for withdrawing money)

                                                      Time value of money
Is a dollar today worth more than a dollar tomorrow?
Yes
Why?
-opportunity cost and inflation. This is the reason for charging and paying interest.
                                     How to calculate time value of money
V= future value of $
P= present value of $
r= real interest rate (nominal rate-inflation rate) expressed as a decimal.
n=years
k= number of times interest is credited per year.
The simple interest formula: v= (i+r)^n * p
The compound interest formula: v= (i+r/k)^nk * p
            Demand for money has an INVERSE relationship between nominal interest rates and the quantity of money demanded.
1.      What happens to the quantity demanded of money when interest rates increases? – Quantity demanded decreases because individuals would prefer to have interest earning assets instead of borrowed liabilities.
2.      What happens to the quantity demanded when interest rates decreases?
Quantity demanded increases. There is no incentive to convert cash into interest earning assets.
            Slope of demand is always downward sloping. Money supply is upward sloping.

Increasing money supply


Increasing price level




                                         Decreasing money supply
Decrease>increase>decrease>decrease money supply interest rate investment AD

                                               Financial assets
Examples are stocks and bonds. They provide an expected future benefit. It is what you own.
                                             Financial liabilities
                                        It is simply what you owe.

                                                  Interest rate
                                It is the cost of borrowing money.

                                                     Stocks
             They are financial assets that convey ownership in a company.

                                                      Bonds
    It is a promise to pay a certain amount of money or interest in the future.


                                                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:
1.      Currency in bank vaults.
2.      Bank reserve: deposits held at the Federal Reserve.

What banks do-
Basic accounting review
·         T account (balance sheet)


-          Statements of assets and liabilities.
·         Assets (amounts owned)
-          Items to which a bank holds legal claim.
-          The uses of funds by financial intermediates.
·         Liabilities (amounts owed)
-          The legal claims against a bank.
-          The sources of funds for financial intermediaries.

 

                                                     Functions of FED

1.      To issue currency.
2.      Set reserve requirement and hold reserves of banks.
3.      To lend money to banks and charge them interest.
4.      They are a check clearing servings for banks.
5.      Acts as a personal bank to the Government.
6.      Supervises member banks.
7.      Controls money supply in the economy.

  





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