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Financial Sector
Ashley OngCourtney ChanJamie LamKevin Co
Key TermsMoney – A current medium of
exchange in the form of coins and banknotes
Stocks – The goods or merchandise kept on the premises of a business or warehouse and available for sale or distribution
Bonds – A debt investment in which an investor loans money to an entity that borrows the funds for a defined period of time at a fixed interest rate
Main IdeasMoney does not retain its value
over time.Banks can “create” money
through loans.Money is a product, and has a
demand/supply of its own.The Fed can influence the
economy through control of the money supply.
More money leads to more inflation.
Time Value and MoneyIdea that money available at the
present time is worth more than the same amount in the future (due to inflation)
In other words…
The real worth of money today is less than it will be in the future.
Ex. A bottle of ketchup cost $0.19 in 1970.
Today, it costs about $2.99
How to Find Future Value
FV = PV (1 + i)^t
Future value = present value * (1 + real interest rate)^(# of years)
How to Find Present Value
PV = FV / (I + i)^t
Present Value = Future Value / (1 + real interest rate)^(# of years)
• Therefore, if you get the $10,000 in the present time, it will be worth more in the future.
Future vs. Present
ExampleIf the interest rate is 9%, and
inflation is at 4%, how much will $1,000 be worth in ten years?
FV = PV (1 + i)^t
FV = 1000 (1 + 0.05)^10
FV ≈ $1628.89
Example 2In five years time, you will have
exactly $2,000 in a bank account. If the interest rate was 7% and inflation was 2%, how much money did you initially invest?
PV = FV / (1 + i)^t
PV = 2000 / (1 + 0.05)^5
PV ≈ $1567.05
Money SupplyThe entire and total quantity of
bills, coins, loans, credit, and other liquid instruments in a single country’s economy.
M1First category of money supplyIncludes the most “liquid” or
easily spent fundsPhysical Money (coins &
currency)Checking AccountsNOW (negotiable order of
withdrawal) accounts
M2Second category of money
supplySecond most liquid or spendable
fundsIncludes all of M1Time related depositsSavings DepositsNon-institutional money market
funds
M3Third categoryLarge time depositsinstitutional money-market fundsShort term repurchase
agreementsLarge liquid assets
Creation of Money
Banks can essentially “create” money.
Reserve Requirement Ratio – minimum amount of money a bank needs to retain within their vaults.
How do they do it?
Bob the Bunny saves in the bank. The bank can use that money to give a loan to Jarvis the Chicken. When Jarvis pays his loan back, the bank will have both Bob’s money and Jarvis’ money.
However…
It is a bit more complicated in practice.
Banks have many customers, all of whom loan, save, or both.
In the end, the bank usually makes a decent amount of money due to interest rates on the amount of money a borrower has to pay back.
More Equations
Money Banks Creates = Money Multiplier * Excess Reserves
Money Multiplier = 1 / (Reserve Ratio)
Excess Reserves = incoming money – required reserves
Example 3A bank gets a deposit of $10,000.
If the reserve ratio is 2%, how much “new money” can the bank create?
Money Multiplier = 1 / 0.02 = 50
Excess Reserve = 10000 – 200 = 9800
New Money = 50 * 9800 = $490,000
Money (cont.)
Think of money as a product.
It has supply and demand, just like a normal product such as Computers or Widgets or Gnomes.
Money Market Graph
Money Demand / SupplyIf the money supply increases,
the demand will decrease.This will cause the worth of
money to decrease, causing inflation.
If the money supply decrease, the demand will increase.
This leads to an increase in the worth of money.
Loanable Funds Market
IMPORTANTMoney Market Graph
◦Shows the demand/supply of money in a country’s economy
Loanable Funds Market◦Shows the relationship between a
borrower’s demand for money and a loaner’s supply of money.
Central Bank
The Federal Reserve (the Fed) can control the money supply through monetary policy.
Open Market OperationsDiscount RateReserve Requirements
Quantity Theory of Money
The price level of goods and services sold is directly related to the quantity of money.
Ex. If the amount of money in Hyrule doubles, price levels will also double.
Fisher Equation
MV = PT
Money Supply * Velocity of Circulation = Price Level * Volume of Transactions of Goods and Services
Interest Rates
Real Interest Rate = Nominal Interest Rate – Inflation
Nominal Interest Rate = Real Interest Rate + Inflation
Works Cited
http://www.investopedia.comhttp://www.images.google.comhttp://www.federalreserve.gov