Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education...

Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

CHAPTER 18

Understanding Money

and Banking

18-2


Learning Objectives

Define money and identify the different forms it takes in the nation’s money supply.

Describe the different kinds of financial institutions that make up the Canadian financial system and explain the services they offer.

Explain how banks create money and identify the means by which they are regulated.

Explain the functions of the Bank of Canada and describe the tools it uses to control the money supply.

Identify ways in which the banking industry is changing.

Understand some of the activities in international banking and finance

18-3


Money

Characteristics: Portable:

lightweight and easy to handle

Divisible: easily broken down to match the value of goods

Durable: must not spoil or easily wear out

Stable: must be stable enough to hold its value over time, apart from

minor fluctuations

Any objectAny objectgenerally accepted generally accepted

as payment for as payment for goods & servicesgoods & services

18-4


Functions of Money

Medium of exchange a single medium of exchange for goods and

services instead of barter

Store of valuecan be used for future purchases

Unit of account allows measurement of the relative value of

goods and services

18-5


The Money Supply

Buyers and sellers must agree on the value of money

The value of money depends on its supplyas supply , valueas supply , value

Narrow definition is called M-1 Wider definition is called M-2

18-6


M-1 Money Supply

The most liquid forms of moneycurrency:

paper money and coins issued by the Canadian government

demand deposits: money in chequing accounts, which can be

transferred to others by cheque

18-7


M-2 Money Supply

Everything in M-1 plus Savings deposits:

savings account holdings

Time deposits: deposit requiring prior notice before withdrawal of funds

Money market mutual fundsPooled assets from many investors invested in short-term, low

risk financial securities

Measures the store of monetary value that is available for making financial transactions

18-8


Credit Cards

Not included in M-1 or M-2 Not money

no store of value

Money substitute temporary medium of exchange

Popular:ConvenientProfitable

annual fees, merchants fees & interest

18-9


Financial Institutions

Traditionally consisted of four financial pillars

Chartered banks

Alternate banks (trust companies, credit unions, caisses

populaires)

Life insurance companies and specialized lending and

saving intermediaries

Investment dealers

DifferencesDifferencesare now blurredare now blurred

due to changes in due to changes in financial industry financial industry

regulationsregulations

18-10


Pillar #1: Chartered Banks

Privately owned, profit-oriented, financial intermediary Largest and most important of financial institutions

Each bank has many branches

Schedule A Banks must be Canadian-owned with no more than 10% of

voting shares controlled by a single interest (90% of all bank assets)

Schedule B Banks may be foreign-owned and need not meet the 10% limit

(foreign-owned bank deposits cannot exceed 8% of the total domestic assets of all banks)

18-11


Services Offered by Banks

Pension services

Trust services

International services

Financial advice

Electronic technologies

Bank deposits

Bank loans

Bank accounts

18-12


Bank Deposits

Accept deposits from some customers to obtain money to lend to otherschequing accounts

term deposits (money that remains with the bank for a period of time with interest paid to the depositor)

18-13


Bank Loans

Major source of short-term financing

Prefer to finance inventories or accounts receivable rather than long-term loans to many businesses

Secured loan backed by collateral

(e.g.: inventory)

Unsecured loan backed only by promise

Prime rate of interest lowest rate charged to

best customers

18-14


Banks as Creators of Money

Bank New DepositReserve

Requirement New Loan

1 $100.00 $10.00 $90.00

2 $90.00 $9.00 $81.00

3 $81.00 $8.10 $72.90

4 $72.90 $7.29 $65.61

5 $65.61 $6.56 $59.05

6 $59.05 $5.91 $53.14

7 $53.14 $5.31 $47.83

8 $47.83 $4.31 $38.74

9 $43.05 $4.31 $38.74

Totals for the first nine banks $612.58 $61.26 $551.32

Expansion limit for entire banking system $1,000.00 $100.00 $900.00

18-15


Other Changes in Banking

Deregulation is causing banks to shift from their historical role as intermediaries between borrowers and depositors

Diversification into other financial products

Investment banking

Commercial paper

18-16


Electronic Funds Transfer

Debit cards Plastic money that immediately adjusts the consumers

account balance and pays the merchant

Point of Sale terminals Electronic device used to facilitate debit card use

Smart Cards A credit card sized computer that can be programmed

with “electronic money”

Ecash Money that moves among consumers and businesses

via digital electronic transmission

18-17


The Bank of Canada

The central bank of CanadaManaged by a Board of Governors

Regulates operations of chartered banksManages the money supply by Buying/selling securitiesChanging the bank rate

Bank rate = rate at which chartered banks can borrow from Bank of Canada

18-18


Monetary Policy Actions of the Bank of Canada

Expansionary Policy Restrictive PolicyTools (stimulate business (slow down business activity

activity and increase the and decrease the moneymoney supply) supply)

Open Buy government securities: Sell government securities:

Market (increases bank reserves (decreases bank reserves

Operations enabling banks to make loans limiting the banks' abilities to businesses and to make loans to businesses

consumers) and consumers)

Lower the bank rate: Raise the bank rate:(increase the willingness of (decrease the willingness of

Bank Rate banks to borrow, more loans can banks to borrow, fewer loans canbe made to businesses and be made to businesses and

consumers) consumers)

18-19


Pillar #2: Alternate Banks

Trust companies safeguard funds and estates entrusted to it

serves as a trustee, transfer agent, & registrar for corporations

Credit unions (caisses populaires) cooperative savings and lending institution formed by a

group of individuals with common interests

offer savings accounts, loans, mortgages to members

invest its own funds in corporate & government securities

18-20


Pillar #3: Specialized Lending and Savings Intermediaries

Life insurance firms

Factoring companies

Financial corporations

Venture capital or

development firms

Pension funds

18-21


Life Insurance Firms

Life Insurance companiesmutual or stock company that shares risks

with policy holders for payment of premiums

some money from premiums is lent back out

substantial investments in real estate, mortgages and government bonds

largest financial intermediaries in Canada next to the chartered banks

18-22


Factoring Companies

Buy uncollected accounts receivable from a firm for less than its face value Attempts to collect the face value of the receivables

from customers

The difference between the amount collected and the cost of the receivables is the firm’s profit

Allows firms with old, or uncollectible, accounts receivable to redeem at least part of their value rather than writing them off completely

18-23


Financial Corporations

Sales finance company finances instalment purchases made by

individuals or businesses

loans are secured by the item being financed (e.g.: computer)

Consumer finance companymakes personal loans to consumers

collateral may or may not be required

18-24


Venture Capital or Development Firms

Provide funds for new or expanding firms that have great potential

Obtains funds from individual investors, financial intermediaries, retained earnings

While accepting increased risk with new ventures, VC firms seek to earn higher than normal returns

18-25


Pension Funds

Accumulate cash that will be paid out to subscribers in the future in the form of pension incomeMoney is invested until it is needed

Investments include stocks and bonds, mortgages

18-26


Pillar #4: Investment Dealers

Underwriters

Distribute new stock and bond issues (underwriting)

Stock brokers

Facilitate trading of stock and bond on exchanges (brokerage)

18-27


Other Sources of Funds

Government financial institutions and granting agencies Business Development Bank of Canada (BDC)

Canada Mortgage and Housing Corporation (CMHC)

Export Development Corporation

Canada and its provinces borrow from international sources of funds, including other nations

The Canadian Capital Market (international funds)

18-28


Exchange Rates and Trade

Exchange rates influence the willingness to

invest abroad and buy imported items

A trade surplus occurs when Canada is

exporting more products than it is importing

(likely to occur when the dollar is undervalued)

A trade deficit occurs when Canada is

importing more products than it is exporting

(likely to occur when the dollar is overvalued)

18-29


The Law of One Price

a basic commodity should be priced equally across all countries (if prices differ it is assumed to be due to over or under

valuation of the local currency)

Country Big Mac Price Equiv.

(US Dollars)

Over/Under

Valuation

United States $2.71 --

Canada 2.63 -14%

Switzerland (francs)

5.05 +65%

Britain(pounds)

3.44 +12%

China (yuan) 1.27 -59%

TheBigMac

Index

18-30


International Payments Process

When equal values of money are moving back and forth between nations, no real funds need to be transferred between nations because the payments are in balance

Local banks convert payments to the currency required by foreign trade associates

Local banks then send payment, in foreign currency, to the foreign trade partner

The foreign trade partner deposits the payment in his/her own foreign-based bank

18-31


International Bank Structure

World Bank UN agency that funds infrastructure projects in

developing countries

IMF 150 nations who combined resources to

promote stable exchange rates, provide temporary short-term loans, encourage cooperation on international monetary issues, and develop a system for international payments

International banking is governed by a network of loose agreements

between individual countries or groups of countries.

Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education...

Documents

Transcript of Business, Sixth Canadian Edition, by Griffin, Ebert, and StarkeCopyright © 2008 Pearson Education...