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