ZeePedia buy college essays online


Money and Banking

<<< Previous MONEY & THE PAYMENT SYSTEM:Distinctions among Money, Wealth, and Income Next >>>
 
img
Money & Banking ­ MGT411
VU
Lesson 3
MONEY & THE PAYMENT SYSTEM
Money
Characteristics of Money
Liquidity
Payment system
Commodity vs. Fiat Money
Cheques
Other forms of payments
Future of Money
Money
Money is an asset that is generally accepted as payment for goods and services or repayment of
debt.
Not the same as wealth or income
Money is a component of wealth that is held in a readily- spend able form
Money is made up of
Coin and currency
Chequing account balances
Other assets that can be turned into cash or demand deposits nearly instantaneously, without
risk or cost (liquid wealth)
Distinctions among Money, Wealth, and Income
While money, income and wealth are all measured in some currency unit, they differ
significantly in their meaning.
People have money if they have large amounts of currency or big bank accounts at a point in
time. (Stock variable)
Someone earns income (not money) from work or investments over a period of time. (Flow
variable)
People have wealth if they have assets that can be converted into more currency than is
necessary to pay their debts at a point in time. (Stock variable)
Characteristics of Money
A means of payment
A unit of Account
A Store of Value
A means of payment
The primary use of money is as a means of payment.
Money is accepted in economic exchanges.
Barter is an alternative to using money but it doesn't work very well.
Barter requires a "double coincidence of wants," meaning that in order for trade to take place
both parties must want what the other has.
Money finalizes payments so that buyers and sellers have no further claim on each other.
As economies have become more complex and physically dispersed the need for money has
grown.
Just as the division of labor and specialization allow for efficient production, money allows for
efficient exchange.
A unit of Account
We measure value using rupees and paisas.
Money is the unit of account that we use to quote prices and record debts.
6
img
Money & Banking ­ MGT411
VU
Money can be referred to as a standard of value.
Using money makes comparisons of value easy
Under barter the general formula for n goods, we will have n (n - 1) / 2 prices
Two goods
1 price
3 goods
3 prices
100 goods
4,950 prices
10,000 goods
50 million prices
A Store of Value
For money to function as a means of payment it has to be a store of value too because it must
retain its worth from day to day.
The means of payment has to be durable and capable of transferring purchasing power from one
day to the next.
Money is not the only store of value; wealth can be held in a number of other forms.
Other stores of value can be preferable to money because they pay interest or deliver other
services.
However, we hold money because it is liquid, meaning that we can use it to make purchases.
Liquidity is a measure of the ease with which an asset can be turned into a means of payment
(namely money).
The more costly an asset is to turn into money, the less liquid it is.
Constantly transforming assets into money every time we wish to make a purchase would be
extremely costly; hence we hold money
Liquidity
Liquidity is a measure of the ease an asset can be turned into a means of payment, namely
money
An asset is liquid if it can be easily converted into money and illiquid if it is costly to convert.
Cash is perfectly liquid.
Stocks and bonds are somewhat less liquid.
Land is least liquid.
The Payments System
The payment system is a web of arrangements that allows for the exchange of goods and
services, as well as assets among different people
Money is at the heart of payment system!
Types of Money
Commodity Money ­ Things that have intrinsic value
Fiat Money ­ Value comes from government decree (or fiat)
Commodity Money
The first means of payment were things with intrinsic value like silk or salt.
Successful commodity monies had the following characteristics
They were usable in some form by most people;
They could be made into standardized quantities;
They were durable;
They had high value relative to their weight and size so that they were easily transportable; and
They were divisible into small units so that they were easy to trade
For most of human history, gold has been the most common commodity money
Fiat Money
Today we use paper money that is fiat money, meaning that its value comes from government
decree (or fiat).
A note costs about 0.04% its worth to produce.
These notes are accepted as payment for goods or in settlement of debts for two reasons:
7
img
Money & Banking ­ MGT411
VU
We take them because we believe we can use them in the future.
The law says we must accept them; that is what the words "legal tender" printed on the note
means.
As long as the government stands behind its paper money, and doesn't issue too much of it, we
will use it. In the end, money is about trust.
Fiat or Commodity Money?
Does money need to be backed by a commodity at all?
The logical answer to this question is no.
If the monetary system is stable and functions effectively, "backing" is expensive, inconvenient,
and unnecessary.
Today, money is only backed by confidence that government will responsibly limit the quantity
of money to ensure that money in circulation will hold its value.
Advantages of Fiat Money
Fewer resources are used to produce money.
The quantity of money in circulation can be determined by rational human judgment rather than
by discovering further mineral deposits--like gold or diamonds
Disadvantage
A corrupt or pressured government might issue excessive amounts of money, thereby
unleashing severe inflation.
Cheques
Cheques are another way of paying for things, but
They are not legal tender
They are not even money.
Cheques are instructions to the bank to take funds from your account and transfer those funds to
the person or firm whose name is written in the "Pay to the Order of" line.
When you give someone a Cheque in exchange for a good or service, it is not a final payment;
A series of transactions must still take place that lead to the final payment
Following are the steps in the process
1- You hand a paper cheque from your bank to a merchant in exchange for some good
2- The merchant deposits the cheque into merchant's bank and merchant's account is credited
3- The merchant's bank sends the cheque to the local central bank
4- The Central Bank
(a) Credits the merchant's bank's reserve account
(b) Debits your bank's reserve account
(This step involves money)
5- The Central Bank returns the cheque to your bank
6- Your bank debits your Chequing account by the amount of the cheque
The whole process is time consuming and expensive;
Though cheque volumes have begun to fall, paper Cheques are still with us because a cancelled
cheque is legal proof of payment
Other Forms of Payments
Debit Cards
Credit Cards
Electronic Funds transfers
Stored Value Cards
8
Table of Contents:
  1. TEXT AND REFERENCE MATERIAL & FIVE PARTS OF THE FINANCIAL SYSTEM
  2. FIVE CORE PRINCIPLES OF MONEY AND BANKING:Time has Value
  3. MONEY & THE PAYMENT SYSTEM:Distinctions among Money, Wealth, and Income
  4. OTHER FORMS OF PAYMENTS:Electronic Funds Transfer, E-money
  5. FINANCIAL INTERMEDIARIES:Indirect Finance, Financial and Economic Development
  6. FINANCIAL INSTRUMENTS & FINANCIAL MARKETS:Primarily Stores of Value
  7. FINANCIAL INSTITUTIONS:The structure of the financial industry
  8. TIME VALUE OF MONEY:Future Value, Present Value
  9. APPLICATION OF PRESENT VALUE CONCEPTS:Compound Annual Rates
  10. BOND PRICING & RISK:Valuing the Principal Payment, Risk
  11. MEASURING RISK:Variance, Standard Deviation, Value at Risk, Risk Aversion
  12. EVALUATING RISK:Deciding if a risk is worth taking, Sources of Risk
  13. BONDS & BONDS PRICING:Zero-Coupon Bonds, Fixed Payment Loans
  14. YIELD TO MATURIRY:Current Yield, Holding Period Returns
  15. SHIFTS IN EQUILIBRIUM IN THE BOND MARKET & RISK
  16. BONDS & SOURCES OF BOND RISK:Inflation Risk, Bond Ratings
  17. TAX EFFECT & TERM STRUCTURE OF INTEREST RATE:Expectations Hypothesis
  18. THE LIQUIDITY PREMIUM THEORY:Essential Characteristics of Common Stock
  19. VALUING STOCKS:Fundamental Value and the Dividend-Discount Model
  20. RISK AND VALUE OF STOCKS:The Theory of Efficient Markets
  21. ROLE OF FINANCIAL INTERMEDIARIES:Pooling Savings
  22. ROLE OF FINANCIAL INTERMEDIARIES (CONTINUED):Providing Liquidity
  23. BANKING:The Balance Sheet of Commercial Banks, Assets: Uses of Funds
  24. BALANCE SHEET OF COMMERCIAL BANKS:Bank Capital and Profitability
  25. BANK RISK:Liquidity Risk, Credit Risk, Interest-Rate Risk
  26. INTEREST RATE RISK:Trading Risk, Other Risks, The Globalization of Banking
  27. NON- DEPOSITORY INSTITUTIONS:Insurance Companies, Securities Firms
  28. SECURITIES FIRMS (Continued):Finance Companies, Banking Crisis
  29. THE GOVERNMENT SAFETY NET:Supervision and Examination
  30. THE GOVERNMENT'S BANK:The Bankers' Bank, Low, Stable Inflation
  31. LOW, STABLE INFLATION:High, Stable Real Growth
  32. MEETING THE CHALLENGE: CREATING A SUCCESSFUL CENTRAL BANK
  33. THE MONETARY BASE:Changing the Size and Composition of the Balance Sheet
  34. DEPOSIT CREATION IN A SINGLE BANK:Types of Reserves
  35. MONEY MULTIPLIER:The Quantity of Money (M) Depends on
  36. TARGET FEDERAL FUNDS RATE AND OPEN MARKET OPERATION
  37. WHY DO WE CARE ABOUT MONETARY AGGREGATES?The Facts about Velocity
  38. THE FACTS ABOUT VELOCITY:Money Growth + Velocity Growth = Inflation + Real Growth
  39. THE PORTFOLIO DEMAND FOR MONEY:Output and Inflation in the Long Run
  40. MONEY GROWTH, INFLATION, AND AGGREGATE DEMAND
  41. DERIVING THE MONETARY POLICY REACTION CURVE
  42. THE AGGREGATE DEMAND CURVE:Shifting the Aggregate Demand Curve
  43. THE AGGREGATE SUPPLY CURVE:Inflation Shocks
  44. EQUILIBRIUM AND THE DETERMINATION OF OUTPUT AND INFLATION
  45. SHIFTS IN POTENTIAL OUTPUT AND REAL BUSINESS CYCLE THEORY