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Money and Banking

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Money & Banking ­ MGT411
VU
Lesson 4
OTHER FORMS OF PAYMENTS
Debit Card
The money in your account is used for payments
Works like a cheque and there is usually a fee for the transaction
Credit card
It is a promise by a bank to lend the cardholder money with which to make purchases.
When the card is used to buy merchandise the seller receives payment immediately
The money that is used for payment does not belong to the buyer
Rather, the bank makes the payment, creating a loan that the buyer must repay.
So, they do not represent money; rather, they represent access to someone else's money
Electronic Funds Transfer
Move funds directly from one account to another.
Banks use these transfers to handle transactions among themselves
Individuals may be familiar with such transfers through direct deposit of their paycheques and
the payment of their utility bills, etc
E-money
Used for purchases on the Internet.
You open an account by transferring funds to the issuer of the e-money
When shopping online, instruct the issuer to send your e-money to the merchant
It is really a form of private money.
Stored-value card
Retail businesses are experimenting with new forms of electronic payment
Prepaid cellular cards, Internet scratch cards, calling cards etc
The Future of Money
The time is rapidly approaching when safe and secure systems for payment will use virtually no
money at all
We will also likely see
Fewer "varieties" of currency, (a sort of standardization of money) and
A dramatic reduction in the number of units of account
Money as a store of value is clearly on the way out as many financial instruments have become
highly liquid.
Measuring Money
Different Definitions of money based upon degree of liquidity. Federal Reserve System defines
monetary aggregates.
Changes in the amount of money in the economy are related to changes in interest rates,
economic growth, and most important, inflation.
Inflation is a sustained rise in the general price level
With inflation you need more money to buy the same basket of goods because it costs more.
Inflation makes money less valuable
The primary cause of inflation is the issuance of too much money
Because money growth is related to inflation we need to be able to measure how much money is
circulating
Money as a means of payments
We measure the quantity of money as the quantity of currency in circulation ­ an unrealistically
limited measure, since there are other ways of payments
Alternatively, broadly categorize financial assets and sort them by the degree of liquidity
Sort them by the ease with which they can be converted into a means of payments
Arrange them from most liquid to least liquid
Draw a line and include everything on one side of the line in the measure of the money
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Money & Banking ­ MGT411
VU
Where to draw the line?
In reality, we draw line at different places and compute several measures of money called the
monetary aggregates
M1, M2, and M3
M1 is the narrowest definition of money and includes only currency and various deposit
accounts on which people can write Cheques.
Currency in the hands of the public,
Traveler's Cheques,
Demand deposits and
Other chequeable deposits
M2 includes everything that is in M1 plus assets that cannot be used directly as a means of
payment and are difficult to turn into currency quickly,
Small-denomination time deposits,
Money market deposit accounts,
Money market mutual fund shares
M2 is the most commonly quoted monetary aggregate since its movements are most closely
related to interest rate and economic growth.
M3 adds to M2 other assets that are important to large institutions
Large-denomination time deposits,
Institutional money market mutual fund shares,
Repurchase agreements and
Eurodollars
_Symbol
Assets included
C
Currency
M1
C + demand deposits, travelers' Cheques,
other chequeable deposits
M2
M1 + small time deposits, savings deposits,
money market mutual funds, money market deposit accounts
M3
M2 + large time deposits, repurchase agreements, institutional money market
mutual fund balances
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Money & Banking ­ MGT411
VU
Monetary Aggregates
Figures in millions as of March 2005
1. Currency issued
711,997
2. Currency held by SBP
3,188
3. Currency in tills of Scheduled Banks
43,914
4. Currency in circulation (1 ­ 2 ­ 3)
664,895
5. Scheduled Banks demand deposits
93,272
6. Other Deposits with SBP
4,826
7. M1 (4+5+6)
1,602,423
8. Scheduled Banks Time Deposits
1,037,678
9. Resident Foreign Currency Deposits
172,074
10. Total Monetary Assets (M2)
2,812,175
11. M3
3,833,686
Source: State Bank of Pakistan
Table : The Monetary Aggregates
Monetary Aggregates
Value as of August 2004 (U.S.$ billion)
M1= Currency in the hands of the public
686.2
+ Traveler's checks
7.6
+ Demand deposits
315.3
+ Other checkable deposits
328.5
Total M1
1,337.6
M2=M1
+ Small-denomination time deposits
794.7
+ Savings deposits including money market deposit
accounts
3415.3
+ Retail money market mutual fund shares
735.5
Total M2
6,283.1
M3=M2
+ Large-denomination time deposits
1,036.3
+ Institutional money market mutual fund shares
1,104.7
+ Repurchase agreements
516.6
+ Eurodollars
344.5
Total M3
9,285.2
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Money & Banking ­ MGT411
VU
Figure: Growth rates in monetary aggregates
40
35
30
25
M1
20
M2
15
M3
10
5
0
-5
Figure: Money growth and Inflation
%
30
25
20
15
10
5
0
-91  1-92  2-93  3-94  4-95  5-96  6-97  7-98  8-99  9-00  0-01  1-02  2-03  3-04
90
0
0
9
9
0
9
0
9
9
9
9
9
9
20
20
19
19
20
19
20
19
19
19
19
19
19
19
Years
Measures of Inflation
Fixed-weight Index - CPI
Deflator ­ GDP or Personal Consumption Expenditure Deflator
Consumer Price Index (CPI)
Measure of the overall level of prices used to
Track changes in the typical household's cost of living
Allow comparisons of dollar figures from different years
Survey consumers to determine composition of the typical consumer's "basket" of goods.
Every month, collect data on prices of all items in the basket; compute cost of basket
CPI in any month equals
C o s t o f b a s k e t in th a t m o n th
100
C o s t o f b a s k e t in b a s e p e r io d
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Money & Banking ­ MGT411
VU
Example:
The basket contains 20 pizzas and 10 compact discs.
Prices
Years
Pizza
CDs
2002
$10
$15
2003
$11
$15
2004
$12
$16
2005
$13
$15
From this table, we can calculate the inflation rate as:
Years
Cost of Basket
CPI
Inflation rate
2002
$350
100.0
n.a.
2003
370
105.7
5.7%
2004
400
114.3
8.1%
2005
410
117.1
2.5%
GDP Deflator
The GDP deflator, also called the implicit price deflator for GDP, measures the price of output relative
to its price in the base year. It reflects what's happening to the overall level of prices in the economy
GDP Deflator = (Nominal GDP / Real GDP) 100
Years
Nom. GDP
Real GDP
GDP Deflator
Inflation Rate
2001
Rs46, 200
Rs46, 200
100.0
n.a.
2002
51,400
50,000
102.8
2.8%
2003
58,300
52,000
112.1
9.1%
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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