Unit 4 Notes

Tuesday, April 5, 2016

Unit 4: Functions of the Fed

Functions of the Federal Reserve

1. It issues paper currency
2. It sets reserve requirements and holds reserve of the banks.
3. It lends money to the banks and charges them interest.
4. They are check clearing service for banks.
5. They act as a personal bank for the government.
6. They supervise member banks.
7. They control the money supply in the economy.

Unit IV: Money

March 4, 2016

Money

Uses of Money

1. Medium of exchange - Barter and trade
2. Unit of account - Establishes economic value
• Ex: Instead of money, you pay with cake
3. Store of value - Money holds its value over a period of time. Where as products may not. (purchasing power changes)

Types of Money

1. Commodity - Gets its value from the type of material from which its made.
• Ex: Gold and silver wins
2. Representative Money - Paper money backed by something tangible that gives its value.
3. Flat - Money because the government says so; backed by the US government

Characteristics of Money

1. Divisible - can be broken down many ways (coins)
2. Portable - can be carried anywhere
3. Uniform - money is money; it is acceptable anywhere
4. Acceptable - 
5. Scarce -
6. Durable - can last without physically being ruined

Money Supply

1. M1 Money - 75% of money that is in circulation, because it is the most liquid. It is easy to convert to cash.
• Currency - cash and deposit
• Checkable Deposits/Demand Deposits (checking account)
• Traveler's Checks
2. M2 Money - consists of M1 Money, saving's accounts, and deposits held by banks outside of the United States.
• not as liquid
3. M3 Money - consists of M2 Money and certificates of deposits, better known as CD's.
• CD's: Keep money for (x) amount of time

March 4, 2016

Time Value of Money

• Is a dollar today worth more than a dollar tomorrow?
• YES.
• Why?
• Because of Inflation.
• Opportunity costs and inflation
• This is the reason for charging and paying interest.

• V = Future value of Money
• P = Present value of Money
• r = Real Interest Rate
• n = years
• k = number of times interest is credited per year (12)
• The Simple Interest Formula
• V = (1 + r )^n(p)
• The Compound Interest Formula
• V = (1+ r/k)^nk(p)

*Demand for Money has an inverse relationship between nominal interest rates and the quantity of money demanded.*

1. What happens to the quantity demanded of money when interest rates increase? 
• Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities.
2. What happens to the quantity demanded when interest rates decrease?
• Quantity demanded increases. There is no incentive to covert cash into interest earning assets. 

Demand For Money

What happens if Price Level (PL) increases?

Money Demand Shifters:

1. Changes in price level
2. Changes in income
3. Changes in taxation that affects investment

Increasing the Money Supply

If the FED increases the money supply, a temporary surplus of money will occur at 5% interest. The surplus will cause the interest rate to fall 2%.

Decreasing the Money Supply

If the FED decreases the money supply, a temporary shortage of money will occur at 5% interest. The shortage will cause the Interest Rate to rise to 10%.

DECREASE MONEY SUPPLY

↓

INCREASE INTEREST RATE

↓

DECREASE INVESTMENT

↓

DECREASE AD

Financial Assets vs. Financial Liabilities 

• Financial Assets - it is stocks and bonds who's benefit to the owner depends upon the issuer of the asset meeting certain obligations.
• Financial Liabilities - it is liabilities incurred by the issuer of a financial asset to stand behind the issued asset.
• Interest Rate - the price paid for the use of a financial asset.

Stocks vs. Bonds

• Stock- financial asset that conveys ownership in a corporation.
• Bond- a promise to pay a certain amount of money plus interest in the future.

"WHAT BANKS DO"

A bank is a Financial Intermediary

• Uses liquid assets (ie bank deposits) to finance the investments of borrowers
• Known as Fractional Reserve Banking 
• a system in which depository institutions hold liquid assets less than the amount of deposits
• can take the form of 
1. currency in bank vaults
2. Bank reserves: deposits held at the Federal Reserve

Basic Accounting Review

T-Account (balance sheet)

• statements of assets and liabilities

Assets (what you own)

• Items to which a bank holds legal claim.
• The uses of funds by financial intermediaries.

Liabilities (what you owe)

• The legal claims against a bank.
• The sources of funds for financial intermediaries.