Unit 4

Money
Any asset that can be easily used to purchase goods and services

Three uses of money

•  medium of exchange
• used to determine value
• unit of account  
•  store a value

Three types of money

• Commodity money 
• value within itself (ex: salt, olive oil, gold)
• Representative money 
• represents something of value (ex:IOU)
• Fiat Money 
•  money because the government says so (ex: paper money and coins)

*All money is not currency*

6 characteristics of money

1. Durability - how long it last
2. Portability - take it anywhere
3. Divisibility - can be broken down (coins or $)
4. Uniformity - money that is the same no matter where you go
5. Limited supply
6. Acceptability 

Money Supply: Total value of financial assets available in the U.S economy.


M1 Money:

• consist of liquid asset 
•  easily convertible to cash (ex: currency, coins, checkable deposits(checks), travelers check)

M2 Money:
M1 Money + Savings Account + Money Market Account

3 Purposes of Financial Institutions

1.  store money
2.  save money
3.  loan money 
• credit card 
•  mortgages

4 ways to save money

1. Savings account
2. Checking account
3. Money market account
4. Certificate of deposit (CD)

Loans:

• Banks operate on a fractional reserve banking system which means they keep a fraction of the funds and loan out the rest.

Interest Rate:

• principal 
• amount of money borrowed
• interest
•  price paid from the use of borrowed money
1. Simple interest- paid on the principal
2. Compound- Paid in the principle plus accumulated interest

I = PRT/100

T= Ix100/PR

P = Ix100/RT

R = Ix100/PT

I = Simple Interest

P = Principal

R = Interest Rate

T = Time

Types of financial institution

1. commercial banks
2. savings and loans institutions
3. mutual savings bank
4. credit union
5. finance companies

Investment: redirecting resources you would consume now for the future 

Financial Assets: claims on property and income of borrower 

Financial Intermediaries: institutions that channel funds from savers to borrowers 

1.     Share risk through diversification - spreading out investments to reduce risk
2.     Provide information
3.     Liquidity (returns) - the money an investor receives above and beyond the sum of money that was initially invested

**Bonds you loan**Stocks you own

Bonds: loans or IOUs that represent debt that the government or a corporation must repay to an investor. Generally low risk investments. 

3 Components of a Bond

1.  Coupon Rate: the interest rate that a bond issuer will pay to a bond holder
2.  Maturity: the time at which payment to a bond holder is due
3.  Par Value: the amount that an investor pays to purchase a bond (Principal)

Yield: the annual rate of return on a bond if the bond were held to maturity 

Time Value of Money

• Is a dollar today worth more than a dollar tomorrow? Yes. 
• Why? Opportunity cost & inflation. This is the reason for charging and paying interest. 

Let v = future value of $

p = present value of $

r = real interest rate (nominal rate - inflation rate), expressed as a decimal

n = years

k = number of times interest is credited per year 

The simple Interest Formula:

v = (1+r)^n x p

The Compound Interest Formula

v = (1 + r/k)^(nk) x p

The Monetary Equation of Exchange

MV = PQ

M = money supply (M1 or M2)

V = money's velocity (M1 or M2)

P = price level (PL on the AS/AD diagram)

Q = real GDP (sometimes labeled y on the AS/AD diagram)

7 Functions of the Fed

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

The Three Types of Multiple Deposit Expansion Question

Type 1: 

Calculate the initial change in excess reserves. aka, the amount a single bank can loan from the initial deposit. 

Type 2: 

Calculate the change in loans in the banking system

Type 3: Calculate the change in the money supply.Sometimes type 2 and type 3 will have the same result (I.e. No Fed involvement)

Type 4: Calculate the change in demand deposits. 

The amount of new deposits of new depots - required reserve = the i risk change in excess reserves. 

Reserve Ratio = (Commercial Bank's Required Reserves) / (Commercial Bank's Checkable-Deposit Liabilities)

Excess Reserves = Actual (Total) Reserves - Required Reserves

Required Reserves = Checkable Deposits x Reserve Ratio