Chapter 1: Intro to Money & the Financial System

5 Core Principles of Money & Banking Time has value Risk requires compensation Information is the basis for decisions Markets set prices and allocate resources Stability improves welfare

in the news

Subprime lending market meltdown

impact on mortgage markets Impact on financial institutions impact on the stock market impact on the economy

 The U.S. dollar Federal Reserve Chair Ben

Largest since 1984

parity with the Canadian $! Revaluation of the Chinese yuan?

Bernanke Reduction of federal funds rate

A re-emergence of stagflation?

1. Time has value

$100 today vs. $100 in one year

Are you indifferent? Forensic economics Value of a financial instrument depends on SIZE and TIMING of payments

Example: HGTV

My House is Worth What?

House purchased 2001: $225,000 Renovations over 5 years: $41,000 Estimated current value: $350,000 Profit: $84,000..Really?
NO! not really!

2. Risk requires compensation

Risk comes from uncertainty Risk is unavoidable We dont like it.

 To take on risk, we demand

compensation Subprime mortgage rates > prime mortgage rates We pay to avoid certain risks Auto, life insurance Low rates on checking, savings accounts

 The value of a financial asset

depends on the size, timing, and CERTAINTY of its payments.

3. Information is the basis for decisions

Rational decisions use all available info Asymmetric info can impede markets Financial institutions play a big role in gathering info Financial regulation demands disclosure of certain info

4. Markets set prices and allocate resources

Eco 101! Markets set a price that rations

scarce resources Prices send a signal Financial market prices allocate funds

5. Stability improves welfare

Back to #2we do not like

uncertainty Financial stability feeds economic growth and standards of living Role of institutions, Federal Reserve