Money and banking

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Emily Holmes

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The Financial Sector and the Economy © Collection of the New-York Historical Society, accession number 1971.10 4 After reading this chapter, you should be able to: LO29-1. Discuss the functions and measures of money. LO29-2. Define banks and explain how they create money. LO29-3. Explain why the financial sector is so important to macroeconomic debates. LO29-4. Explain the role of interest rates in an economy. “The peculiar essence of our banking system is an unprecedented trust between man and man; and when that trust is much weakened by hidden causes, a small accident may greatly hurt it, and a great accident for a moment may almost destroy it.” Walter Bagehot The financial sector is exciting (as suggested in this famous painting The Bulls and Bears in the Market); it is also central to almost all macroeconomic debates. This central role is often not immediately obvious to students. In thinking about the economy, students often focus on the real sector—the market for the production and exchange of goods and services. In the real sector, real goods or services such as shoes, operas, automobiles, and textbooks are exchanged. That’s an incomplete view of the economy. The financial sector—the market for the creation and exchange of financial assets such as money, stocks, and bonds— plays a central role in organizing and coordinating our economy; it makes modern economic society possible. A car won’t run without oil; a modern economy won’t operate without a financial sector. As I’ve noted throughout this book, markets make specialization and trade possible and thereby make the economy far more efficient than it otherwise would be. But the efficient use of markets requires a financial sector that facilitates and lubricates those trades. Let’s consider an example of how the financial sector facilitates trade. Say you walk into a store and buy a T-shirt. You shell out a 20-dollar bill and the salesperson hands you the T-shirt. Easy, right? Right—but why did the salesperson give you a T-shirt for a little piece of paper? The answer to that question is: Because the economy has a financial system that has convinced him that that piece of paper has value. To convince him (and you) of that requires an enormous structural system, called the financial sector, underlying the T-shirt transaction and all other transactions. That financial system makes the transaction possible; without it the economy as we know it would not exist. The modern financial sector is highly sophisticated. It disperses credit throughout the economy in highly diverse ways. For example, when a bank makes you a loan, often that loan is securitized, which means that it is packaged with other loans (say 1,000 such similar loans) into a security, or bond, and sold to individuals. These bonds based on other loans are calledderivatives because they are derived from another loan. An individual who buys that securitized bond in a sense owns 1/1,000 of your loan. Sometimes these securitized b ...

The Financial Sector and the Economy© Collection of the New-Yo.docx

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Please respond to at both learning activity topics below and respond to at least two classmates' postings. Use APA format for citations and include a reference list. Topic 1 What recommendations would you make for investors and businesses in the event of a sudden stock market major drop or crash? Topic 2 From reading Chapters 12 & 13, tell me something valuable that you have learned and how you will apply it in the future. Incorporate at least one piece of research that relates to your topic. 1 This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work’s original creator or licensee. http://creativecommons.org/licenses/by-nc-sa/3.0/ http://creativecommons.org/licenses/by-nc-sa/3.0/ 2 Chapter 13 Managing Financial Resources How to Keep from Going Under How can you manage to combine a fantastic business idea, an efficient production system, a talented management team, and a creative marketing plan…and still go under? It’s not so hard if you don’t understand finance. Everyone in business—not finance specialists alone—needs to understand how the U.S. financial system operates and how financial decisions affect an organization. Businesspeople also need to know how securities markets work. In this chapter, we’ll discuss these three interrelated topics. Let’s start by taking a closer look at one of the key ingredients in any business enterprise—money. 13.1 The Functions of Money L E A R N I N G O B J E C T I V E 1. Identify the functions of money and describe the three government measures of the money supply. Finance is about money. So our first question is, what is money? If you happen to have one on you, take a look at a $5 bill. What you’ll see is a piece of paper with a picture of Abraham Lincoln on one side and the Lincoln Memorial on the other. Though this piece of paper—indeed, money itself—has no intrinsic value, it’s certainly in demand. Why? Because money serves three basic functions. Money is the following: 3 1. A medium of exchange 2. A measure of value 3. A store of value To get a better idea of the role of money in a modern economy, let’s imagine a system in which there is no money. In this system, goods and services are bartered—traded directly for one another. Now, if you’re living and trading under such a system, for each barter exchange that you make, you’ll have to have something that another trader wants. For example, say you’re a farmer who needs help clearing his fields. Because you have plenty of food, you might enter into a barter transaction with a laborer who has time to clear fields but not enough food: he’ll clear your fields in return for three square meals a day. This system will work as long as two people have exchangeable assets, but needless to say, it can be inefficient. If we identify the functi.

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I need a 100 word reply to each of the following 8 forum post from a finance class. (800 words total): Finance Forum Reply #1 By using ratios, financial analysts are able to “ predict financial variables and to evaluate relative performance” when looking at financial statements (Giacomino and Mielke, 1993). This provides the advantages of being able to evaluate the strength and profitability of a company, as well as being helpful in identifying and predicting possible bankruptcy and financial distress (Giacomino and Mielke, 1993). A disadvantage of using financial ratio analysis is that to be effective, a company has to have another company to compare to. Without comparison, all of the financial data analyzed for a particular business could be useless. This is especially the case with small, niche-type businesses (Accounting Explained, 2013). Another disadvantage of using financial ratio analysis is that it is analyzing historical information, while the users of the data are more interested in “current and future information” (Accounting Explained, 2013). References : Giacomino, D. E., & Mielke, D. E. (1993). Cash flows: Another approach to ratio analysis. Journal of Accountancy, 175 (3), 55. Accounting Explained (2011-2013). Advantages and Limitations of Ratio Analysis. Finance Forum Reply #2 Making a choice of a ratio is determined on the present need and purpose of the individual. Liquidity, leverage and investment return are what can be used to study the usage of ratios. Strong liquidity, cash and capital help with the financing that a company has for any given project. In the article by James Horrigan, it provides a short history of financial ratio analysis. It tells of the five financial ratios that are used for the studies. The financial ratios are: working capital-to-current liabilities ratio (WC/CL) for short term liquidity; cash flow-to-current liabilities ratio (CFCL) for cash position; net worth-to-total liabilities ratio (NW/TL) for long-term solvency; return on total assets (EBIT/TA) for profit-generating ability; and revenue-to-total (REV/TA) for managerial performance (Halim, Jaafar& Osmon). Ratios are formed to be simple and are an advantage with analysis. In the article by Paul Barnes he gives two principals for using ratios, 1. To control for the effect of size on the financial variables being examined. The use of ratios was necessarily based on a hypothesis about the relationship between the numerator variable and the denominator size variable. 2. To control for industry-wide factors. Ratios aid comparisions between subject firm and its industry. As financial ratios are constructed from two accounting variables, the joint distribution will depend on the behavior of both the numerator and the denominator and on the relationship between these two coordinates. 1. Horrigan, J. O. (1968). A Short History of Financial Ratio Analysis. Accounting Review, 43(2), 284-294.. 2. Barnes, P. (1987).

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