Lecture 3 - Introduction to Financial Markets
from last time
advantages of fiat money
evolution of payments system
why study banks?
why study financial markets?
financial intermediaries
government regulation of financial markets and intermediaries
internationalization of financial markets
From Last Time
- You do need to memorize the items that make up M1, M2, and M3. The M probably refers to Monetary Aggregate. Don't worry about L.
- Full-bodied money has a value in another use equal to its value as money, e.g. if there was 1 cent worth of copper in a penny, it would be full-bodied money. Gresham's Law says that if there are two types of money (say, those copper pennies and zinc
pennies) in circulation, the one with the smaller value in another use (the zinc pennies) will stay in circulation as money while the good money will be hoarded.
- Pure fiat money is costless to produce. Its only value comes from what it can be used to purchase.
It has no value as anything other than money. The Susan B. Anthony dollar was the closest thing we've had to
money that was costless to produce and keep in circulation.
Advantages of Fiat Money
The fundamental defect of full-bodied money, from society's point of view, is that it requires the use of
real resources to add to the stock of money. People must work hard to dig something out of the ground in one
place, say to dig gold out of the ground in south Africa, in order to rebury it in Fort Knox.
Seignorage is the profits earned by producing money. With full-bodied money, there is no seignorage. But, fiat money enables the government to acquire resources and provide society with services equal to the real value of the money created. We can have
money without any sacrifice. By switching from full-bodied money like gold coins to fiat paper money, the government can now hire miners and mining equipment to build us a subway system rather than mine gold.
Evolution of Payments System
- until several hundred years ago, the payments system in all advanced
countries was based on gold or silver
- then came the introduction of paper currency convertible into a quantity of
gold or silver
- this was eventually replaced by fiat money not convertible into anything
- major drawbacks of currency are that it is easily stolen and costly to
transport in large quantities
- the invention of checks; but checks take time to clear and are costly to process
- electronic payments
Why Study Banks?
- provide a link between those who want to save and those who want to invest
- play a role in determining the quantity of money in the economy
- source of financial innovation expanding the ways to invest savings
Why Study Financial Markets?
Financial markets are markets in which funds are transferred from those who have excess funds (savers, lenders) to those who have a shortage (investors, borrowers).
- bond market - determines interest rates
- stock market - influences wealth and business decisions
- foreign exchange market - affects prices of imports and exports
Financial markets improve social welfare by allowing funds to move from those without productive investment opportunities to those with such opportunities. Consumers also benefit by being allowed to make purchases when they need them the most.
kinds of financial markets:
- debt v. equity
- primary v. secondary
- exchanges v. over-the-counter markets
- money v. capital markets
Financial Intermediaries
Financial intermediaries acquire funds by issuing liabilities such as deposits and then use these funds to acquire assets by purchasing securities or making loans.
types:
- banks
- contractual savings institutions
- invesmtment intermediaries
Government Regulation of Financial Markets and Intermediaries
purposes:
- provide information to investors
- ensure a sound financial system
- improve control of monetary policy
- encourage home ownership
Internationalization of Financial Markets
Eurobonds (a bond denominated in a currency other than that of the country in which it is sold, e.g. a bond
denominated in U.S. dollars sold in Tokyo) account for 80% of new issues in the world bond market. They have
now passed the U.S. corporate bond market as a source of new funds.
In the late 1980's, the Japanese stock market at times exceeded the value of stocks traded in the U.S.
EC 230, Money and
Banking Files 
