© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin

Chapter 1

An Introduction to Money and the Financial System

Dr. John V. Padua

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Introduction

• The Five Parts of the Financial System

• The Five Core Principles of Money and Banking

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Five Parts of the Financial System

1. MoneyTo pay for purchases and store wealth

2. Financial InstrumentsTo transfer resources from savers to investors and to transfer risk to those best equipped to bear it.

3. Financial MarketsBuy and sell financial instruments

4. Financial Institutions.Provide access to financial markets, collect information & provide services

5. Central BanksMonitor financial Institutions and stabilize the economy

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Five Core Principles of Money and Banking

1. Time has value2. Risk requires compensation3. Information is the basis for decisions4. Markets determine prices

and allocation resources5. Stability improves welfare

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Five Core Principles of Money and Banking

1. Time has value

– Time affects the value of financial instruments

– Interest payments exist because of time properties of financial instruments

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Five Core Principles of Money and Banking

2. Risk requires compensation

– In a world of uncertainty, individuals will accept risk only if they are compensated in some form.

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Five Core Principles of Money and Banking

3. Information is the basis for decisions

– The collection and processing of information is the basis of foundation of the financial system.

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Five Core Principles of Money and Banking

4. Markets determine prices and allocate resources

– The “places” where buyers & sellers “meet” are the core of the economic system

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Five Core Principles of Money and Banking

5. Stability improves welfare.

– A stable economy reduces risk and improves everyone's welfare.

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• Do your best not to tell people your– Date of birth– Birthplace– Your mother’s maiden name– Your address

• Guard your Social Security Number– Don’t tell anyone unless you have to– Remove it whenever you can

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Measuring Economic Activity

• Gross Domestic Product:The market value of final goods and services produced in a country during a year.

• Real vs. Nominal GDP:– Need to distinguish changes in prices from

changes in quantities– Real GDP uses base-year prices

Isolates change in quantities.– Nominal GDP = Prices x Real GDP