Week 10 - Financial Markets Flashcards
Purpose of money
1) medium of exchange
2) store of value
3) unit of account
4) standard of deffered payment
What are the properties money should have?
1) acceptable to most people
2) of a standardised quality
3) durable
4) valuable relative to its weight
5) divisable
What is the problem with commodity money
Can be debased by the metal being made less pure and the overall money supply if fixed by the supply of the metal
What is fiat money?
authorised by a central bank or gov and doesn’t have to be exchanged by a central bank for a commodity. It offers much more flexibility but depends on the belief in the integrity of the gov
What is credit?
loans, advances and bills provided to the private non-bank sector by financial intermediates.
What is financial intermediation?
facilitate money transactions and specialise in particular function to make them more efficient
What are commercial banks?
Businesses where bank accepts money from savers and lends out this borrowed money. The core business is to connect surplus financial units and deficit financial units. Also invest deposits in financial securities.
What are investment banks
Only have a trading book and structure business financing transactions such as a corporate share issues.
What is leverage?
refers to the use of financial debt. Commercial banks are leveraged as banks use other’s money to make more money
Formula for spread
interest rate received - paid
How does money creation work?
banks keep reserves and lend out the money that is not kept as reserves and leverage the money. deposit some, keep a percentage and lend out the rest, next institution keeps some and lends the rest and so on.
What are the 3 functions of a bank?
1) act as private businesses to connect savers and borrowers to earn profit
2) systemic functions of providing an efficient allocation of funds across present and future and leverage existing money
3) increase financial liquidity
Formula for shareholders’ equity
equity = assets - liabilities
What is the reserve ratio?
ration of reserves to deposits
Define excess reserves
reserves above normal ration, banks try to minimise reserve (as they can earn no money and depreciate)
Formula for simple deposit multiplier
SDM = 1/RR
Why is the simple deposit multiplier the maximum that can be created
banks may hold excess reserves and people don’t deposit all their money.
3 main roles of the RBA
1) maintain the financial integrity and stability of Australia
2) implement monetary policy
3) intervene (as needed) in foreign exchange markets
What is the new quantity theory of money?
Fischer argued only V was constanct in change in P = change in M + change in V - change in Y. If M growth faster than economic growth, there will be inflation V is actually not constant
What are the technical goals of the RBA?
- low stable inflation
- sufficient financial system liquidity
- calibrated exchange rate
- overall financial system intergrity
What effects the demand for money
- Real GDP can shift the curve as higher incomes mean higher demand
- inflation can also shift it as it mean you need more nominal cash to make a purchase
What is seignorage?
Difference between the value of money and cost of producing and distributing it
Who benefits most from contractionary monetary policy?
savers can benefit more and increase their spending, borrowers face higher interest repayments, low income earners are often ‘marginal’ borrowers and may be at a higher risk of loan defaults.
What is quantative easing?
A central bank prints money and uses this money to but assets off firms and bank balances sheets. Generally, the prices paid by the CB were well above the market price to ensure financial institutions don’t become insolvent.
What is the fundementals based approach to banking crisis
a financial crisis is a period of adjustment to shift in real economic forces as reflected in financial system adjustments.
What is the financial panic/speculative excesses to banking crisis
speaks of normal financial system leverage and functioning morphing into speculation leading to price bubbles, overvaluation and ultimate collapse.
What is the impact of the RBA buying gov bonds?
increase in money supply, higher cash rate.
What happened with quantative easing in the GFC
Since there was a 0 interest rate, monetary policy was ineffective. Central banks printed money to purchases assets from more than they were worth. The aim was to maintain liquidity, prevent deflation and inject liquidity.
