MONEY & BANKING

2ND GRADE

ENGLISH SECTION
 CHAPTER (3)
WHAT IS MONEY?

I) The Meaning of Money:

Economists define money (as referred as the money

supply) as anything that is generally accepted in payment for
goods and services or in the repayment of debts.

II) Functions of Money:

Money has 3 functions in any economy

1. Medium of exchange.
2. Unit of account.
3. Store of value.

1) Medium of exchange:
 Money is used to pay for goods and services.
 Using money as a medium of exchange promotes
economic efficiency by minimizing the time spent in
exchanging goods and services.
 Look at a "barter economy" in which goods and services
are exchanged directly for other goods and services.
 For a commodity to function effectively as money, it has to
meet several criteria:

Money & Banking -2- 2nd Grade

 1. It must be easily standardized, making it simple to
ascertain its value;
2. It must be widely accepted;
3. It must be divisible, so that it is easy to make change;
4. It must be easy to carry;
5. It must not deteriorate quickly.

2) Unit of Account:
 Money is used to measure value in the economy.
 We measure the value of goods and services in terms of
money.
 Using money as a unit of account reduces transaction costs
in an economy by reducing the number of prices that need
be considered.

3) Store of Value:
 Money is a repository of purchasing power over time.
 Store of value is used to save purchasing power from the
time income is received until the time is spent.
 This function of money is useful because most of us don’t
want to spend our income immediately upon receiving it,
but rather prefer to wait until we have time or the desire to
shop.

Money & Banking -3- 2nd Grade

III) Evolution of The Payments System:
The payments system is the method of conducting transactions
in the economy:
1. Commodity Money:
 Money made up of precious metals or another valuable
commodity, like Gold coins.
 Problems:
a. Very heavy.
b. Hard to transport from one place to another, especially
for large purchases.
2. Fiat Money :
 Pieces of paper that function as a medium of exchange.
 Paper currency decreed by governments as legal tender
but not convertible into coins or precious metal.
3. Checks:
 An instruction from you to your bank to transfer money
from your account to someone else.
4. Electronic Payment:
 Make payments electronically over the internet.
5. E- Money:
 Money that exists only in electronic form.
 Ex: (Debit cards - Credit cards: like Visa and Master
Card - E-cash)

Money & Banking -4- 2nd Grade

IV) Measuring Money (M1 & M2):

M1 = Currency + Demand deposits + Traveler’s checks.

M2 = M1 + Savings deposits + Small denomination time

deposits + money market deposits + money market
mutual fund shares.

M3 = M2 + large time deposits

Ex.:
M1 = Currency 725.2
+ Traveler's checks 7.3
+ Demand deposits 338.8
+ Other checkable deposits 317.8
Total 1.389.1

M2 = M1
+ Small-denomination time deposits 968.8
+Savings deposits and money market deposit accounts 3626.5
+ Money market mutual fund shares (retail) 723.9
Total M2 5.319.2

Money & Banking -5- 2nd Grade

 Chapter 5
The Behavior of Interest Rates

Determinants of Asset Demand:

1. Wealth:
 Holding everything else constant, an increase in wealth
raises the quantity demanded of an asset.
 When we find that our wealth has increased so the
quantity demands of assets we demanded increases.
 The quantity demanded of an asset is positively related
to wealth.
2. Expected returns:
 The return expected over the next period.
 The quantity demanded of an asset is positively related
to its expected return relative to alternative assets.
 An increase in an asset’s expected return relative to that
of an alternative asset, holding everything else
unchanged, raises quantity demanded of the asset.
3. Risk:
 Degree of uncertainty associated with the return.
 Holding everything else constant, if an asset’s risk rises
relative to that of alternative assets, its quantity
demanded will fall.
 The quantity demanded of an asset is negatively related
to risk of its returns relative to alternative assets.

Money & Banking -6- 2nd Grade

  Most people prefer to hold the less risky asset.
4. Liquidity:
 The ease and speed with which an asset can be turned
into cash.
 The quantity demanded of an asset is positively related
to its liquidity relative to alternative asset.
 The more liquidity of an asset is relative to alternative
assets, holding everything else unchanged, the more
desirable it is and the greater will be quantity demanded.

Supply and demand in the money market:

Determines the equilibrium interest rate supply and
demand in the market for money.
1- Demand Curve of Money:
 The quantity of money demanded and the interest rate
should be negatively related so, demand curve for money
slopes is down ward.
interest Interest rate

If interest rate increased from

100 demand curve of money
50 100, the quantity demanded
inc.
50 of money will decrease from
dec 100 50
50 100 Q
Q.D of Money

 When interest rate increased that will encourage you to

put it in the bank (your demand will be lower).

Money & Banking -7- 2nd Grade

 2- Supply curve of money:
 We will assume that a central bank controls the amount of
money supplied at fixed quantity.
 So, the supply curve for money Ms money supply is a
vertical line.

MS
- (100) the quantity of money
supply are determined by central
bank.
- Whatever interest rate changed,
supply of money is constant.
100 Q

 This amount of money supply is very important.

 If money supply increased that will lead to  Inflation.
 If money supply decreased that will lead to  deflation.

3- Equilibrium Curve:
 The equilibrium where the quantity of money demanded is
equals the quantity of money supplied occurs at the interest
section of the supply demand curve at point C where
Md = Ms

Money & Banking -8- 2nd Grade

Interest rate

- Equilibrium point of interest

C Md = Ms rate is (C point) where is Md
= Ms
Q

Chapter 11
Banking and the management of
the financial Institution

Banking balance sheet:

 A list of the bank’s assets and liabilities it has the
characteristics that: total assets = total liabilities + capital
 A bank's balance sheet is a list of its sources of bank
funds (liabilities) and uses of bank funds are put (assets).

A) Liabilities:
 The funds obtained from issuing liabilities are used to
purchase income-earnings assets. Such as:
A) Checkable deposits.
B) Non transaction deposits.
C) Borrowings.
D) Bank capital.

1) Checkable deposits:
 Checkable deposits are bank accounts that allow the
owner of the account to write checks to third parties,

Money & Banking -9- 2nd Grade

 Checkable deposits include all accounts on which
checks can be drawn. It is an asset for the depositor
because it's a part of his wealth.

2) Non transaction deposits:

 It’s the primary source of bank funds. Owners cannot
write checks on non-transaction deposits, but the
interest rates paid on these deposits are usually higher
than those on checkable deposits.
 There are two types of nontransaction deposits:
i. Saving accounts: Funds can be added & withdrawn
at any time, transactions and interest payments are
recorded in a monthly statement.
ii. Time deposits: have a fixed maturity length,
ranging from several months to over five years and
have penalties for early withdrawal.
3) Borrowings:
 Banks also obtain funds by borrowing from "Federal
Reserve System", the federal home loan banks, other
banks and corporation, Borrowing from the fed are
called discount loans (also known as advances).banks
borrow funds overnight to have enough deposits at the
F.R to meet the amount required by the fed.

Money & Banking -10- 2nd Grade

 4) Bank Capital:
 Capital equals the difference b/w total assets &
liabilities (12% of total bank assets) it is a cushion
against the drop in the value of its assets, which could
force the bank into insolvency.

B) Assets:
 A bank uses the funds that it has acquired by issuing
liabilities to purchase income-earnings assets.
 Bank assets are referred to as uses of funds.
A. Reserves.
B. Cash item in process of collection.
C. Deposits at other bank.
D. Securities.
E. Loans.
F. Other assets.

1) Reserves:
 are these deposits plus currency that is physical held by
bank (called value cash), also reserves earn a low
interest rate, banks held them because of required
reserves & required reserve ratio & Excess reserves.

2) Cash item in process of collection:

 Suppose that a check written on an account at another
bank is deposited in your bank and the funds for this

Money & Banking -11- 2nd Grade

 check have no yet been received (collected) from the
other bank, the check is classified as a cash item in
process of collection, and it is an asset for your bank
because it is a claim on another bank for funds that will
be paid within few days.

3) Deposits at other banks:

 Many small banks hold deposits in large banks in
exchange for a variety of services, including check
collecting, foreign exchange transactions and help with
securities purchases.

4) Securities:
 A bank’s holding of securities are an important income-
earning asset.
 Securities (made up entirely of debt instruments for
commercial banks, because banks are not allowed to
hold stock).

5) Loans:
 Banks make their profits primarily by issuing loans.
 They have generally produced more than half or bank
revenues.
 A loan is a liability for the individual or corporation
receiving it, but an asset for a bank.

Money & Banking -12- 2nd Grade

 6) Other asset:
 They physical capital owned by the bank is included in
this category.
 Ex: Bank buildings & Computers & Other equipment.

Chapter 15
Central Banks in the World Today

The Basics: How Central Banks Originated and Their Role Today.

» The central bank started out as the government’s bank and

over the years added various other functions.

I) The Government’s Bank:

1. As the government’s bank, the central bank occupies a

privileged position: It has a monopoly on the issuance of
currency.

2. The ability to print currency means that the central bank

can control the availability of money and credit in a
country’s economy by adjusting short term interest rates
{monetary policy}.

3. Central bank use monetary policy to stabilize economic

growth and inflation.

Money & Banking -13- 2nd Grade

 4. An expansionary or accommodative policy, through lower
interest rates, raises both growth and inflation over the
short run, while restrictive policy reduces them.
5. The primary reason for a country to create its own central
bank, is to ensure control over its currency and remain
inflation low.

II) The Bankers’ Bank:

1. As the bankers’ bank, the central bank took on the roles it
plays today. The important day to day jobs of the central
bank are to :
a. Provide loans during times of financial crises.
b. Manage the payments system.
c. Oversee commercial banks and the financial system.

2. The central bank’s ability to print money means that it can

make loans even when no one else can, including during a
crisis.

3. Every country has to have secure and efficient payments

system. People need ways to pay each other, and financial
institutions and a cheap and reliable way to transfer funds
to one another.

4. Central bank does not control securities markets & does

not control the government’s budget.

Money & Banking -14- 2nd Grade

III) The Functions of a Modern Central Bank :
1. The Government’s Bank :
a. Manages the finances of the government.
b. Through interest rates, controls the availability of money
and credit.

2. The Bankers’ Bank:

a. Guarantees that sound banks can do business by lending
to them, even during crises.
b. Operates a payments system for interbank payments.
c. Oversees financial institutions to ensure confidence in
their soundness.

IV) Stability: The Primary Objective of All Central Banks:

» Central bankers work to reduce the volatility of the
economic and financial systems by pursuing five
specific objectives:
1. Low and stable inflation.
2. High and stable real growth, together with high
employment.
3. Stable financial markets.
4. A stable interest rate.
5. A stable exchange rate.

Money & Banking -15- 2nd Grade