AP Macroeconomics Unit 4 Notes: Money, Banks, and the Financial Sector

Financial asset

A claim on future benefits (future income or repayment) that someone else is obligated or expected to provide.

Bond

A loan made by the bond buyer (lender) to the bond issuer (borrower), typically a government or corporation.

Principal (face value)

The amount of money a bond issuer repays to the bondholder at maturity.

Maturity

The date when a bond’s principal (face value) is repaid.

Coupon (interest payment)

The periodic interest payment a bond pays to the bondholder (usually fixed for an existing bond).

Inverse bond price–interest rate relationship

Bond prices and market interest rates (yields) move in opposite directions: if interest rates rise, existing bond prices fall; if interest rates fall, existing bond prices rise.

Stock

A financial asset representing ownership (equity) in a corporation; returns depend on firm performance and investor expectations.

Dividend

A (not guaranteed) payment a corporation may distribute to shareholders.

Capital gains

Profit earned when a stock’s price rises and the investor sells it for more than they paid.

Money (macroeconomic definition)

Any asset that is generally accepted for payment for goods and services and for repayment of debts.

Medium of exchange

A function of money: it is used to buy goods and services, reducing the need for barter.

Unit of account

A function of money: it provides a common measure for quoting prices and recording debts (e.g., dollars).

Store of value

A function of money: it allows purchasing power to be transferred into the future, though inflation can erode that value.

Liquidity

How easily an asset can be used for transactions (or converted into spendable funds) without loss of value.

M1

The most liquid money supply measure; typically includes currency in circulation and checkable (demand) deposits.

M2

A broader money supply measure: includes M1 plus “near money” that is less liquid than M1 but can be converted to spendable funds relatively easily; larger than M1.

Fractional reserve banking system

A banking system in which banks keep only a fraction of deposits as reserves and loan out the rest, allowing the money supply to expand.

Reserves

Funds banks hold to meet withdrawals and legal requirements; includes vault cash and deposits held at the central bank.

Required reserve ratio (rr)

The fraction of deposits a bank is legally required to hold as reserves.

Required reserves (RR)

Minimum reserves a bank must hold; calculated as RR = rr × D (where D is deposits in simplified AP problems).

Excess reserves

Reserves held by a bank above required reserves; can be lent out (or held) at the bank’s discretion.

Simple money multiplier

In the simplified AP model (banks lend all excess reserves and the public holds no extra cash), m = 1/rr.

Open market operations (OMOs)

Fed purchases or sales of government securities: buying injects reserves and tends to increase the money supply; selling removes reserves and tends to decrease the money supply.

Money demand

The desire to hold wealth in liquid form; it slopes downward with the nominal interest rate because higher interest rates raise the opportunity cost of holding money.

Money supply (AP money market model)

The quantity of money set by the Fed; typically drawn as a vertical line in the money market because it is policy-determined in the simplified model.