ECO FIN 331 Money and Banking Chapters 1–9

Money

An asset generally accepted as payment that also provides a unit of account and a store of value.

Financial instrument (security)

A written, legally enforceable arrangement specifying transfers of value between parties at future dates under stated conditions; examples include bonds, stocks, loans, and insurance contracts.

Financial market

A setting where financial instruments can be bought and sold, helping funds and risks move between participants at relatively low transaction costs.

Financial institution (financial intermediary)

A firm, such as a bank or insurance company, that helps savers and borrowers access financial services and markets.

Government regulatory agency

An organization that sets rules, supervises financial firms, and monitors risk to promote a safe and reliable financial system.

Central bank

An institution that manages monetary conditions, serves commercial banks, supports financial stability, and often provides banking services to the government.

Evolution of money

Payments have moved from commodities and metal coins toward paper currency and electronic transfers, making transactions faster and more convenient.

Evolution of banks

Banks developed from safekeeping facilities into deposit-taking and lending institutions; many now offer investment, insurance, mortgage, and payment services.

Time has value

A dollar received today is more valuable than the same dollar received later because it can be invested or spent immediately.

Interest rate

The cost of borrowing or reward for lending, expressed as a percentage of the amount borrowed over a specified period.

Risk requires compensation

Investors generally require a higher expected return to accept greater uncertainty; insurance companies likewise charge premiums to assume risk.

Information is the basis for decisions

Screening borrowers and researching investments help lenders and savers judge repayment ability, profitability, and risk.

Markets allocate resources

Supply and demand determine financial prices, helping channel savings toward productive investments and reduce information and transaction costs.

Stability improves welfare

Stable prices and financial conditions reduce uncertainty, facilitate transactions and investment, and support economic growth.

Forward guidance

Central bank communication about the likely future direction of monetary policy, intended to help households and firms plan.

Policy reaction function

A description of how policy responds to economic conditions such as inflation and unemployment, rather than a promise of a specific future policy path.

Income

A flow of earnings measured over a period, such as hourly wages or annual salary.

Wealth (net worth)

The value of assets minus liabilities at a point in time; money is only one component of wealth.

Medium of exchange (means of payment)

Money's role as an accepted item used to purchase goods and services or repay debt.

Barter

Direct exchange of goods or services without money; it requires finding someone whose wants match yours.

Double coincidence of wants

The requirement that each trading partner wants what the other offers; money removes this barrier to exchange.

Unit of account

Money's role as a common measurement for prices and debts, allowing easy comparison of values.

Store of value

An asset's ability to transfer purchasing power from the present to the future; inflation can erode money's purchasing power.

Liquidity

The ease of converting an asset into spendable money quickly and with little loss of value; money itself is highly liquid.

Opportunity cost of holding money

The interest or other return forgone by keeping funds as money instead of investing in alternative assets.

Payments system

The arrangements that allow people and organizations to exchange funds for goods, services, and assets.

Commodity money

Money consisting of an item with value apart from its monetary use, such as gold or cigarettes.

Intrinsic value

Value an item has independently of whether people use it as money.

Fiat money

Money that is not backed by a commodity and has little intrinsic value; acceptance depends on confidence, institutions, and its role in payments and taxes.

Check

An instruction directing a bank to transfer money from the writer's account to another account; the check initiates payment rather than constituting final settlement itself.

Debit card

A payment instrument that transfers funds from an existing bank account, rather than creating a new loan.

Credit card

A payment instrument through which an issuer lends funds to the cardholder to make a purchase; using it creates debt.

Electronic funds transfer (EFT)

Movement of funds directly between accounts using electronic systems.

Automated clearinghouse (ACH)

An electronic payment network commonly used for payroll deposits and recurring bill payments.

Goals of payment innovation

Improve speed, reliability, and security while reducing transaction costs.

Merchant payment costs

Merchants compare processing fees, settlement speed, fraud risk, and insufficient-funds risk; the slides rank cash as relatively inexpensive and credit cards as fee-intensive.

Cryptocurrency

A digital asset transferred using a distributed recordkeeping system; whether it functions as money depends on acceptance, price stability, and its use in pricing and saving.

Stablecoin

A digital token designed to maintain a stable value relative to a reference asset, often supported by reserves such as deposits or short-term securities.

Cryptocurrency and money's functions

Limited acceptance weakens its payment role; volatile prices weaken its unit-of-account and store-of-value roles. Digital form alone does not make an asset effective money.

Inflation rate

The percentage change in the overall price level between periods: [(new price index − old price index)/old price index] × 100.

Deflation

A decrease in the overall price level; inflation is negative.

Disinflation

A decline in the inflation rate while prices may still rise; inflation falling from 5% to 2% means slower price increases.

M1

The slides describe a narrow, highly liquid aggregate including currency, demand deposits, other checkable deposits, and traveler's checks.

M2

The slides describe a broader aggregate comprising M1 plus savings deposits, small time deposits, and retail money market mutual fund balances.

Market maker

An institution that stands ready to buy and sell securities, helping support trading and liquidity.

Market liquidity

The ability to sell an asset for money quickly without a substantial price concession.

Funding liquidity

The ability to obtain borrowing or other funding needed to buy assets, make loans, or meet obligations.

Liquidity spiral

Falling asset prices reduce collateral values and borrowing capacity, forcing asset sales that push prices still lower and further weaken liquidity.

Short-term funding of long-term assets

Borrowing for short periods to hold long-term assets creates refinancing risk: funding may disappear before assets mature or can be sold.

Direct finance

Savers hold a direct claim on the borrower, such as a company's bond; a broker may facilitate the transaction without changing that direct claim.

Indirect finance

Savers hold a claim on an intermediary, which in turn holds claims on borrowers; depositing money in a bank that makes loans is an example.

Financing the farming cycle

Loans allow farmers to purchase seed and fertilizer before harvest revenue arrives; repayment occurs after crops are sold.

Geographic risk dispersion

Spreading loans or investments across locations reduces exposure to a local shock such as a poor harvest.

Bank loan

An agreement supplying funds now in exchange for promised repayment; it transfers resources to the borrower and provides an asset to the lender.

Bond

A debt security specifying future payments by an issuer to a holder; unlike many bank loans, it can be traded in a market.

Treasury bill

A short-term U.S. government debt security, generally paying face value at maturity without periodic coupons.

Home mortgage

A loan secured by real estate; the property serves as collateral if the borrower defaults.

Collateral

An asset pledged to secure repayment that the lender may claim under the loan's terms following default.

Stock (equity)

An ownership share in a company, giving a claim to residual profits and usually voting rights.

Asset-backed security (ABS)

A security whose payments are supported by cash flows from a pool of assets, such as loans or receivables.

Mortgage-backed security (MBS)

A security backed by a pool of mortgages, with payments funded by borrowers' mortgage payments.

Insurance contract

An arrangement transferring specified losses to an insurer in exchange for premiums, with payment contingent on covered events.

Derivative instrument

A contract whose value depends on an underlying asset, rate, index, or event; examples include futures, options, and swaps.

Underlying instrument (primitive security)

An instrument such as a stock or bond that directly channels funds to an issuer; its performance helps determine related derivative values.

Standardization

Using common contract terms and formats to reduce complexity and the cost of understanding, comparing, and trading instruments.

Counterparty

The other person or organization involved in a financial contract.

Asymmetric information

A situation in which one party knows more than another, potentially affecting contract terms, decisions, and repayment risk.

Screening and monitoring

Screening evaluates a borrower before lending; monitoring evaluates behavior and compliance afterward. Both reduce information problems.

Primary market

The market for newly issued securities, where issuers obtain funds from investors.

Secondary market

The market for trading existing securities among investors; the original issuer generally receives no new funds from these trades.

Centralized exchange

An organized trading venue with common rules bringing buyers and sellers together; trading may be physical or electronic.

Over-the-counter (OTC) market

A decentralized market in which participants or dealers negotiate trades outside a centralized exchange.

Electronic communication network (ECN)

An electronic system matching buy and sell orders, reducing the need for traditional intermediated trading.

Debt market

A market for borrowing instruments such as loans, mortgages, and bonds.

Money market

A market for short-term debt instruments, generally with original maturities of one year or less.

Bond market

A market for debt securities, especially those with longer maturities.

Equity market

A market for ownership shares in companies.

Derivatives market

A market for contracts such as futures, options, and swaps that transfer exposure to underlying risks.

Depository institution

An institution that accepts deposits and makes loans; examples include commercial banks, savings banks, and credit unions.

Nondepository institution

A financial firm funded through sources other than ordinary deposits; examples include insurers, securities firms, pension funds, and finance companies.

Insurance company

Collects premiums, invests funds, and makes payments when specified insured events occur.

Broker

Facilitates purchases and sales of securities for clients, typically for a fee.

Investment bank

Helps firms issue securities, arrange financing, and receive advice on financial transactions.

Mutual fund

Pools investors' resources and invests in a portfolio of assets, providing diversification and professional administration.

Hedge fund

A pooled investment vehicle typically serving a limited group of eligible investors and using a wider range of strategies than traditional mutual funds.

Private equity and venture capital

Investment firms provide capital to selected businesses and often actively influence management; venture capital commonly focuses on young firms.

Pension fund

Invests employer and employee contributions to provide retirement payments in the future.

Finance company

Raises funds in financial markets and lends to individuals or firms, often specializing in a type of lending such as vehicle loans.

Government-sponsored enterprise (GSE)

A government-chartered entity intended to support credit availability in selected sectors, such as housing or agriculture.

Future value (FV)

The value at a future date of an investment made today, including accumulated interest.

Future value formula

FV = PV(1 + i)^n, where PV is the initial amount, i is the interest rate per period as a decimal, and n is the number of periods.

Compound interest

Interest earned on both the original principal and previously accumulated interest.

Present value (PV)

The value today of a promised or expected future payment, found by discounting at an appropriate rate.

Present value formula

PV = FV/(1 + i)^n. Higher discount rates or longer waiting periods lower PV, holding the future payment constant.

Internal rate of return (IRR)

The discount rate that makes an investment's present value of future cash flows equal its initial cost; equivalently, net present value equals zero.

Coupon bond

A bond promising periodic coupon payments plus repayment of face value at maturity.

Coupon payment (C)

The periodic interest payment specified by a bond contract; annual coupon dollars equal coupon rate × face value.

Face value (par value or principal)

The amount a bond issuer promises to repay at maturity.

Maturity date

When principal becomes due.

Nominal interest rate (i)

The rate quoted in dollars without adjusting for inflation.