Monetary Economics (BEC 350) - Lecture 1: Financial Systems Basics

Administrative Information and Syllabus Details

Course Metadata: * Course Title: Monetary Economics * Course Code: BEC 350 * Instructor: Dr. Albert Chongo * Academic Year: 2026 * Lecture Number: 01 * Lecture Topic: Financial Systems Basics
Required Course Literature: * Primary Text: The Economics of Money, Banking, and Financial Markets: European Edition by Mishkin, Matthews, & Giuliodori (Pearson, 2013). * Requirements: Students are expected to complete specific readings indicated in the syllabus prior to class and review previous lectures prior to class.
Lecture Schedule and Attendance: * Frequency: Lectures occur twice a week for a duration of $1:30$ hours (1 hour and 30 minutes) each. * Session 1: Tuesday, 9:00 am – 10:15 am (Location: TBA). * Session 2: Wednesday, 9:00 am – 10:30 am (Location: TBA). * Tutorials: There are no separate tutorial sessions assigned for this course.

Course Evaluation and Problem Set Structure

Evaluation Components: * Periodic Quizzes. * Test I: Scheduled for the week of MARCH 6 (In-class). * Test II: Scheduled for the week of JUNE 6 (In-class). * Problem Sets (Weekly). * Final Examination.
Problem Set Guidelines: * Distribution: Handed out at the end of lectures. * Submission: Due at the BEGINNING of the next lecture. * Solution Keys: Provided through class representatives and distributed at the beginning of the lecture following the submission. * Grading Rules: Each graded test counts equally toward the final grade. Only two tests are graded for the overall grade. Attendance at ALL tests is mandatory.
Grading Calculation Example for Problem Sets: * Let $\text{PS1} = 58\%$ and $\text{PS2} = 68\%$ . * The raw average would be $63\%$ . * If a student fails to turn in two (2) problem sets, a penalty of $5$ points per missing set is applied. * Calculation: $63\% - (2 \times 5) = 53\%$ . * Presentation Requirement: Problem sets must be presented in a professional manner.

Quiz 1: Definitions and Zambia Monetary Context

Core Definitions: * Economics: The study of how individuals and societies decide to allocate scarce resources left to them by previous generations and nature. * Money: Anything generally accepted in payment for goods and services or in the repayment of debts.
Contemporary Case Study - Zambia: * Scenario: Zambia recently enacted a significant monetary policy change. * Specific Action: The government declared $86\%$ of their currency no longer legal tender.

Course Structure: The Three Core Pillars

Part 1: Financial Assets and Markets: * Focus on assets (particularly Bonds) and Interest Rates.
Part 2: Financial Intermediaries and Central Banks: * Focus on the importance, risks, and management of institutions, with a deep dive into Central Banks.
Part 3: Monetary Policy and the Macroeconomy: * Focus on monetary policy, inflation, and economic growth.

Comparative Analysis: Goods Markets vs. Financial Markets

Defining the Goods Market: * What is traded: Goods and Services. * Key Actors: Individuals and Firms. * Venues: Goods Markets. * Temporal Relationship: Represents current consumption.
Defining the Financial Market: * What is traded: Financial Assets (FA). * Key Actors: Individuals, Firms, and Intermediaries. * Venues: Financial Markets. * Temporal Relationship: Represents future consumption (transferring resources over time).

Flows and Interactions within the Financial System

The Simplified Flow: Lenders/Savers → Financial Intermediaries/Financial Markets → Borrowers/Spenders.
Detailed Breakdown of Actors: * Lenders/Savers: Individuals, Companies, Pension Funds, Mutual Funds, Foreign Exchange entities. * Intermediaries: Banks, Insurance Companies, Mutual Funds. * Market Venues: Interbank Market, Stock Exchange, Money Market, Bond Market. * Borrowers/Spenders: Individuals, Companies, Central Government, Municipalities, Public Corporations.
Complexity Beyond Fund Transfer: Modern financial systems are not just about moving funds; they involve complex products like derivatives, hedge funds, and swaps. These focus on supply, demand, Time, and Risk.

The Five Parts, Six Functions, and Five Principles of Financial Systems

Five Core Parts: 1. Financial Instruments (Assets). 2. Financial Markets. 3. Financial Institutions. 4. Money. 5. Central Banks.
Six Core Functions: 1. Clearing and settling payments. 2. Pooling resources and subdividing shares. 3. Transferring resources across time and space. 4. Managing risk. 5. Providing information. 6. Dealing with incentive problems.
Five Core Principles: 1. Time has value: Decisions are influenced by when payments are made. 2. Risk requires compensation: Investors expect higher returns for taking on higher risks. 3. Information is the basis for decisions: Financial markets function based on the availability and processing of information. 4. Markets set prices and allocate resources: Prices are determined by market forces, not central banks. 5. Stability improves welfare: Volatility is generally negative for economic well-being; central banks aim to maintain stability.

Financial Instruments (Assets)

Definition: A financial instrument is a written legal obligation of one party to transfer something of value to another party at some future date, under certain conditions.
Primary Functions: * Means of payment. * Store of Value. * Trading of Risk.
Classes of Assets: * Primitive Securities: Used by savers/lenders to directly transfer resources to investors/borrowers (e.g., Stocks or Bonds). * Derivative Instruments: Assets that derive their value or payoff from the behavior of an underlying instrument (e.g., futures, options). Their primary use is the shifting of risk.

Money: The Special Financial Asset

Definition: Anything generally accepted in payment for goods and services or in the repayment of debts.
Four Primary Functions: 1. Means of payment. 2. Store of Value. 3. Unit of Account. 4. Standard of Deferred Payment.
Distinguishing Feature: The Central Bank maintains the monopoly power of issuance.

Financial Intermediaries (Institutions)

Definition: A firm that provides access to financial markets to both savers (who wish to purchase assets) and borrowers (who wish to issue them), as well as individuals wishing to trade risk.
Core Functions: * Provisions of payment mechanisms. * Liquidity Provision. * Maturity Transformation. * Risk Transformation.
Types of Intermediaries: * Depository: Commercial banks, Savings institutions, Building Societies. * Insurance: Life, Property, and Casualty insurance providers. * Pension Funds. * Securities Entities: Brokers, Investment Bankers, Underwriters, Mutual Funds. * Finance Companies: Providers of specialized loans (e.g., GMAC). * Government Sponsored Enterprises (GSEs): National insurance, Social Security (SS), Government mortgage programs. * Central Banks. * International Organizations.

Central Banks: The Special Intermediary

Definition: A government agency that oversees the banking system and is responsible for the amount of money and credit supplied to an economy.
Key Functions: * Credit Creation. * Supervision and Regulation of the financial system. * Conducting Monetary Policy.
Variable Functions: Other roles depend on the specific legal mandate, available tools, degree of independence, and institutional history.

Financial Markets

Definition: A venue where financial instruments (assets) are bought and sold.
Key Characteristics: * Price Discovery: Determining the fair value of assets. * Trading Mechanisms: Providing structures for exchange, such as auctions or lotteries. * Execution of Agreements: The settlement function.
Primary Agents: * Public Investors (private individuals, trusts, pension/insurance funds). * Brokers. * Dealers.
Essential Functions: * Liquidity provision. * Information dissemination. * Risk Sharing.
Market Classifications: * By type of asset traded. * By maturity of the asset (e.g., money market vs. capital market). * By issuance (Primary vs. Secondary markets). * By means of settlement. * By organization of the market (e.g., exchanges vs. OTC). * By method of sale or pricing.