Unit 4 Money (3-9-16)

Unit 4 Time Value of Money

• Is a dollar today worth more than a dollar tomorrow? - Yes

• Why? - Opportunity costs & inflation -Reason for charging and paying interest 

Let 

v = future value of $ 

p = Present value of $

r = real interest rate (nominal - inflation rate) expressed as decimal

n = years

k = # of times interest is credited per year

Formulas

• Simple Interest Formula - -v = (1 + r)^n x p 
• Compound Interest Formula - - v = (1 + r / k)^nk x p

Money demand has an inverse relationship between nominal interest rates and the quantit of money demanded

1. What happens to the quantity demanded of money when interest rates increases?- Quantity demanded falls because individuals would prefer to have interest earning assets instead of borrowed liabilities. 
2. What happens to quantity demanded when interest rates decrease? - Quantity demanded increases, there is no incentive to convert cash into interest earning assets

What happens if price level increases?

• Money demand Shifters that affects investment 1. Changes in Price Level 2. Changes in Income 3. Changes in Taxation

Increasing the Money Supply

- If the FED increases the money supply a temporary surplus of money will occur at 5% interest. The Surplus will cause the interest rate to fall to 2%

How does this affect AD

Money supply (increase) -> interest rate(decrease) -> Investment (increases) -> Increases AD

Decreasing the Money Supply

Money supply (decreases) -> interest rate (increase) -> investment (decrease) -> Decrease AD

Financial Sector

Financial Assets (Own) vs Financial Liabilities (Owe)

Financial Assets -

-Stocks or bonds that provide expected future benefits

-Benefits the owner only if the issuer of the asset met certain obligations

Financial Liabilities

-Incurred by the issuer of a financial asset to stand behind/by the issued asset

Interest Rate - price paid for use of a financial asset

Stocks vs Bonds

Stocks

- Financial assets that convey ownership in a corporation

Bonds

-Promise to pay a certain amount of money plus interest in the future

What Banks do

• A bank is a financial intermediary - uses liquid assets (i.e. bank deposits) to finance the investment of borrowers
• Process kown as Fractional Reserve Banking - system which depository institutions hold liquid assets less than the amount of deposits

- Can take the form of: 1. Currency in bank vaults. 2. Bank Reserves - deposits held at the Federal Reserve

Basic accounting review

-T- Account (Balance sheet) - statement of assets and liabilities

Ex image:

- Assets (Amounts owned) - items to which a bank holds legal claim - the uses of funds by financial intermediaries

-Liabilities ( Amounts owed) - the legal claims against a bank - the sources if funds for financial intermediaries