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CHAPTER 18 Understanding Money and Banking Business, Sixth Canadian Edition, by Griffin, Ebert, and CHAPTER 18 Understanding Money and Banking Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

2 Learning Objectives Define money and identify the different forms it takes in the 2 Learning Objectives Define money and identify the different forms it takes in the nation’s money supply. Describe the different kinds of financial institutions that make up the Canadian financial system and explain the services they offer. Explain how banks create money and identify the means by which they are regulated. Explain the functions of the Bank of Canada and describe the tools it uses to control the money supply. Identify ways in which the banking industry is changing. Understand some of the activities in international banking and finance Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

3 Money Any object generally accepted as payment for goods & services Characteristics: < 3 Money Any object generally accepted as payment for goods & services Characteristics: < Portable: t lightweight and easy to handle < Divisible: t easily broken down to match the value of goods < Durable: t must not spoil or easily wear out < Stable: t must be stable enough to hold its value over time, apart from minor fluctuations Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

4 Functions of Money Medium of exchange < a single medium of exchange for 4 Functions of Money Medium of exchange < a single medium of exchange for goods and services instead of barter Store of value

5 The Money Supply Buyers and sellers must agree on the value of money 5 The Money Supply Buyers and sellers must agree on the value of money The value of money depends on its supply

6 M-1 Money Supply The most liquid forms of money <currency: tpaper money and 6 M-1 Money Supply The most liquid forms of money

7 M-2 Money Supply Everything in M-1 plus < Savings deposits: t savings account 7 M-2 Money Supply Everything in M-1 plus < Savings deposits: t savings account holdings < Time deposits: t deposit requiring prior notice before withdrawal of funds < Money market mutual funds t Pooled assets from many investors invested in short-term, low risk financial securities Measures the store of monetary value that is available for making financial transactions Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

8 Credit Cards Not included in M-1 or M-2 Not money tno store of 8 Credit Cards Not included in M-1 or M-2 Not money tno store of value Money substitute ttemporary medium of exchange Popular:

9 Financial Institutions Traditionally consisted of four financial pillars < Chartered banks < Alternate 9 Financial Institutions Traditionally consisted of four financial pillars < Chartered banks < Alternate banks (trust companies, credit unions, caisses populaires) < Life insurance companies and specialized lending and saving intermediaries < Investment dealers Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Differences are now blurred due to changes in financial industry regulations Copyright © 2008 Pearson Education Canada

10 Pillar #1: Chartered Banks Privately owned, profit-oriented, financial intermediary < Largest and most 10 Pillar #1: Chartered Banks Privately owned, profit-oriented, financial intermediary < Largest and most important of financial institutions < Each bank has many branches Schedule A Banks < must be Canadian-owned with no more than 10% of voting shares controlled by a single interest (90% of all bank assets) Schedule B Banks < may be foreign-owned and need not meet the 10% limit (foreign-owned bank deposits cannot exceed 8% of the total domestic assets of all banks) Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

11 Services Offered by Banks Pension services Trust services International services Financial advice Business, 11 Services Offered by Banks Pension services Trust services International services Financial advice Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Electronic technologies Bank deposits Bank loans Bank accounts Copyright © 2008 Pearson Education Canada

12 Bank Deposits Accept deposits from some customers to obtain money to lend to 12 Bank Deposits Accept deposits from some customers to obtain money to lend to others

13 Bank Loans Major source of shortterm financing Prefer to finance inventories or accounts 13 Bank Loans Major source of shortterm financing Prefer to finance inventories or accounts receivable rather than long-term loans to many businesses Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Secured loan < backed by collateral (e. g. : inventory) Unsecured loan < backed only by promise Prime rate of interest < lowest rate charged to best customers Copyright © 2008 Pearson Education Canada

14 Banks as Creators of Money Business, Sixth Canadian Edition, by Griffin, Ebert, and 14 Banks as Creators of Money Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

15 Other Changes in Banking Deregulation is causing banks to shift from their historical 15 Other Changes in Banking Deregulation is causing banks to shift from their historical role as intermediaries between borrowers and depositors Diversification into other financial products

16 Electronic Funds Transfer Debit cards < Plastic money that immediately adjusts the consumers 16 Electronic Funds Transfer Debit cards < Plastic money that immediately adjusts the consumers account balance and pays the merchant Point of Sale terminals < Electronic device used to facilitate debit card use Smart Cards < A credit card sized computer that can be programmed with “electronic money” Ecash < Money that moves among consumers and businesses via digital electronic transmission Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

17 The Bank of Canada The central bank of Canada <Managed by a Board 17 The Bank of Canada The central bank of Canada

18 Monetary Policy Actions of the Bank of Canada Expansionary Policy Restrictive Policy Tools 18 Monetary Policy Actions of the Bank of Canada Expansionary Policy Restrictive Policy Tools (stimulate business activity and increase the money supply) (slow down business activity and decrease the money supply) Open Market Operations Buy government securities: Sell government securities: (increases bank reserves (decreases bank reserves enabling banks to make loans to businesses and consumers) limiting the banks' abilities to make loans to businesses and consumers) Lower the bank rate: Raise the bank rate: (increase the willingness of (decrease the willingness of Bank Rate banks to borrow, more loans can be made to businesses and consumers) Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke banks to borrow, fewer loans can be made to businesses and consumers) Copyright © 2008 Pearson Education Canada

19 Pillar #2: Alternate Banks Trust companies < safeguard funds and estates entrusted to 19 Pillar #2: Alternate Banks Trust companies < safeguard funds and estates entrusted to it < serves as a trustee, transfer agent, & registrar for corporations Credit unions (caisses populaires) < cooperative savings and lending institution formed by a group of individuals with common interests < offer savings accounts, loans, mortgages to members < invest its own funds in corporate & government securities Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

20 Pillar #3: Specialized Lending and Savings Intermediaries Life insurance firms Factoring companies Financial 20 Pillar #3: Specialized Lending and Savings Intermediaries Life insurance firms Factoring companies Financial corporations Venture capital or development firms Pension funds Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

21 Life Insurance Firms Life Insurance companies <mutual or stock company that shares risks 21 Life Insurance Firms Life Insurance companies

22 Factoring Companies Buy uncollected accounts receivable from a firm for less than its 22 Factoring Companies Buy uncollected accounts receivable from a firm for less than its face value < Attempts to collect the face value of the receivables from customers < The difference between the amount collected and the cost of the receivables is the firm’s profit Allows firms with old, or uncollectible, accounts receivable to redeem at least part of their value rather than writing them off completely Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

23 Financial Corporations Sales finance company <finances instalment purchases made by individuals or businesses 23 Financial Corporations Sales finance company

24 Venture Capital or Development Firms Provide funds for new or expanding firms that 24 Venture Capital or Development Firms Provide funds for new or expanding firms that have great potential Obtains funds from individual investors, financial intermediaries, retained earnings While accepting increased risk with new ventures, VC firms seek to earn higher than normal returns Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

25 Pension Funds Accumulate cash that will be paid out to subscribers in the 25 Pension Funds Accumulate cash that will be paid out to subscribers in the future in the form of pension income

26 Pillar #4: Investment Dealers Underwriters Distribute new stock and bond issues (underwriting) Business, 26 Pillar #4: Investment Dealers Underwriters Distribute new stock and bond issues (underwriting) Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Stock brokers Facilitate trading of stock and bond on exchanges (brokerage) Copyright © 2008 Pearson Education Canada

27 Other Sources of Funds Government financial institutions and granting agencies < Business Development 27 Other Sources of Funds Government financial institutions and granting agencies < Business Development Bank of Canada (BDC) < Canada Mortgage and Housing Corporation (CMHC) < Export Development Corporation Canada and its provinces borrow from international sources of funds, including other nations The Canadian Capital Market (international funds) Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

28 Exchange Rates and Trade Exchange rates influence the willingness to invest abroad and 28 Exchange Rates and Trade Exchange rates influence the willingness to invest abroad and buy imported items A trade surplus occurs when Canada is exporting more products than it is importing t (likely to occur when the dollar is undervalued) A trade deficit occurs when Canada is importing more products than it is exporting t (likely to occur when the dollar is overvalued) Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

29 The Law of One Price a basic commodity should be priced equally across 29 The Law of One Price a basic commodity should be priced equally across all countries < (if prices differ it is assumed to be due to over or under valuation of the local currency) Country Over/Under Valuation United States $2. 71 -- Canada 2. 63 -14% Switzerland (francs) 5. 05 +65% Britain (pounds) 3. 44 +12% China (yuan) The Big Mac Index Big Mac Price Equiv. (US Dollars) 1. 27 -59% Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

30 International Payments Process Local banks convert payments to the currency required by foreign 30 International Payments Process Local banks convert payments to the currency required by foreign trade associates Local banks then send payment, in foreign currency, to the foreign trade partner The foreign trade partner deposits the payment in his/her own foreign-based bank When equal values of money are moving back and forth between nations, no real funds need to be transferred between nations because the payments are in balance Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada

31 International Bank Structure International banking is governed by a network of loose agreements 31 International Bank Structure International banking is governed by a network of loose agreements between individual countries or groups of countries. World Bank < UN agency that funds infrastructure projects in developing countries IMF < 150 nations who combined resources to t promote stable exchange rates, t provide temporary short-term loans, t encourage cooperation on international monetary issues, t and develop a system for international payments Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke Copyright © 2008 Pearson Education Canada