The Economics of Money, Banking & Financial Markets
Mishkin, Matthews & Giuliodori
Chapter 1 Why study money, banking and financial markets?
Financial markets are markets in which funds are transferred from people
who have an excess of available funds to people who have a shortage.
A security is a claim on the issuer’s future income or assets (any
financial claim or piece of property that is subject to ownership). A bond is
a debt security that promises to make payments periodically for a
specified period of time. An interest rate is the cost of borrowing or the
price paid for the rental of funds.
A common stock represents a share of ownership in a corporation.
It is a security that is a claim on the earnings and assets of the
corporation. Issuing stock and selling it to the public is a way for
corporations to raise funds to finance their activities.
The foreign exchange market is the market where one currency is
bought and sold using another currency. The price at which one currency
is exchanged for anther is known as the foreign exchange rate.
Financial intermediaries are institutions that borrow funds from
people who have saved and in turn make loans to others. Banks are
financial institutions that accept deposits and make loans.
Money, also referred to as the money supply, is defined as anything that is
generally accepted in payment for goods or services or in the repayment
of debts. The aggregate output is the total production of goods and
services. The unemployment rate is the percentage of the available labour
force unemployed. Business cycles are the upward and downward
movement of aggregate output produced in the economy. Recessions are
periods of declining aggregate output. Monetary theory is the theory that
related changes in the quantity of money to changes in aggregate
economic activity and the price level. The average price of goods and
services in an economy is called the aggregate price level (or price level).
Inflation, a continual increase in the price level, affects individuals,
businesses and the government. The inflation rate is the rate of change of
the price level, usually measured as a percentage change per year. The
monetary policy is the management of money and interest rates. The
organization responsible for the conduct of a nation’s monetary policy is
the central bank.
Fiscal policy involves decisions about government spending and
taxation. A budget deficit is the excess of government expenditures over
tax revenues for a particular time period, while a budget surplus arises
when tax revenues exceed government expenditures.
Chapter 4 Understanding interest rates
Different debt instruments have very different streams of cash payments
to the holder (known as cash flows) with very different timings. The
concept of present value (or present discounted value) is based on the
common-sense notion that a euro paid to you one year from now is less
valuable to you than a euro paid to you today.
CF
(4.1) PV =
(1+i )n
, In terms of the timing of their cash flow payments, there are four basic
types of credit market instruments.
1. A simple loan in which the lender provides the borrower with an
amount of funds (called the principal) that must be repaid to the
lender at the maturity date, along with an additional payment for
the interest.
2. A fixed payment loan (also called a fully amortized loan) in which
the lender provides the borrower with an amount of funds, which
must be repaid by making the same payment every period,
consisting of part of the principal and interest for a set number of
years.
3. A coupon bond pays the owner of the bond a fixed-interest payment
(coupon payment) every year until the maturity date, when a
specific final amount (face value or par value) is repaid. A coupon
bond is identified by three pieces of information. First is the
corporation or government agency that issues the bond. Second is
the maturity date of the bond. Third is the bond’s coupon rate, the
money amount of the yearly coupon payment expressed as a
percentage of the face value of the bond.
4. A discount bond (also called zero-coupon bond) is bought at a price
below its face value (at a discount), and the face value is repaid at
the maturity date. A discount bond does not make any interest
payments.
The yield of maturity is the interest rate that equates the present value of
cash flow payments received from a debt instrument with its value today.
For simple loans, the simple interest rate equals the yield to maturity. For
any fixed-payment loan,
FP FP FP FP
(4.2) LV = + + + …+
1+i ( 1+i ) ( 1+i )
2 3
( 1+ i )n
where LV = Loan value, FP = fixed yearly payment, and n = numbers of
years until maturity.
For any coupon bond,
C C C C F
(4.3) P= + + + …+ +
1+i ( 1+ i ) ( 1+i )
2 3
( 1+i ) ( 1+i )n
n
where P = price of coupon bond, C = yearly coupon payment, F = face
value of the bond, n = years to maturity date.
Three interesting facts emerge:
1. When the coupon bond is priced at its face value, the yield of
maturity equals the coupon rate.
2. The price of a coupon bond and the yield to maturity are negatively
related.
3. The yield to maturity is greater than the coupon rate when the bond
price is below its face value.
A consol or a perpetuity is a perpetual bond with no maturity date and no
repayment of principal that makes fixed coupon payment of €C for ever.
C
(4.4) Pc =
ic
where Pc = price of the perpetuity (consol), C = yearly payment, and
i c = yield to maturity of the perpetuity (consol).
Mishkin, Matthews & Giuliodori
Chapter 1 Why study money, banking and financial markets?
Financial markets are markets in which funds are transferred from people
who have an excess of available funds to people who have a shortage.
A security is a claim on the issuer’s future income or assets (any
financial claim or piece of property that is subject to ownership). A bond is
a debt security that promises to make payments periodically for a
specified period of time. An interest rate is the cost of borrowing or the
price paid for the rental of funds.
A common stock represents a share of ownership in a corporation.
It is a security that is a claim on the earnings and assets of the
corporation. Issuing stock and selling it to the public is a way for
corporations to raise funds to finance their activities.
The foreign exchange market is the market where one currency is
bought and sold using another currency. The price at which one currency
is exchanged for anther is known as the foreign exchange rate.
Financial intermediaries are institutions that borrow funds from
people who have saved and in turn make loans to others. Banks are
financial institutions that accept deposits and make loans.
Money, also referred to as the money supply, is defined as anything that is
generally accepted in payment for goods or services or in the repayment
of debts. The aggregate output is the total production of goods and
services. The unemployment rate is the percentage of the available labour
force unemployed. Business cycles are the upward and downward
movement of aggregate output produced in the economy. Recessions are
periods of declining aggregate output. Monetary theory is the theory that
related changes in the quantity of money to changes in aggregate
economic activity and the price level. The average price of goods and
services in an economy is called the aggregate price level (or price level).
Inflation, a continual increase in the price level, affects individuals,
businesses and the government. The inflation rate is the rate of change of
the price level, usually measured as a percentage change per year. The
monetary policy is the management of money and interest rates. The
organization responsible for the conduct of a nation’s monetary policy is
the central bank.
Fiscal policy involves decisions about government spending and
taxation. A budget deficit is the excess of government expenditures over
tax revenues for a particular time period, while a budget surplus arises
when tax revenues exceed government expenditures.
Chapter 4 Understanding interest rates
Different debt instruments have very different streams of cash payments
to the holder (known as cash flows) with very different timings. The
concept of present value (or present discounted value) is based on the
common-sense notion that a euro paid to you one year from now is less
valuable to you than a euro paid to you today.
CF
(4.1) PV =
(1+i )n
, In terms of the timing of their cash flow payments, there are four basic
types of credit market instruments.
1. A simple loan in which the lender provides the borrower with an
amount of funds (called the principal) that must be repaid to the
lender at the maturity date, along with an additional payment for
the interest.
2. A fixed payment loan (also called a fully amortized loan) in which
the lender provides the borrower with an amount of funds, which
must be repaid by making the same payment every period,
consisting of part of the principal and interest for a set number of
years.
3. A coupon bond pays the owner of the bond a fixed-interest payment
(coupon payment) every year until the maturity date, when a
specific final amount (face value or par value) is repaid. A coupon
bond is identified by three pieces of information. First is the
corporation or government agency that issues the bond. Second is
the maturity date of the bond. Third is the bond’s coupon rate, the
money amount of the yearly coupon payment expressed as a
percentage of the face value of the bond.
4. A discount bond (also called zero-coupon bond) is bought at a price
below its face value (at a discount), and the face value is repaid at
the maturity date. A discount bond does not make any interest
payments.
The yield of maturity is the interest rate that equates the present value of
cash flow payments received from a debt instrument with its value today.
For simple loans, the simple interest rate equals the yield to maturity. For
any fixed-payment loan,
FP FP FP FP
(4.2) LV = + + + …+
1+i ( 1+i ) ( 1+i )
2 3
( 1+ i )n
where LV = Loan value, FP = fixed yearly payment, and n = numbers of
years until maturity.
For any coupon bond,
C C C C F
(4.3) P= + + + …+ +
1+i ( 1+ i ) ( 1+i )
2 3
( 1+i ) ( 1+i )n
n
where P = price of coupon bond, C = yearly coupon payment, F = face
value of the bond, n = years to maturity date.
Three interesting facts emerge:
1. When the coupon bond is priced at its face value, the yield of
maturity equals the coupon rate.
2. The price of a coupon bond and the yield to maturity are negatively
related.
3. The yield to maturity is greater than the coupon rate when the bond
price is below its face value.
A consol or a perpetuity is a perpetual bond with no maturity date and no
repayment of principal that makes fixed coupon payment of €C for ever.
C
(4.4) Pc =
ic
where Pc = price of the perpetuity (consol), C = yearly payment, and
i c = yield to maturity of the perpetuity (consol).
