Transcript Ch 18 - Money and Banking

CHAPTER 18
Understanding Money
and Banking
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-2
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
18-3
Money
Any object
generally accepted
as payment for
goods & services
Characteristics:
 Portable:
 lightweight and easy to handle
 Divisible:
 easily broken down to match the value of goods
 Durable:
 must not spoil or easily wear out
 Stable:
 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
18-4
Functions of Money
Medium of exchange
 a single medium of exchange for goods and
services instead of barter
Store of value
can be used for future purchases
Unit of account
 allows measurement of the relative value of
goods and services
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-5
The Money Supply
Buyers and sellers must agree on the
value of money
The value of money depends on its supply
as supply , value
as supply , value
Narrow definition is called M-1
Wider definition is called M-2
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-6
M-1 Money Supply
The most liquid forms of money
currency:
paper money and coins issued by the Canadian
government
demand deposits:
money in chequing accounts, which can be
transferred to others by cheque
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
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M-2 Money Supply
Everything in M-1 plus
 Savings deposits:
 savings account holdings
 Time deposits:
 deposit requiring prior notice before withdrawal of funds
 Money market mutual funds
 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
18-8
Credit Cards
Not included in M-1 or M-2
Not money
no store of value
Money substitute
temporary medium of exchange
Popular:
Convenient
Profitable
annual fees, merchants fees & interest
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-9
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
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18-10
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
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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
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18-12
Bank Deposits
Accept deposits from some
customers to obtain money
to lend to others
chequing accounts
term deposits (money that
remains with the bank for a
period of time with interest paid
to the depositor)
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-13
Bank Loans
Major source of shortterm financing
Prefer to finance
inventories or
accounts receivable
rather than
long-term loans to
many businesses
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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
18-14
Banks as Creators of Money
Bank
1
2
3
4
5
6
7
8
9
Totals for
the first
nine banks
Expansion
limit for
entire
banking
system
New Deposit
Reserve
Requirement
New Loan
$100.00
$90.00
$81.00
$72.90
$65.61
$59.05
$53.14
$47.83
$43.05
$10.00
$9.00
$8.10
$7.29
$6.56
$5.91
$5.31
$4.31
$4.31
$90.00
$81.00
$72.90
$65.61
$59.05
$53.14
$47.83
$38.74
$38.74
$612.58
$61.26
$551.32
$1,000.00
$100.00
$900.00
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-15
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
Investment banking
Commercial paper
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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
18-17
The Bank of Canada
The central bank of Canada
Managed by a Board of Governors
Regulates operations of chartered banks
Manages the money supply by
Buying/selling securities
Changing the bank rate
Bank rate = rate at which
chartered banks can borrow
from Bank of Canada
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-18
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)
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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
18-20
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
18-21
Life Insurance Firms
Life Insurance companies
mutual or stock company that shares risks
with policy holders for payment of premiums
some money from premiums is lent back out
substantial investments in real estate,
mortgages and government bonds
largest financial intermediaries
in Canada
next to the chartered banks
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
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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
18-23
Financial Corporations
Sales finance company
finances instalment purchases made by
individuals or businesses
loans are secured by the item being financed
(e.g.: computer)
Consumer finance company
makes personal loans to consumers
collateral may or may not be required
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
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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
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Pension Funds
Accumulate cash that will be paid out to
subscribers in the future in the form of
pension income
Money is invested until it is needed
Investments include stocks and bonds,
mortgages
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
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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)
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18-27
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
18-28
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
 (likely to occur when the dollar is undervalued)
A trade deficit occurs when Canada is
importing more products than it is exporting
 (likely to occur when the dollar is overvalued)
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-29
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)
The
Big
Mac
Index
Country
Big Mac Price
Equiv.
(US Dollars)
Over/Under
Valuation
United States
$2.71
--
Canada
2.63
-14%
Switzerland
(francs)
5.05
+65%
Britain
(pounds)
3.44
+12%
China (yuan)
1.27
-59%
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada
18-30
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
18-31
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
 promote stable exchange rates,
 provide temporary short-term loans,
 encourage cooperation on international monetary issues,
 and develop a system for international payments
Business, Sixth Canadian Edition, by Griffin, Ebert, and Starke
Copyright © 2008 Pearson Education Canada