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Lecture 1

Economics 2154A/B Lecture 1: Econ 2154 – Textbook Notes

12 Pages
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Department
Economics
Course Code
Economics 2154A/B
Professor
Desmond Mc Keon

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Econ 2154 – Textbook Notes
Chapter 2
An Overview of the Financial System
Direct Finance – Borrowers borrow funds directly from leaders in financial
markets
oBy selling them securities (financial Instruments)
oClaims on the borrower’s future income or assets
oSecurities are assets for the person who buys them, but liabilities for the
individual or firm that sells them
Debt and Market equities
oShort term – Less than a year
oLong Term – 10 years or longer
oIntermediate Term – Between 1 and 10 years
Primary Market
oNew issues are sold to initial buyers
oInitial sells to usually investment banks
oUnderwrites the security, by stating a price it would pay for it
Secondary market
oA financial market in which securities that have been previously issued
can be resold
oBrokers are agents of investors who match buyers with sellers
oDealers link buyers and sellers by buying and selling securities at stated
prices
OTC Exchange
oOver the Counter exchange, dealers at different locations who have an
inventory of securities stand ready to buy and sell securities “Over the
Counter”
Money Market
oA financial Market in which only short-term debt instruments are traded
Capital Market
oIs the market in which longer-term debt and equity instruments are traded
Treasury Bills
oShort-term debt instruments, issued in 1,2,6,12 Month maturities with
almost no possibility of default
Certificate of Deposit
oSame thing as a GIC
Commercial Paper
oUnsecured short-term debt instruments issued by large banks and well-
known corporations or large banks
Repurchase Agreements
oEffectively short term loans for which T-bills Serve as collateral
Overnight Funds
oOvernight loans by banks to other banks
Mortgages
oLoans to households or firms to purchase housing, land or real structures
Mortgage backed securities
oA bond-like debt instrument which is backed by a bundle of individual
mortgages
Corporate bond
oLong-term bonds issued by corporations with very strong credit ratings
Foreign Bonds
oForeign bonds are sold in a foreign country and are denominated in that
countries currency
Eurobond
oA bond denominated in a currency other than that of the country in which it
is sold (ex. Bond issued by a Canadian Corporation, denominated in
Japanese Yen, Sold in Germany
Eurocurrencies
oForeign Currency deposited in Banks outside the home country
Eurodollars
oUS dollars deposited in foreign banks outside the US or in foreign
branches of US banks
Asymmetric Information
oOne party often does not know enough about the other party to make
accurate decisions
Adverse Selection
oThe problem created by asymmetric information before the transaction
occurs
Moral Hazard
othe problem is created by asymmetric information after the transaction
occurs
Economies of Scope
oCan lower the cost of information production for each service by applying
one information resource to many different services
Financial Panic
oAsymmetric information can lead to the widespread collapse of financial
intermediaries
oProviders of funds may not be able to asses whether the institutions
holding their funds are sound or not
Chapter 3
What is Money?
Meaning of money
oAnything that is generally accepted in payment for goods and services
Currency
oType of money consisting of bills and coins
Income
oA flow of earnings per unit of time
Wealth
oThe total collection of pieces of property that serves to store value
Medium of Exchange
oMoney in the form of currency or cheques that is used to pay for goods
and services
Unit of Account
oUsed to measure value in the economy
Store of Value
oRepository of purchasing power
Liquidity
oRelative ease and speed with which an asset can be converted into a
medium of exchange
Hyperinflation
oInflation rate exceeds 50% per month
Payments System
oThe method of conducting transactions in the Economy
Commodity Money
oMoney made up of precious metals or other valuable commodities
Fiat Money
oPaper currency decreed by governments as legal tender but not
convertible into coins or precious metals
Cheque
oInstrument from your bank used to transfer money from your account to
someone else’s account when she deposits the cheque
Electronic Payment
oDevelopment of inexpensive computers now allow you to pay your bills
online
E-money
oMoney that exists in electronic form only

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Description
Econ 2154 Textbook Notes Chapter 2 An Overview of the Financial System Direct Finance Borrowers borrow funds directly from leaders in financial markets oBy selling them securities (financial Instruments) oClaims on the borrowers future income or assets oSecurities are assets for the person who buys them, but liabilities for the individual or firm that sells them Debt and Market equities oShort term Less than a year oLong Term 10 years or longer oIntermediate Term Between 1 and 10 years Primary Market oNew issues are sold to initial buyers oInitial sells to usually investment banks oUnderwrites the security, by stating a price it would pay for it Secondary market oA financial market in which securities that have been previously issued can be resold oBrokers are agents of investors who match buyers with sellers oDealers link buyers and sellers by buying and selling securities at stated prices OTC Exchange oOver the Counter exchange, dealers at different locations who have an inventory of securities stand ready to buy and sell securities Over the Counter Money Market oA financial Market in which only shortterm debt instruments are traded Capital Market oIs the market in which longerterm debt and equity instruments are traded Treasury Bills oShortterm debt instruments, issued in 1,2,6,12 Month maturities with almost no possibility of default Certificate of Deposit oSame thing as a GIC Commercial Paper oUnsecured shortterm debt instruments issued by large banks and well known corporations or large banks Repurchase AgreementsoEffectively short term loans for which Tbills Serve as collateral Overnight Funds oOvernight loans by banks to other banks Mortgages oLoans to households or firms to purchase housing, land or real structures Mortgage backed securities oA bondlike debt instrument which is backed by a bundle of individual mortgages Corporate bond oLongterm bonds issued by corporations with very strong credit ratings Foreign Bonds oForeign bonds are sold in a foreign country and are denominated in that countries currency Eurobond oA bond denominated in a currency other than that of the country in which it is sold (ex. Bond issued by a Canadian Corporation, denominated in Japanese Yen, Sold in Germany Eurocurrencies oForeign Currency deposited in Banks outside the home country Eurodollars oUS dollars deposited in foreign banks outside the US or in foreign branches of US banks Asymmetric Information oOne party often does not know enough about the other party to make accurate decisions Adverse Selection oThe problem created by asymmetric information before the transaction occurs Moral Hazard othe problem is created by asymmetric information after the transaction occurs Economies of Scope oCan lower the cost of information production for each service by applying one information resource to many different services Financial Panic oAsymmetric information can lead to the widespread collapse of financial intermediaries oProviders of funds may not be able to asses whether the institutions holding their funds are sound or not
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