Chapter 8 Textbook Notes

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10 Nov 2010
MGTA04 / 01
Chapter 8: Understanding Money and Banking
- Stocks, bonds, funds in your chequing and savings account are not money but are personal
The Characteristics of Money
- Under the Celts some 2,500 years ago, ancient Ireland had a simple economy where cows
were the unit of exchange instead of money
- Modern money takes form in stamped metal or printed paper ± CDN dollar, U.S. dollar,
British pounds, Japanese Yen ± whish are issued by the governments
- Coins probably came into use around 600 BCE and paper money around 1100 BCE
- Money is any object generally accepted by people as payment for goods and services. Any
object that is portable, divisible, durable and stable can be classified as money
o Portability ± lightweight and easy to handle (e.g. not lugging a 35 Kg fish)
o Divisibility ± modern currency is easily divisible into smaller parts with fixed
values for each unit (e.g. $1 = 4 quarters, 10 dimes, 20 nickels)
o Durability ± modern currency does not spoil, die or wear out (e.g. fish can rot)
o Stability ± value of the paper money we use today has fluctuated over the years
but is considerably more stable than salmon (a shortage of salmon)
The Functions of Money
- Imagine a fisherman wants a new sail for his boat
o Barter economy: exchange goods for another, fisherman must find someone who is
willing to trade a new sail for some fish.
o Money economy: sell his catch, receive money, and exchange the money for such
goods such as a new sail
- The barter economy is quite inefficient but is still used in various places around the world
(e.g. Russia is trying to move to a market-based system from their command economy)
- Money serves three functions:
o Medium of exchange: we use money as a way of buying and selling things
value rather than storing fish for future purchases (will spoil)
o Unit of account: money lets us measure the relative values of goods and services. It
also acts as a unit of account because all products can be valued and accounted for in
terms of money (e.g. $1,000 worth of clothes or $500 in labour costs
Credit Cards: Plastic Money?
- The use of credit cards has become a major factor in the purchase of consumer goods in
- Credit cards do not qualify as money but are rather money substitute (serve as temporary
medium of exchange but are not a store of money)
- Credit cards are big businesses for two reasons:
1. Some cards charge annual fees to holders and charges interest rate on unpaid
balances (depending on the issuer, rates range from 11% - 20%)
2. Merchants who accept credit cards pay fees to card issuers (depending on the
PHUFKDQW¶VDJUHHPHQWZLWKWKHLVVXHUUDtes range from 2% - 5% of credit sales)
What is Money? (pg. 180 ± 182)
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MGTA04 / 02
- Many forms of money especially demand deposits and time deposits depend on the
existence of financial institutions to provide services to both individuals and businesses
- Businesses need stable financial institutions to underwrite modernization and expansion, and
individuals need them to handle currency
Financial Institutions
- Main function of financial institutions is to ease the flow of money from sectors with
surpluses to those with deficits
- Does this by making funds available for chequing and savings account and in turn, its assets
- There are a variety of financial intermediaries in Canada that varies in size, importance,
types of sources they appeal (in forms of users they supply money to and claims they give to
sources of funds)
- For many years, the financial community in Canada was divided rather clearly into four
o (1) chartered banks
o (2) alternate banks (e.g. trust companies and caisses popularies or credit unions)
o (3) life insurance companies and other specialized lending and saving intermediaries
(e.g. finance companies, venture capital firms, mutual funds, and pension funds)
o (4) investment dealers
- The crumbling of the four financial pillars began in 1980 when several changes were made
to the Bank Act and this process accelerated with additional changes were made in 1987 and
- Canadian banks are now permitted to own securities dealers, sell commercial paper and to
own insurance companies. Also established subsidiaries to sell mutual funds
- Changes to the Bank Act allowed subsidiaries of foreign banks to set up business in Canada
(over 40 have done so)
- Trust companies have declined in importance during the last few years and many trust
companies have been bought by banks or insurance companies (e.g. TD Canada Trust)
- A chartered bank is a privately owned profit-seeking firm that serves individuals, non-
business organizations, and businesses as a financial intermediary
- Are chartered by the federal government and are closely regulated
- Offers chequing and savings accounts, make loans and provide many other services to their
customers. Are the mains source of short-term loans for business firms
- Chartered banks are the largest and most important financial institutions in Canada
- In March 2006, Canadian chartered banks had assets totalling $1.3 trillion
- Canada has a branch banking system (few banks, each with hundreds of branches) unlike the
United States (hundreds of banks, few branches)
- The 1980 Bank Act requires:
o Schedule A banks: be Canadian-owned and have no more than 10% of voting shares
controlled by a single interest (e.g. RBC, CIBC, TD bank, Bank of nova Scotia, and
BMO accounts for about 90% of total bank assets)
o Schedule B banks: may be domestically owned banks that do not meet the 10% limit
or may be foreign controlled. Limits to one main office and one branch
- There are thousands of branch offices in Canada, about one for every 3,300 people
The Canadian Financial System (pg. 182 ± 184)
Financial Pillar #1 ± Chartered Banks (pg. 184 ± 192)
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Services Offered by Banks
- The banking business today is a highly competitive industry where accepting deposits and
making loans are not enough.
- Some banks offer credit cards and safe-deposit boxes. Also may offer pension, trust,
international, and financial advice, and electronic money transfer (internet banking)
Pension Services
- Most banks help customers establish savings plans for retirement
- Banks serve as financial intermediaries by receiving funds and investing them as directed by
customers. Also provide customers with information on investment possibilities
Trust Services
- Most banks offer trust services WKHPDQDJHPHQWRIIXQGVOHIW³LQWKHEDQN¶VWUXVW´
- For a fee, trust departments can perform tasks such as making your monthly bill payments
and managing your investment portfolios or manage estates of deceased persons
International Services
- Three main international services offered by banks are currency exchange, letters of credit,
and banker¶VDFFHSWDQFHV
- E.g. Canadian company wants to buy a product from a French supplier
1. Can exchange Canadian dollars for euros at a Canadian bank then pay the French
supplier in euros
2. Pay its bank to issue a letter of credit (a promise by the bank to pay the French
firm a certain amount if specified conditions are met)
3. Pay its bank to draw up a EDQNHU¶VDFFHSWDQFH (a promise that the bank will pay
some specified amount at a future date)
only after certain conditions are met (e.g. French supplier shows shipping documents)
Financial Advice
- Many banks both large and small help their customers manage their money by
recommending different investment opportunities (e.g. [guaranteed investment certificates]
GICs, mutual funds, stocks, and bonds)
- Today bank advertisements often stress the role of banks as financial advisers
Automated teller Machines
- Electronic automated teller machines (ATMs) allow customers to withdraw money and
make deposits 24 hours a day, seven days a week
- Also allows transfers of funds between accounts and provide information on account status
- Machines are now located at bank buildings, grocery stores, airports, shopping malls, and
other locations around the world
Western Europe and 8% in Latin America
Bank Deposits
- Chartered banks provide a financial intermediary service by accepting deposits and making
loans with this money
- Banks make various types of loans to businesses so when businesses asks for a loan, the
banker must remember that the bank is interested in making money through this loan, how
the loan will be repaid and how it will be secured
- One type of deposit a customer can make in a bank is a chequable deposit which is a
chequing account. Customers who deposit money into their chequing accounts can write
cheques against the balance in their accounts, they are also called demand deposits
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