Money, Banking, and International Finance
transactions. Fiat money is paper money and is more convenient to carry around than gold
coins. However, a central bank can print as much fiat money that it needs. Finally,
commodity money retains its value and has other purposes than as money.
- Transaction approach focus on any assets that are used as money in a transaction, while the
liquidity approach defines any liquid assets as money. People can convert some assets to
money easily, so they are almost money.
- M2 differs from M1 by the small denomination time deposits and savings accounts.
Differences between L, M3, M2, and M1 indicate the size of a country’s financial system.
Large differences imply a country has more developed financial markets.
- Credit cards are loans from a bank or finance company. Of course, many people use credit
cards as money, further complicating the money definition even more.
Answers to Chapter 2 Questions
- Bank deposits are liquid. Banks diversify their loans as a way to reduce the risk. Finally,
banks collect information about borrowers, so banks know whom to lend, reducing the
default risk.
- Stocks are ownership of a corporation, while bonds are a loan to a corporation.
- Primary market is for newly issued stocks and bonds, while the secondary markets allow
investors to buy or sell their existing stocks or bonds. Dealers usually operate in the primary
market, while the secondary market is an exchange.
- Presence of a secondary market increases liquidity. Thus, investors can sell their securities
easily if they do not want to hold them anymore.
- Financial disintermediation is depositors withdraw their deposits from financial institutions
and invest directly into the financial markets because the financial markets offer a better
return and/or reduce risks.
- Money market instruments include: U.S. Treasury bills (T-bills), commercial paper,
banker’s acceptances, negotiable bank certificates of deposit (CDs), repurchase agreements,
Federal Funds, and Eurodollars. Capital market instruments are Treasury notes (T-notes),
Treasury bonds (T-bonds), general-obligation bonds, revenue bonds, and mortgages.
- Money market is for securities with a maturity less than one year, while the capital market
includes securities with maturities over one year.
- Stock has no maturity date because a corporation can theoretically live forever.
