Syllabus

Outlines

Classnotes

Exercise

CLASS HOURS: T&R 9:35 - 10:50; STV 228
INSTRUCTOR: Dr. Hassan Mohammadi
OFFICE: STV 423D
PHONE: 438-7777
OFFICE HOURS: T&R 11:00-12:00; 2:00 - 3:00

REQUIRED TEXT:
The Economics of Money, Banking, and Financial Markets, Sixth Edition, Frederic S. Mishkin, 2000

RECOMMENDAED TEXTS:
Study Guide and Workbook to Accompany Money, Banking, and Financial Markets, by John McArthur and Frederic S. Mishkin

OTHERS: The Wall Street Journal, The Economist, Barron's, Handouts, …

INTRODUCTION

Money, banking, and financial markets are the three important features of all modern industrial economies, and the study of these subjects has become one of the most exciting areas in economics. Financial markets are changing rapidly, and new financial instruments appear almost daily; the banking industry has responded to new economic conditions and has become highly dynamic; advancements in financial markets and international trade have resulted in an integrated world economy in which events in one country's financial markets affect financial markets in other countries. Similarly, new developments in monetary theory have changed our view on the role of money in the economy and the conduct of monetary policy.

COURSE OBJECTIVE

In this course, we will study the subject of money, banking and financial markets by developing a unifying analytical framework that stresses the economic way of thinking; development of simple models; and applications-oriented perspective.

Our economic way of thinking will be based on a few basic economic principles such as (1) the theory of asset demand (or portfolio choice); (2) the concept of equilibrium; (3) the simple demand and supply analysis to explain the behavior of financial markets; (4) profit maximization; (5) the concept of transactions cost and asymmetric information to analyze financial structure, and (6) aggregate supply and demand analysis to investigate the impact of changes in money stock on macroeconomic variables.

In developing our simple economic models we follow a careful step-by-step procedure which include: (1) highlighting the objectives of the model, (2) listing all the variables which are held constant, (3) showing the step-by-step derivation of the model, (4) using the model to explain an specific event by focusing on changes in one variable at a time, holding all other variables constant.
In order to demonstrate their usefulness in analyzing real-world situations, we apply our economic models to several real events. Examples are: the link between money and interest rates, the rise and fall of dollar in the foreign exchange market, and the link between money and inflation.

COURSE EVALUATION AND GRADE

My evaluation of your course performance is based on four examinations, eight quizzes, a research project, and your class participation. Each examination has a maximum of 100 points; each quiz 10 points; the project 80 points, and class participation 40 points. Thus, the maximum total point that can be earned is 600. Your course grade is based on the following distribution,

600 - 530: A
529 - 470: B
469 - 410: C
409 - 350: D
349 and less: F

Exams are given approximately every four weeks. They may consist of multiple-choice and short-essay questions. Quizzes are given at random, and are usually 10 multiple-choice questions. Your research project should deal with a fairly recent issue pertaining to money, financial intermediaries (banks, insurance companies, investment intermediaries) or financial markets (stock, bonds, foreign exchange). Each paper should consist of 5 to 7 pages with at least three references. It should be written in your words. If you are quoting others, that should be stated very clearly. It should have the following format:
A. Introduction
B. Main body of the text
C. Summary and Conclusions
D. References

IMPORTANT REMINDERS

1. Please keep up with your readings. Over the course of this session we will cover a substantial amount of new information. It would be very difficult to understand all the new information just before each examination. Also, many of the subject matters are accumulative. Therefore, lack of understanding of one subject might cause serious hindrance in grasping the new information.

2. You are expected to attend classes regularly. It is your responsibility to inform me of scheduled absences, provide me with a schedule of all semester absences, and arrange to complete missed class work. Ultimately, you are responsible for materials covered in class.

3. Make-up examinations will be given only for documented emergencies and sickness, and must be scheduled prior to the examination date.

COURSE CONTENTS

PART I. INTRODUCTION
Chapter 1: Why Study Money, Banking, and Financial Markets?

Why Study Money?
Money and Business Cycles
Money and Inflation
Money and Interest rates
Conduct of Monetary Policy
Budget Deficits and Monetary Policy

Why Study Banking?
Financial Intermediation
Banking and the Money Supply
Financial Innovation

Why Study Financial Markets?
Bond Market
Stock Market
Foreign Exchange market

Chapter 2: An Overview of the Financial System

Function of Financial Markets
Structure of Financial Markets
Debt and Equity Markets
Primary and Secondary Markets
Organized-Exchanges and Over-the Counter Markets
Money and Capital Markets

Financial Market Instruments
Money Market Instruments
Capital Market Instruments

Function of Financial Intermediaries
Transactions Costs
Asymmetric Information: Adverse Selection and Moral Hazard

Financial Intermediaries
Depository Institutions
Contractual Savings Institutions
Investment Intermediaries

Regulation of the Financial System
Increasing Information Available to Investors
Ensuring the Soundness of Financial Intermediaries
Improving Control of Monetary Policy

Chapter 3: What is Money?
Meaning of Money
Functions of Money
Medium of Exchange
Unit of Account
Store of Value

Evolution of the Payment System
Primitive Economy
Barter Economy
Monetary Exchange Economy

Measuring Money
The Federal Reserve's Monetary Aggregates

How Reliable Are the Money Data?

PART II. FINANCIAL MARKETS

Chapter 4: Understanding Interest Rates

Measuring Interest Rates
Four Types of IOU's
Present Value
Yield to Maturity

Other Measures of Interest Rates
Current Yield
Yield on Discount Basis

The Distinction between Interest Rates and Returns
Maturity and Volatility of Bond Returns: Interest Rate Risk

The Distinction between Real and Nominal Interest Rates

Chapter 5: The Behavior of Interest Rates

Theory of Asset Demand
Wealth
Expected Returns
Risk
Liquidity

Loanable Funds Framework: Supply and Demand in the Bond Market
Demand Curve
Supply Curve
Market Equilibrium
Supply and Demand Analysis
Changes in Equilibrium Interest Rates
Shifts in Demand for Bonds
Shifts in the Supply of Bonds
Changes in the Equilibrium Interest Rate

Liquidity Preference Framework: Supply and Demand in the Market for Money
Changes in Equilibrium Interest Rates
Shifts in the Demand for Money
Shifts in the Supply of Money
Changes in the Equilibrium Interest Rate

Does a higher rate of growth of the money supply lower interest rates?

Chapter 6: The Risk and Term Structure of Interest Rates
Risk structure of interest rates: default risk, liquidity, income-tax considerations
Default risk, default-free bonds, risk premium, junk bonds
Liquidity considerations, income-tax considerations

Term-Structure of interest rates: Yield curve and inverted yield curve
Expectations Theory, Segmented Market Theory, Liquidity Premium Theory

Chapter 7: The Foreign Exchange market
Foreign Exchange market
What are Foreign Exchange Rates?
Why are Exchange Rates Important?
How is Foreign Exchange Traded?

Exchange Rates In the Long-Run
Low of One Price
Theory of Purchasing Power Parity
Weaknesses of the Purchasing Power Parity Theory
Other Factors that Affect Exchange Rates in the Long-Run

Exchange Rates in the Short-Run
Interest parity condition
Equilibrium in the foreign exchange market

Explaining Changes in Exchange Rates
Changes in the foreign interest rate
Changes in the domestic interest rate
Changes in the expected future exchange rate

PART III: FINANCIAL INSTITUTIONS

Chapter8: An Economic Analysis of Financial Structure

Basic Puzzles About Financial Structure

Transactions Costs and their Roles
How Transactions Costs Influence Financial Structure
How Financial Intermediaries Reduce Transactions Costs

Asymmetric Information: Adverse Selection and Moral Hazard

Effect of Adverse Selection on Financial Structure
The Lemons Problem in the Stock and Bond Markets
Solutions to the Adverse Selection Problems

Effect of Moral Hazard on the Choice of Debt vs Equity Contracts
Moral Hazard in Equity Contracts: The Principal-Agent Problem
Solutions to Principal-Agent Problem

Effect of Moral Hazard on Financial Structure in Debt Market
Solutions to Moral Hazard in Debt Contracts


Financial Development and Economic Growth
Financial Crisis and Aggregate Economic Activity

Chapter 9: The Banking Firm and the Management of Financial Institutions

The Bank Balance Sheet
Liabilities
Assets

Basic Operation of Bank

General Principles of Bank Management
Liquidity Management and the Role of Reserves
Asset Management
Managing Capital Adequacy
Managing Bank Capital

Managing Credit Risk
Screening and Monitoring
Long-Term Customer Relationships
Loan Commitments
Collateral And Compensating Balances
Credit rationing

Managing Interest-Rate Risk
Gap and Duration Analysis

PART IV. Central Banking and the Conduct of Monetary Policy

Chapter 14: Structure of Central Banks and the Federal Reserve System
Origins of the Federal Reserve System
Formal Structure of the Federal Reserve System
How Independent Is the FED?
Explaining Central bank Behavior
Should the FED be Independent?

Chapter 15: Multiple Deposit Creation and Money Supply Process
Four Players in the Money Supply Process
The FED's Balance Sheet and the Monetary Base
Control of the Monetary Base
Multiple Deposit Creation: a simple model

Chapter 16: Determinants of the Money Supply
The Money Supply Model and the Money Multiplier
Factors that Determine the Money Multiplier

Behavior of Currency Ratio (k=C/DD)
Effect of a Change in Wealth
Effect of a Change in Expected Return
Explaining Bank Behavior
Determinants of Excess Reserves (e=ER/DD)
Determinants of Discount Loan Borrowing
The Complete Money Supply Model
Determinants of Money Supply
Interplay of Determinants

Chapter 17: Tools of Monetary Policy
The Market for Reserves and the Federal Funds Rate
How changes in the tools of monetary policy affect the federal funds rate
Open Market Operations
Discount lending
Reserve requirements

Open Market Operations: types and advantages

Discount Policy
Operation of the Discount Window
Lender of Last Resort
Advantages and disadvantages of Discount Loan Policy

Reserve Requirement Policy
Advantages and Disadvantages

Chapter 19. Conduct of Monetary Policy: Goals and Targets

Goals of Monetary Policy
High Employment
Economic Growth
Price Stability

Interest rate Stability
Stability of Financial markets
Stability in Foreign Exchange Markets
Conflict Among Goals

The Fed's Strategy: Use of Targets

Choosing the Targets
Criteria for Choosing Intermediate targets
Criteria for Choosing Operating Targets