Tab 1

♡financial sector ♡

● introduction:

○ introduction:

■ a financial sector is a section of the economy made up of firms and

institutions that provide financial services to commercial and retail

customers

● eg:

○ banks

○ investment companies

○ real estate firms

○ functions:

■ plays an important part role in the functioning of the economy, where

it sits between savers and borrowers, and takes funds from savers

(investors) (eg: deposits) and lends them to those who wish to borrow

such as households, businesses and governments to generate

profit

■ encourages savings

■ provides support for businesses:

● provides short–term loans to firms so that they can cover

their expenses
● introduction to money:

○ money is a medium of exchange, unit of account, store of value and

standard of deferred payment, generally accepted as a means of settling

debts (legal tender)

■ money is also a legal tender (anything recognized by law as a means

to settle a public or private debt or to meet a financial obligation)

○ functions:

■ medium of exchange:

● money is widely accepted in exchange for goods and

services, the central bank declared money as a legal tender

(acceptable in the settlements of debts)

■ unit of account:

● money is a common measure of the relative value of goods

and services

○ without money, it is difficult to set prices for goods

and services

■ store of value:

● money has the ability to hold value overtime, and can be put

away without spoilage

■ standard of deferred payment:

 ● money facilitates transactions to be carried out on a credit

basis

○ payments for goods and services can be made in the

future

○ characteristics:

■ homogeneity:

● money should be uniform, with each unit having the same

size, shape and value

■ durability:

● money must be able to last a very long time (it should not

wear out easily)

■ divisibility:

● it should be easy for money to broken down into smaller units

■ scarce or limited in supply:

● this is in order to maintain its value, money must have a

limited supply (it should not be plentiful)

■ portability:

● money should be very lightweight so it can be easily carries

around

■ acceptability:

● money should be easily recognizable and generally accepted

by a population

○ the development of money:

■ back then the barter system was relied upon:

● barter is the direct exchange of goods and services

○ eg:

■ a farmer may exchange a bushel of wheat for

a pair of shoes from a shoemaker

● the process of meeting one’s needs is slow, cumbersome

and very impractical, and there must be double

coincidence of wants (where two people have to have the

appropriate goods or services which each other wants)

○ therefore, money makes the whole process of

exchange and trade easier

● slowly, trading items such as animal skins, salt and shells,

developed over the centuries, and served as the medium of

exchange

○ around 770 b.c, china used tools and weapons as a

medium of exchange, but were eventually simplified

into objects in the shape of a circle, that modern

people may recognize as coins

■ around this time, the chinese moved from

coins to paper money

● parts of europe were still using metal coins as their sole

form of currency to the 16th century, but banks started using

 paper banknotes for depositors and borrowers to use in place

of coins

○ these notes could be taken to the bank at any time

and exchanged for their face value in metal, usually

silver or gold, coins, and could be used to buy

goods and services

■ in this way, it operated much like currency

does today in the modern world

● however, it was issued by banks and

private institutions, not the

government, which is now

responsible for issuing currency in

most countries

● in the 21st century, people use credit and debit cards,

electric money (like paypal) and virtual currencies such as

bitcoin

○ problems with barter:

■ double coincidence of wants:

● a person had to find someone who wanted what they had

and who is also offering what they want

○ this is extremely difficult at times

■ divisibility of goods:

● rates of exchange could not be divided

 ■ storage of wealth:

● it was impossible for certain goods to be kept for a long

period of time, because they would spoil

● demand for money:

○ demand for money refers to the desire to hold money in the form of cash or

in current accounts (bank accounts)

■ three motives for holding money:

● transaction demand for money:

○ this refers to the stock of money people hold for

everyday expenses (predictable expenses) (eg: bus

fare, lunch money)

■ this demand for money is determined by the

level of income, where the larger the income,

the more money will be demanded for

transaction purposes

■ this demand for money is also determined

by the price level, where if prices are

increases, more money will be held for the

transactional motive

■ this demand for money is interest inelastic

(not affected by changes in the interest rate)

● precautionary demand for money:
○ this refers to money held as a means of insurance

against unforeseen circumstances

■ this demand for money increases as income

increases

■ this demand for money is interest inelastic

○ money held for the transaction and precautionary

motives are sometimes referred to as active

balances, as they are likely to be spent in the near

future
● speculative demand for money:

○ this refers to when people wish to hold money rather

than buy bonds or risky investment

■ the motive is interest elastic

■ money held for this motive is sometimes

called idle balances

● money supply:

○ money supply is refers to the total amount of money available in an

economy at a specific time that people can use for buying goods and

services

■ measures of money supply:

● m0

○ this is the most basic form of money, including

cash that people have, and money reserves held by

the central bank for commercial banks

● m1

○ this includes m0 plus the money in current accounts

that can be accessed immediately, like notes, coins,

and checking accounts

● m2

○ this includes m1 plus savings accounts, foreign

currency deposits (fcds), certificates of deposit (cds),

and repurchase agreements (which are short-term

loans)
 ■ m2 is sometimes referred to as broad money

(because it includes money that is a bit

harder to access quickly) while m0 and m1 are

sometimes referred to as narrow money

(because they focus on money that’s easily

accessible)

● the central bank:

○ a central bank is responsible for overseeing the monetary system for a

nation (or group of nations), along with a wide range of other responsibilities,

from overseeing monetary policy to implementing specific goals such as

currency stability, low inflation, and full employment

■ central banks also supervise other financial institutions, especially

commercial banks (ncb, scotia banks)

● eg:

○ bank of jamaica

■ role of a central bank:

● issuing money:

○ has responsibility for issuing notes and coins and ensure

people have faith in notes which are printed

■ eg:

● protect against forgery

○ printing money is also an important responsibility because

printing too much can cause inflation

● lender of last resort to commercial banks:

○ if banks get into liquidity shortages then the central bank is

able to lend the commercial bank sufficient funds to avoid

the bank running short

○ this is important as it helps maintain confidence in

the banking system (if a bank ran out of money,

people would lose confidence and want to withdraw

their money)

■ having a lender of last resort means that a

liquidity crisis within banks are not expected,

and therefore, people have high confidence

in keeping their saving in banks

■ target low inflation:

● many governments give the central bank a target for

inflation

○ eg:

■ the bank of jamaica has an inflation target of

4% to 6%

■ target growth and unemployment:

● as well as low inflation, a central bank will consider other

macroeconomic objectives such as economic growth and

targeting unemployment

○ eg:
 ○ in a period of temporary cost–push inflation, the

central bank may accept a higher rate of inflation

because it does not want to push the economy into a

recession

■ operate monetary policy & interest rates:

● the central bank set interest rates to target low inflation and

maintain economic growth

○ the central bank uses interest rates to control the

money supply in the economy, which then affects the

level of inflation

● instruments of monetary control:

○ instruments of monetary control are the tools used by the central bank to

regulate the money supply and influence economic activity

■ eg:

● open market operations

● reserve requirements

● the interest rate

■ ways the central bank can control the money supply:

● interest rate:

○ the instrument of monetary policy aims to influence

the amount of bank lending by acting on the demand

for loans
■ this is based on the view that the demand for

bank loans depend on the price

■ the price, in this case the interest rate

● central banks will therefore target the

interest rate in order to influence the

money supply

○ when interest rate

decreases, people demand

more loans, money supply

increases (more money in the

hands of the public)

○ when interest rate increases,

people demand less loans,

money supply decreases

 (less money in the hands of

the public)

■ reserve requirement:

● commercial banks practice fractional reserves

banking (where a portion of what they accept as

deposit is kept at the central bank as reserves and

the other portion is used to make loans)

○ the amount that is kept as reserves is

determined by the reserves ratio (the

percentage of deposits that commercial

banks will hold as reserves)

■ eg:

● if the reserves ratio is 10%

and the total deposits are

$1000, then $100 will be kept

as reserves and $900 will be

used to make loans

● if the central bank wants to increase the money

supply, it could decrease the reserves ratio, so banks

would have more money to lend

○ if it wants to decrease the money supply, it

could increase the reserves ratio so banks

would have less money to lend

■ open market operation:

● this describes the purchase and sale of financial

instruments by the central bank to increase or

decrease the money supply

○ these financial instruments are certificates

issued by central bank

■ trading is done in the open market

through regular dealers and securities

○ to decrease the money supply, the central

bank will sell treasury bills (taking money out

of the hands of the public)

■ the public will be issued with

certificates of deposits which carry a

special rate of interest

○ to increase the money supply, the central

bank will purchase treasury bills or

certificates of deposits (putting money into

the hands of the public)

■ moral suasion:

● this is persuasion that takes place in the form of

letters and verbal statements that the central bank

uses to try to encourage commercial banks to take

actions necessary to control or encourage spending

 ○ governments sometimes appeal to the public

to control spending or reduce imports

● commercial bank:

○ a commercial bank a financial institution that accepts deposits, offers

checking account services, makes various loans, and offers basic financial

products like certificates of deposit (cds) and savings accounts to individuals

and small businesses

■ eg:

● national commercial bank (ncb)

○ roles of a commercial bank:

■ accepting deposits:

● commercial banks accept money from the public in the form

of current accounts, savings account or fixed deposits

■ granting loans/ or credit creation:

● a percentage of deposits is used to make loans to the

general public

■ promoting entrepreneurship:

● loans by commercial banks induces new entrepreneurs to

start their own businesses

■ financing foreign trade:

● a commercial bank helps in foreign trade by financing its

customers and by accepting foreign bills of exchange

 ○ it also transacts foreign exchange business and

buys and sells foreign currency

■ financing the government

● banks provide long–term credit to governments by investing

their funds in government securities and short–term finance

by purchasing treasury bills

○ governments also borrow from commercial banks to

finance budget deficits

● stock exchange:

○ a stock exchange is a market where securities such as stocks, shares and

bonds are bought and sold (eg: jamaica stock exchange)

■ roles of a stock exchange:

● creating investment opportunities for small investors:

○ stock markets allow investors to put their money to

good use in a business without dealing with all the

hassles of actually owning and running a company

■ if investors choose wisely, they make money

through their investments, and in return the

companies they invested in get to use the

influx of money to develop their businesses

● individual investors get a chance to

participate in the benefit from the

growth of various businesses, while

 limiting their risk to more than what

they invested

● raising capital for businesses:

○ for businesses that lack the resources necessary for

growth, selling shares on the stock market can

provide an infusion of capital, which a company can

then use to develop and strengthen the organization

■ eg:

● suppose a company has an idea for a

new product but cannot afford to

produce and market it

○ the company can sell shares

of itself on a stock

exchange, trading partial

ownership for the chance to

increase the company’s value

● government capital–raising for development projects:

○ governments may decide to borrow money in order

to finance infrastructure projects such as sewage and

water treatment works or housing estates by

selling bonds
 ■ these bonds can be raised through the stock

exchange, where members of the public buy

them, thus loaning money to the government

● the issuance of such bonds may

result in a reduction in taxes as the

government may not see a need to

tax citizens in order to finance

development

● credit union:

○ a credit union is a cooperative that makes small loans to its members at

low interest rates and offers other banking services (such as savings and

checking accounts)

■ like banks, credit unions accept deposits, make loans and provide a

wide array of other financial services, however, as member–owned

and cooperative institutions, credit unions provide a safe place to

save and borrow at reasonable rates

● eg:

○ educom co–operative credit union

● development bank:

○ a development bank is a bank which have been set up mainly to provide

infrastructure facilities for the industrial growth of a country

■ eg:

● development bank of jamaica

○ roles of a development bank:

■ development of the housing sector:

● development banks promote and finance housing

■ agricultural and rural development:

● development banks help in the development of agriculture

by providing credit to the agriculture sector and also for rural

development activities

○ it coordinates the working of all financial institutions

that provide credit to agriculture and rural

development

○ it also provides training to agricultural banks and

helps to conduct agricultural research

■ enhance foreign trade:

● development banks help to promote foreign trade by

providing medium and long–term loans to exporters and

importers

○ they also encourage abroad banks to provide finance

to the buyers in their country to buy capital goods

from local countries

■ regional development:

● development banks facilitate rural and regional

development:
 ○ they provide project management for starting

companies in backwards areas

● insurance company:

○ an insurance company is a financial institution that provides a range of

insurance policies to protect individuals and businesses against the risk of

financial losses in return for regular payments of premiums

■ eg:

● advantage general insurance company

○ roles of an insurance company:

■ pay a beneficiary in the event of a claim:

● when a client purchases an insurance policy, he pays a

premium every month as part of the contractual

understanding that he will receive a certain amount of money

in the event of a specific loss

■ act without discrimination:

● while an insurance company may reserve the right to refuse

service, it cannot refuse service to an individual or cancel a

policy based on a client’s marital status, race, disability,

religion or sexual orientation

○ additionally, an insurance company cannot restrict

the terms or benefits listed in an insurance policy

 because of a client’s marital status, race, disability,

religion or sexual orientation

● mutual fund:

○ a mutual fund is a company that pools money from many investors and

invests the money in securities such as stocks, bonds and short-term debt

■ eg:

● jamaica national mutual funds

○ roles of an mutual fund:

■ make investment decisions for potential investors:

● some persons prefer to let mutual funds to make their

investment decisions for them

■ sell unprofitable investments:

● after making an investment decision, mutual funds can

always sell any securities that are not expected to perform

well

● building society:

○ a building society is a bank that holds and invests the money saved by its

members and is one that provides loans and mortgages

■ eg:

● victoria mutual building society (vmbs)

○ roles of an building society:

■ attract savings from its members:

 ● the savings of the members provide most of the funds that

the borrowers use to buy their properties

○ the borrowers pay interest on their loans and this is

used to pay investors interest on their deposits

■ they make loans for house purchases to

borrowers

● investment trust company:

○ an investment trust company is a company which invests in the shares of

other companies

■ eg:

● panjam investment limited

○ roles of an investment trust company:

■ they provide funds to businesses by acting as intermediaries:

● they channel funds from financial institutions and households

to businesses through the stock market and these funds can

help businesses grow and expand

○ they provide their investors with investments tailored

to investors’ individual requirements (eg: the degree

of risk an investor is willing to take and the rate of

return he or she expects)

● informal credit institutions:

○ informal credit institutions (informal financial institutions) are financing

activities that are mostly legal but their activities are often unrecorded,

unregistered and unregulated by government

■ eg:

● partner (sou–sou), box, & meeting turns

○ roles of an informal credit institution:

■ they minimize transaction costs that are generally not available to

most formal financial institutions

■ they act like a ‘bank’ in rural areas and for people who do not trust

formal financial institutions

● financial instruments:

○ a financial instrument is a contract between two parties that hold a

monetary value

■ eg:

● treasury bills, notes & bonds:

○ treasury bills are government bonds or debt

securities with maturity of less than a year

○ treasury notes are government bonds or debt

securities with maturity of 2 to 10 years

○ treasury bonds are government bonds or debt

securities with maturity of more than 10 years

● corporate bonds:

○ corporate bonds are debt securities (bonds) issued

by companies that are seeking to raise funds to

invest in their businesses

● municipal bonds:

○ municipal bonds are debt securities issued by state

and local governments, and can be thought of as

loans that investors make to local governments, and

are used to fund public works such as parks,

libraries, bridges & roads and other infrastructure

● equity securities:

○ equity securities are investments in stock issued by

another company

● share and stock certificates:

○ share and stock certificates are legal documents

that certifies ownership of a specific number of

shares or stock in a corporation

● certificates of deposit (cds):

○ a certificate of deposit (cd) is a savings account

that holds a fixed amount of money for a fixed period

of time, such as six months, one year, or five

 years, and in exchange, the issuing bank pays

interest

● questions:

○ questions:

■ introduction:

● what is the financial sector?

● what are examples of firms and institutions in the financial

sector?

● what role does the financial sector play within the economy?

■ introduction to money:

● what is money?

● what are the four key functions of money?

● what characteristics should money possess?

● what is barter?

● what are the main problems associated with the barter

system?

● how did money solve the issues associated with barter?

● explain the historical development of money (summarize)

■ demand for money:

● what is the demand for money?

● what are the three motives for holding money?

● what is the transaction motive for holding money?

● what is the precautionary motive for holding money?

 ● why are the transaction & precautionary motives called

‘active balances’?

● what is the speculative motive for holding money?

● why is the speculative motive called ‘idle balance’?

■ money supply:

● what is money supply?

● how is money supply measured?

● why is m0 and m1 considered narrow money?

● why is m2 considered broad money?

■ the central bank:

● what is a central bank, and give an example.

● what is the role of the central bank in issuing money? what

would an excess in money result in?

● what is the role of the central bank as a lender of last resort to

commercial banks? what does this maintain?

● how does the central bank target low inflation?

● how does the central bank target growth and unemployment?

what does it consider?

● how does the central bank operate monetary policy and set

interest rates?

■ instruments of monetary control:

● what are instruments of monetary control, and give examples.

 ● what role does the interest rate play in monetary policy?

● how do changes in the reserve requirement impact the

money supply? give an example.

● what are open market operations? give an example.

● what is moral suasion, and how does it work?

■ commercial bank:

● what is a commercial bank, and give an example.

● what role does accepting deposits play for a commercial

bank?

● how does a commercial bank grant loans or create credit?

● how do commercial banks help in financing foreign trade?

● how do commercial banks finance the government?

■ stock exchange:

● what is a stock exchange, and give an example.

● explain what are some roles of the stock exchange, including:

○ creating investment opportunities for small investors

○ raising capital for businesses

○ government capital–raising for development projects

■ credit union:

● what is a credit union, and how does it differ from a

commercial bank?

● what services do credit unions provide?

■ development bank:

● what is a development bank, and give an example.

● what are the main roles of a development bank?

■ insurance company:

● what is an insurance company, and give an example?

● what are the main roles of an insurance company?

■ mutual fund:

● what is a mutual fund, and give an example?

● what are the main roles of a mutual fund?

■ building society:

● what is a building society, and give an example?

● what are the main roles of a building society?

■ investment trust company:

● what is an investment trust company, and give an example?

● what are the main roles of an investment trust company?

■ informal credit institutions:

● what are informal credit institutions, and give examples?

● what are the roles of informal credit institutions?

■ financial instruments:

● what is a financial instrument? Give an example.

● what are treasury bills, notes, and bonds?

● what are corporate bonds?

● what are municipal bonds?

● what are equity securities?

● what are share and stock certificates?

● what is a certificate of deposit (CD)?