Chapter 1 revised

Financial Markets and Institutions University of Economics, The University of Danang    Course code: FIN2001 Credit: Pre-requisite: Macro-economics (ECO1001) Micro-economics (MGT1001) Course description In this course, students will learn:  what financial markets are  how financial markets function  different types of financial institutions  instruments and policy approaches Learning Outcomes      The role and the benefits of financial markets, and intermediaries The types of financial markets: fixed-income security markets, equity markets and derivatives markets The operation of commercial banks and non-bank financial institutions The nature, determination and role of interest rates The operation of central banks Outline        Chapter 1: Overview of the financial system Chapter 2: Interest rates Chapter 3: Fixed-income security markets Chapter 4: Equity markets Chapter 5: Derivatives markets Chapter 6: Commercial banks Chapter 7: Non-bank financial institution Textbook David S Kidwell, David W Blackwell, David A Whidbee, Richard W Sias (2012), Financial Institutions, Markets & Money, John Wiley & Sons  Jeff Madura (2010), Financial Markets and Institutions, SouthWestern Cengage Learning  Federic S Mishkin, Stanley G Eakins (2012), Financial Markets and Institutions, Pearson Supplementary Reading  Christopher Viney (2012), Financial Institutions, Instruments & Markets, McGraw-Hill  Assessment    Attendance and group-assignment: - Attendance : 20 % - Group-assignment (presentation): 5% 15 % Midterm Exam: Final Exam: Total: 20 % 60 % 100 % Class Rules       Attend class on time No food allowed Turn on cell phone silent mode No talking when teacher or your classmates are speaking to class Be prepared for lecture before class Be responsible and contribute in class Contact   Contact by email is best My email address: khanhbpn@due.edu.vn My email policy:   Email must have subject Body line: Start with your name and class, then your query There is no excuse for poorly worded emails and as such I will just NOT REPLY to any that aren’t written in a concise, respectful and professional manner Chapter Overview of the Financial System 10 1.4 Central bank 1.4.2 Objectives of a modern central bank      Low, stable inflation High, stable growth Financial system stability Stable interest rate Stable exchange rate 27 1.4 Central bank 1.4.3 Tools of monetary policy:  Open market operations  Discount rate  Reserve requirement 28 1.4.3 Tools of monetary policy    Open market operations – OMO: refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system, facilitated by central banks Discount rate: The interest rate charged to commercial banks and other depository institutisons for loans received from the central bank’s discount window Reserve requirement: Reserve requirements are requirements regarding the amount of cash a bank must hold in reserve against deposits made by customers This money must be in the bank's vaults or at the closest of central banks 29 1.4.4 The Federal Reserve System 1.4.4.1 Structure of the Federal Reserve System:   Established in 1913 according to Federal Reserve Act The Federal Reserve System includes the following entities:      The Federal Reserve District banks The Board of Governors of the Federal Reserve System The Federal Open Market Committee (FOMC) The Federal Advisory Council 2,800 member commercial banks 30 Federal Reserve Banks 31 1.4.4.2 Conduct of monetary policy   The conduct of monetary policy by the Federal Reserve involves actions that affect its balance sheet The Federal Reserve’s Balance Sheet: 32 The Federal Reserve’s Balance Sheet     Liabilities: currency in circulation and reserves - the monetary liabilities The increases in either or both will lead to an increase in the money supply Currency in circulation: Currency in circulation is the amount of currency in the hands of the public (outside of banks) Reserves: consist of deposits at the Fed plus currency that is physically held by banks  An increase in reserves leads to an increase in the level of deposits and hence in the money supply  Total reserves: reserves that the Fed requires banks to hold (required reserves) and any additional reserves the banks choose to hold (excess reserve ) 33 The Federal Reserve’s Balance Sheet    Assets: Government securities:  The U.S Treasury securities are held by Fed  The Fed provides reserves to the banking system by purchasing securities  An increase in government securities held by the Fed leads to an increase in the money supply Discount loans:  The Fed can provide reserves to the banking system by making discount loans to banks  An increase in discount loans can also be the source of an increase in the money supply 34 Tools of monetary policy ① ② ③ Open Market Operations Discount policy Reserve requirement 35 Open Marker Operation     The most important monetary policy tool The central bank’s purchase or sale of bonds in the open market The primary determinant of changes in reserves in the banking system and interest rates Monetary base: the Fed’s monetary liabilities plus the U.S Treasury’s monetary liabilities (Treasury currency in circulation, primarily coins)  Two types of open market operations:   Dynamic open market operations: are intended to change the level of reserves and the monetary base Defensive open market operations: are intended to offset movements in other factors that affect reserves and the monetary base 36 Open Marker Operation  An open market purchase leads to an expansion of reserves and deposits in the banking system and hence to an expansion of the monetary base and the money supply  An open market sale leads to a contraction of reserves and deposits in the banking system and hence to a decline in the monetary base and the money supply 37 Discount policy The facility at which banks can borrow reserves from the Federal Reserve is called the discount window  The Fed’s discount loans to banks are of three types:     Primary credit: plays the most important role in monetary policy o Healthy banks are allowed to borrow all they want at very short maturities (usually overnight) Secondary credit: is given to banks that are in financial trouble and are experiencing severe liquidity problems Seasonal credit: is given to meet the needs of a limited number of small banks in vacation and agricultural areas that have a seasonal pattern of deposits 38 Discount policy   A discount loan leads to an expansion of reserves, which can be lent out as deposits, thereby leading to an expansion of the monetary base and the money supply When a bank repays its discount loan and so reduces the total amount of discount lending, the amount of reserves decreases along with the monetary base and the money supply 39 Reserve requirement     Reserve requirement is the amount of funds that financial institutions must hold at the Fed in order to back their deposit A rise in reserve requirements means that banks must hold more reserves, which leads to a decline of the monetary base and the money supply A reduction means that they are required to hold less, which leads to an expansion in the monetary base and the money supply Reserve requirements have rarely been used as a monetary policy tool because raising them can cause immediate liquidity problems for banks with low excess reserves 40 1.4.5 The State Bank of Vietnam 41 ...   Course code: FIN20 01 Credit: Pre-requisite: Macro-economics (ECO10 01) Micro-economics (MGT10 01) Course description In this course, students will learn:...       Chapter 1: Overview of the financial system Chapter 2: Interest rates Chapter 3: Fixed-income security markets Chapter 4: Equity markets Chapter 5: Derivatives markets Chapter 6: Commercial... Viney (2 012 ), Financial Institutions, Instruments & Markets, McGraw-Hill  Assessment    Attendance and group-assignment: - Attendance : 20 % - Group-assignment (presentation): 5% 15 % Midterm