Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc....

Business Fifth Canadian edition, Griffin, Ebert & Starke

© 2005 Pearson Education Canada Inc.

CHAPTER 18

Understanding Money

and Banking


© 2005 Pearson Education Canada Inc. 18-2

Learning Objectives

Define money and identify the different forms it takes in the nation’s money supply.Describe the different kinds of financial institutions that make up the Canadian financial system and explain the services they offer.Explain how banks create money and identify the means by which they are regulated.Explain the functions of the Bank of Canada and describe the tools it uses to control the money supply.Identify ways in which the banking industry is changing.Understand some of the activities in international banking and finance



Money

Any object generally accepted by people as payment for goods and services

Characteristics:Portable: lightweight and easy to handle

Divisible: easily broken down to match the value of goods

Durable: must not spoil or easily wear out

Stable: must be stable enough to hold its value over time, apart from minor fluctuations



Functions of Money

Medium of exchange a single medium of exchange for goods and services instead of barter

Store of valuecan be used for future purchases

Unit of account allows measurement of the relative value of goods and services



The Money Supply

Buyers and sellers must agree on the value of moneyThe value of money is dependent on its supply

as supply increases, value decreasesas supply decreases, value increases

Consists of both M-1 and M-2 forms of money



M-1 Money Supply

The most liquid forms of moneycurrency: paper money and coins issued by the Canadian government

demand deposits: money in chequing accounts, which can be transferred to others by cheque



M-2 Money Supply

Everything in the M-1 Money supply plusSavings deposits: savings account holdings

Time deposits: deposit requiring prior notice before withdrawal of funds

Money market mutual fund investments

Measures the store of monetary value that is available for making financial transactions



Credit Cards

Not included in M-1 or M-2 Money Supplies

Major source of consumer spending

Are a substitute for money, but they are not money

Are privately issued and very profitable due to annual fees, merchants fees & interest



Financial Institutions

Traditionally consisted of four financial pillarsChartered banks

Alternate banks (trust companies, credit unions, caisses populaires)

Life insurance companies and specialized lending and saving intermediaries

Investment dealers

Changes due to deregulation of the banking industry



Pillar #1: Chartered Banks

Privately owned, profit-oriented, financial intermediary Largest and most important of financial institutions

Each bank has many branches

Schedule A Banks must be Canadian-owned with no more than 10% of voting shares controlled by a single interest (90% of all bank assets)

Schedule B Banks may be foreign-owned and need not meet the 10% limit (foreign-owned bank deposits cannot exceed 8% of the total domestic assets of all banks)



Services Offered by Banks

Pension services

Trust services

International services

Financial advice

Buy/sell securities

Electronic technologies

Bank deposits

Bank loans

Bank accounts



Bank Deposits

Accept deposits from some customers to obtain money to lend to others

chequing accounts

term deposits (money that remains with the bank for a period of time with interest paid to the depositor)



Bank Loans

Major source of short-term financing for business

Banks prefer to finance inventories or accounts receivable rather than provide long-term loans to many businesses

Secured loanbacked by collateral (e.g.: inventory)

Unsecured loan not backed by property

Prime rate of interest lowest rate charged to best customers



Banks as Creators of Money

Bank New DepositReserve

Requirement New Loan

1 $100.00 $10.00 $90.00

2 $90.00 $9.00 $81.00

3 $81.00 $8.10 $72.90

4 $72.90 $7.29 $65.61

5 $65.61 $6.56 $59.05

6 $59.05 $5.91 $53.14

7 $53.14 $5.31 $47.83

8 $47.83 $4.31 $38.74

9 $43.05 $4.31 $38.74

Totals for the first nine banks $612.58 $61.26 $551.32

Expansion limit for entire banking system $1,000.00 $100.00 $900.00



Other Changes in Banking

Deregulation is causing banks to shift from their historical role as intermediaries between borrowers and depositors

Diversification into other financial products

Investment banking

Commercial paper



The Impact of E-Technologies

Debit cardsPlastic money that immediately adjusts the consumers account balance and pays the merchant

Point of Sale terminalsElectronic device used to facilitate debit card use

Smart CardsA credit card sized computer that can be programmed with “electronic money”

Ecash Money that moves among consumers and businesses via digital electronic transmission



The Bank of Canada

The central bank of Canada

Managed by a Board of Governors

Regulates operations of the chartered banks

Manages the economy by manipulating the money supply to expand or restrict the economy



Monetary Policy Actions of the Bank of Canada

Expansionary Policy Restrictive PolicyTools (stimulate business (slow down business activity

activity and increase the and decrease the moneymoney supply) supply)

Open Buy government securities: Sell government securities:

Market (increases bank reserves (decreases bank reserves

Operations enabling banks to make loans limiting the banks' abilities to businesses and to make loans to businesses

consumers) and consumers)

Lower the bank rate: Raise the bank rate:(increase the willingness of (decrease the willingness of

Bank Rate banks to borrow, more loans can banks to borrow, fewer loans canbe made to businesses and be made to businesses and

consumers) consumers)



Pillar #2: Alternate Banks

Trust companiessafeguard funds and estates entrusted to it

serves as a trustee, transfer agent, & registrar for corporations

Credit unions (caisses populaires)cooperative savings and lending institution formed by a group of individuals with common interests

offer savings accounts, loans, mortgages to members

invest its own funds in corporate & government securities



Pillar #3: Specialized Lending and Savings Intermediaries

Life insurance firms

Factoring companies

Financial corporations

Venture capital or development firms

Pension funds



Life Insurance Firms

Life Insurance companiesmutual or stock company that shares risks with policy holders for payment of premiums

some money from premiums is lent back out

substantial investments in real estate, mortgages and government bonds

largest financial intermediaries in Canada next to the chartered banks



Factoring Companies

Buy uncollected accounts receivable from a firm for less than its face value

Attempts to collect the face value of the receivables from customers

The difference between the amount collected and the cost of the receivables is the firm’s profit

Allows firms with old, or uncollectible, accounts receivable to redeem at least part of their value rather than writing them off completely



Financial Corporations

Sales finance company finances instalment purchases made by individuals or businesses

loans are secured by the item being financed (e.g.: computer)

Consumer finance companymakes personal loans to consumers

collateral may or may not be required



Venture Capital or Development Firms

Provide funds for new or expanding firms that have great potential

Obtains funds from individual investors, financial intermediaries, retained earnings

While accepting increased risk with new ventures, VC firms seek to earn higher than normal returns



Pension Funds

Accumulate cash that will be paid out to subscribers in the future in the form of pension income

Money is invested until it is needed

Investments include stocks and bonds, mortgages

$



Pillar #4: Investment Dealers

Stock brokers or underwriters

Distribute new stock and bond issues (underwriting)

Facilitate trading of stock and bond on exchanges (brokerage)



Other Sources of Funds

Government financial institutions and granting agencies

Business Development Bank of Canada (BDC)

Canada Mortgage and Housing Corporation (CMHC)

Export Development Corporation

Canada and its provinces borrow from international sources of funds, including other nations

The Canadian Capital Market (international funds)

?



Exchange Rates and Trade

Exchange rates influence the willingness of Canadians to invest abroad and buy imported items (or vice versa)

A trade surplus occurs when Canada is exporting more products than it is importing (likely to occur when the dollar is undervalued)

A trade deficit occurs when Canada is importing more products than it is exporting (likely to occur when the dollar is overvalued)



The Law of One Price

a basic commodity should be priced equally across all countries

(if prices differ it is assumed to be due to over or under valuation of the local currency)

Country Big Mac Price(Local Dollar)

Big Mac Price Equiv.(US Dollars)

Over/UnderValuation

United States $2.71 $2.71 --

Denmark 27.75 krone 4.10 +51%

Switzerland 6.30 Francs 4.50 +69%

Britain 1.99 pounds 3.14 +16%

Japan 262 yen 2.19 -19%

TheBigMac

Index



International Payments Process

Local banks convert payments to the currency required by foreign trade associatesLocal banks then send payment, in foreign currency, to the foreign trade partnerThe foreign trade partner deposits the payment in his/her own foreign-based bankWhen equal values of money are moving back and forth between nations, no real funds need to be transferred between nations because the payments are in balanceBanks also trade currencies



International Bank Structure

International banking is governed by a network of loose agreements between individual countries or groups of countries.The World Bank and the International Monetary Fund assist by financing international trade IMF

150 nations who combined resources to promote stable exchange rates, provide temporary short-term loans, encourage cooperation on international monetary issues, and develop a system for international payments

Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc....

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Transcript of Business Fifth Canadian edition, Griffin, Ebert & Starke © 2005 Pearson Education Canada Inc....