BUS 353

Part IV: Money and Markets

A. The Economy and the Business Cycle1. The Economy – The interaction of

people producing, buying, and selling goods and services

2. The Business Cyclea. Boom – the peak of the business cycle,

with high capacity utilization and low unemployment

b. Recession (Contraction) – a shrinking economy, indicated by rising unemployment and falling output

A. The Economy and the Business Cyclec. Recovery – the economy is stable following a

contraction, unemployment is stable to falling slightly

d. Expansion – a growing economy, indicated by increasing employment and output (Gross Domestic Product, or GDP)

3. Investing and the Business Cyclea. It is nearly impossible to pick exact market

tops and bottomsb. The best protection against the business

cycle is a diversified portfolioc. The best environment for investors is slow,

steady growth

B. Tracking the Business Cycle With Government Data

1. Jobs Data – Monthly payroll information released on the first Friday of every month – includes the number of jobs created, unemployment rate, wages, hours worked per week, and weekly unemployment claims (http://www.bls.gov/ces/)

2. Inflation Measures – High inflation curbs economic growth and erodes the value of fixed income investments (http://www.bls.gov/bls/inflation.htm)

i. Core – excludes food and energyii. Measures include CPI, PPI, etc.

B. Tracking the Business Cycle With Government Data

3. Sales – Measure economic strength through consumer spending (http://www.census.gov/epcd/econ/www/indijun.htm)

4. Gross Domestic Product (GDP) – A measure of economic growth (economic output) – generally, 3% or more annually is regarded as robust economic growth (http://www.bea.gov/)

C. The Federal Reserve

1. Created as the United States Central Bank, similar to those in other countries (Bank of England in the U.K., European Central Bank for the Eurozone, Bank of Japan, etc.) (http://www.federalreserve.gov/)

a. Sets interest ratesb. Issues currencyc. Manages the overall level of money in the

economyd. Oversees the national banking system

C. The Federal Reserve

2. The Federal Reserve’s primary tool in economic regulation is setting short term interest rates

a. Fed Funds Rate – the interest rate banks charge each other for overnight loans

b. Discount Rate – the amount that the Federal Reserve charges member banks for overnight loans (extended so that banks can meet required cash reserves)

(http://www.federalreserve.gov/releases/h15/data.htm)

C. The Federal Reserve

3. The Fed raises interest rates to slow the economy, and lowers interest rates to spur economic growth

4. Specific roles of the Federal Reservea. Policymaker – buys and sells government

securities to control the amount of money in circulation

b. Banker – maintains bank accounts for the U.S. government and government agencies

C. The Federal Reserve

c. Lender – makes loans to banksd. Regulator – interprets laws governing

banks, monitors compliance with banking rules

e. Controller – replaces worn and damaged currency

f. Guardian – watches over gold stored by foreign governments as a reserve for currency exchange

g. Administrator – national check clearinghouse

5. Policies are set by the Federal Reserve Chairman and by meetings of the Open Market Committee (http://www.federalreserve.gov/aboutthefed/default.htm)

D. The Money Supply

1. Money Supply Policiesa. Increasing the money supply increases

liquidity, providing more money for loans and fueling economic expansion but increasing inflation risk

b. Decreasing the money supply decreases liquidity, increasing interest rates, slowing economic growth, and damping inflation

D. The Money Supplyc. The money supply is increased when the

New York Fed purchases government securities from banks and brokerage houses, using money that hasn’t existed before

i. The new money increases that firm’s reservesii. The resulting money can then be re-lentiii. Example – 10% reserve

d. Decreasing the money supply decreases liquidity, increasing interest rates, slowing economic growth, and damping inflation

i. The money supply is decreased when the New York Fed sells government securities, reducing the amount of money in circulation

ii. The contraction spreads through resulting bank transactions

D. The Money Supply

2. Money Supply Gaugesa. M1 = Funds readily available for

spending – cash and checking accountsb. M2 = M1 plus all private depositsc. M3 = M2 plus short term financial assets

(http://www.federalreserve.gov/releases/h6/Current/

)

E. The Banking System

1. Types of Banksa. Commercial Banks – accept deposits and

provide loans to businesses and individuals

b. Savings Banks – generally provide mortgage loans and obtain deposits from individuals

c. Credit Unions – pool depositors’ money to make loans to other members

d. Investment Banks – underwrite stock and bond offerings, advise on mergers and acquisitions; subject to only minimal regulation

E. The Banking System

2. Types of Depositsa. Transaction deposits – deposits against

which checks can be written (checking accounts)

b. Demand deposits – accounts from which money can be withdrawn at any time (savings accounts)

c. Time deposits – provide interest payments for a fixed term (certificates of deposit)

F. The Banking System

3. Government Regulationa. Federal Reserve – regulates how much

cash (reserves) banks must maintain, and serves as the primary regulator for federally chartered banks

b. Office of the Federal Comptroller of the Currency -- charters, regulates, and supervises the activities of national banks, international branches of U.S. banks, and U.S. branches of non-U.S. banks – oversees lending and investments by banks

F. The Banking System

c. Federal Deposit Insurance Corporation – insures bank deposits to $250,000 per individual per bank

d. State Banking Regulators – regulate lending and investment practices of state chartered banks

G. Calculating Rates of Return

1. Basic Formula:

Gain or Loss = (Sale Price + Dividends) – Purchase Price

(Gain or Loss) + Dividends

Percentage = ------------------------------------ Return Initial Cost

G. Calculating Rates of Return

Future Value 1/nCompound = ------------------ -1Annual Return Present Value

Where n = number of years (term)

Gain or loss must include dividend or interest payments (or interest on borrowed funds) plus capital gains (or capital losses)