Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc.
CHAPTER 18
Understanding Money
and Banking
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-3
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-4
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-5
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-6
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-7
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-8
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-9
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-10
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)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-11
Services Offered by Banks
Pension services
Trust services
International services
Financial advice
Buy/sell securities
Electronic technologies
Bank deposits
Bank loans
Bank accounts
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-12
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)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-13
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-14
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-15
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-16
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-17
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-18
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)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-19
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-20
Pillar #3: Specialized Lending and Savings Intermediaries
Life insurance firms
Factoring companies
Financial corporations
Venture capital or development firms
Pension funds
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-21
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-22
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-23
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-24
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-25
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
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Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-26
Pillar #4: Investment Dealers
Stock brokers or underwriters
Distribute new stock and bond issues (underwriting)
Facilitate trading of stock and bond on exchanges (brokerage)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-27
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)
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Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-28
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)
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-29
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-30
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
Business Fifth Canadian edition, Griffin, Ebert & Starke
© 2005 Pearson Education Canada Inc. 18-31
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