The document discusses the nature of money and its key functions as a medium of exchange, store of value, unit of account, and standard of deferred payment. It also defines legal tender and discusses banks, central banks, interest rates, and financial intermediaries. Central banks oversee monetary policy and currency stability while attempting to keep inflation and deflation in check. Financial intermediaries like banks exist to address information asymmetries and economies of scale in channeling funds from savers to borrowers.

1. The Nature of Money
Money, Banking and Interest Rates

2. The Nature of Money
• What is Money
– Anything that functions as a medium of
exchange, store of value, unit of account, and
standard of deferred payment.
• Legal Tender
– Money that cannot be refused as payment for
goods and services or for discharge of debts;
consists of currency and coins.

3. The Nature of Money
• The Functions of Money
– Medium of Exchange or Means of Payment
– Standard of Value
– Unit of Account
– Standard of Deferred Payment

4. The Nature of Money
• Medium of Exchange
– An attribute of money that permits it to be
used as a means of payment.
• Barter
– The direct exchange of one good for another without the
use of money

5. The Nature of Money
• Standard of Value
– An attribute that allows it to be held for future
use without the loss of value in the meantime.

6. The Nature of Money
• Unit of Account
– An attribute that permits it to be used as a
measure of the value of goods, services, and
financial assets.

7. The Nature of Money
• Standard of Deferred Payment
– An attribute that permits it to be used as a
means of valuing future receipts in loan
contracts.

8. Banks
• Banks
– Are institutions that accept various types of
deposits and use the funds primarily to grant
loans.

9. Banks
• Central Bank
– The entity responsible for overseeing the monetary
system for a nation (or group of nations).
– Central banks have a wide range of responsibilities,
from overseeing monetary policy to implementing
specific goals such as currency stability, low inflation
and full employment.
– Central banks also generally issue currency, function
as the bank of the government, regulate the credit
system, oversee commercial banks, manage
exchange reserves and act as a lender of last resort.

10. Interest Rates
• Inflation
– The rate at which the general level of prices for goods
and services is rising, and, subsequently, purchasing
power is falling.
– Central banks attempt to stop severe inflation, along
with severe deflation, in an attempt to keep the
excessive growth of prices to a minimum.
– For example, if the inflation rate is 2%, then a $1 pack
of gum will cost $1.02 in a year.
– Most countries' central banks will try to sustain an
inflation rate of 2-3%.

11. Interest Rates
• Interest Rate
– The cost of borrowing (or the return from
lending) expressed as a percent per year.
• Real Interest Rate
– Interest Rate adjusted for expected inflation.

12. Financial Intermediaries
• Financial Intermediary
– Institutions that serve as "middlemen" from
the transfer of funds from individuals,
businesses, and other entities with surplus
funds to those who borrow.
– The classic example of a financial
intermediary is a bank that consolidates bank
deposits and uses the funds to transform
them into bank loans.

13. Financail Intermediary

14. Financial Intermediaries
• Why do Financial Intermediaries exist?
– To address problems arising in "asymmetric
information", which causes adverse selection
and moral hazard problems.
– Financial Economies of Scale or the ability to
spread costs of managing funds across large
numbers of savers.

15. Financial Intermediaries
• Asymmetric Information
– Possession of information by one party in a
financial transaction but not by the other party
• Adverse Selection
– The likelyhood that those who desire to issue
financial instruments have in mind using the
funds they receive for unworthy, high-risk
projects
• Moral Hazard
– The possibility that the borrower might engage
in more-risky behavior after a loan has been
made.

16. Financial Intermediaries
• Economies of Scale
– The reduction that can be achieved in the
average cost of managing funds of managing
funds by pooling savings together and
spreading the management costs across
many savers.

17. Interest Rates
• Interest Rate
– The cost of borrowing (or the return from
lending) expressed as a percent per year
• Nominal Interest Rate
– Rate of return that does not reflect anticipated
inflation
• Real Interest Rate
– Interest Rate adjusted for expected inflation