Chapter 1
Why Study Money, Banking,
and Financial Markets?
1
Why Study Money, Banking, and
Financial Markets

To examine how financial markets
such as bond, stock and foreign exchange
markets work

To examine how financial institutions such
as banks and insurance
companies work

To examine the role of money in
the economy
2
Financial Markets

Markets in which funds are transferred
from people who have an excess of
available funds to people who have a
shortage of funds
3
The Bond Market and Interest Rates

A security is a claim on the issuer’s future
income or assets

A bond is a debt security that promises to
make pre-determined fixed payment(s)
at a specific date in future (maturity).

An interest rate is the cost of borrowing or
the price paid for the rental of financial
capital. Currently, int. rate is 5.75% in TR.
4
5
18.01.2010
18.10.2009
18.07.2009
18.04.2009
18.01.2009
18.10.2008
18.07.2008
18.04.2008
18.01.2008
18.10.2007
18.07.2007
18.04.2007
18.01.2007
18.10.2006
18.07.2006
18.04.2006
18.01.2006
Interest Rates on Turkish TBills and
Gov. Bonds
simple annual int.rate
30
25
20
15
10
5
0
issue date
6
The Stock Market

Common stock represents a share of
ownership in a corporation

A share of stock is a claim on the earnings
and assets of the corporation

A stock market is where stocks are traded
in a “secondary market”
7
8
/M
Ar on
a t
A r lı k h
a 8
A r lı k 6
al 87
Ar ık
al 88
Ar ık
al 89
Ar ık
al 90
Ar ık
al 91
Ar ık
al 92
Ar ık
a 9
A r lı k 3
a 9
A r lı k 4
a 9
A r lı k 5
a 9
A r lı k 6
a 9
A r lı k 7
a 9
A r lı k 8
a 9
A r lı k 9
al 00
Ar ık
al 01
Ar ık
al 02
Ar ık
al 03
Ar ık
al 04
Ar ık
al 05
ık
06
Ay
ISE Stock Prices
İMKB-100 / ISE-100
50,000.00
45,000.00
40,000.00
35,000.00
30,000.00
25,000.00
20,000.00
15,000.00
10,000.00
5,000.00
0.00
9
The Foreign Exchange Market

The foreign exchange market is where
funds are converted from one currency
into another

The foreign exchange rate is the
price of one currency in terms of
another currency. Currently, 1.77 TL / $

The foreign exchange rate is determined
in the foreign exchange market.
10
02.01.2006
02.01.2002
02.01.1998
02.01.1994
02.01.1990
02.01.1986
02.01.1982
02.01.1978
02.01.1974
02.01.1970
02.01.1966
02.01.1962
02.01.1958
02.01.1954
02.01.1950
TL/$ exchange rate
10000000
1000000
100000
10000
1000
100
10
1
11
Value of Lira against Dollar
See: Dolar 1950-2007.htm
 1950 -1960: 2.82 TL / $
 1960 – August 1970: 9.08 TL / $
 August 1970 – December 1971: 15.15
TL/$
 December 1971 – May 1974: 14.30 TL / $
 After 1980 variable (depreciations).

12
13
Banking and Financial Institutions

Financial Intermediaries—institutions that borrow funds
from people who have saved and make loans to people
who need credit.

Banks—institutions that accept deposits and make loans.
(not all financial intermediaries accept deposits).
Investment banks, insurance companies, etc. do not
accept deposits.

Other Financial Intermediaries—insurance companies,
mortgage companies, pension funds, mutual funds and
investment banks

Financial Innovation—in particular, the advent of
computers and internet globalized the market, sped up
transactions, introduced new financial instruments.
14
Money Supply and Business Cycles

Evidence suggests that money
plays an important role in generating
business cycles.

Business cycles: Recessions
(unemployment) and booms (inflation)
affect all of us.
15
16
Money Supply and Inflation

Monetary Theory relates changes in the
money supply to changes in total output
(=total income) and the price level

The aggregate price level (P) is a weighted
average of the prices of goods and
services produced in an economy

Quantity theory of money (MV = PY)
suggests and empirical data shows a
connection between the money supply and
the price level.
17
Money supply and price level in TR
900000
800000
700000
600000
500000
M2Y (1987=100)
GDP DEFLATOR (1987=100)
400000
300000
200000
100000
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
18
19
Money Supply And İnflation in TR
110.00
100.00
90.00
80.00
70.00
60.00
GDP defl. Growth
M2Y growth rate
50.00
40.00
30.00
20.00
10.00
0.00
1997
1998
1999
2000
2001
2002
2003
2004
20
Inflation İs The Rate Of Change of The
Price Level
GDP deflator vs CPI
110
100
90
80
70
60
GDPDeflator
CPI
50
40
30
20
10
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
21
Turkey
22
Monetary Policy and Fiscal Policy

Monetary policy is the control of the money
supply. It is conducted by the Central bank. CB
uses interest rates and other instruments to
control the money supply. The Purpose of Mon.
Pol. Is to control inflation which is the rate of
change of the price level.
 Conducted in Turkey by CBRT, In the U.S. by
the Federal Reserve Bank (Fed)
 Why is it important to control the money
supply?
23
Monetary Policy and Fiscal Policy

Fiscal policy is the management of the govt.
budget: government spending
and taxation.




Budget deficit is the excess of expenditures over
revenues for a particular year
Budget surplus is the excess of revenues over
expenditures for a particular year
Any deficit must be financed by borrowing.
Before 1994, Turkish Treasury could borrow from the
CB: CB printed money and lent to the govt by buying
govt. bonds from Treasury. But this was abolished
partially after 1994, and fully after 2001. Now CB is
more independent from the govt.
24
GOVERNMENT BUDGET
CONSTRAINT
At any year t, govt. budget must satisfy
Gt + rBt-1 = Tt + Bt-Bt-1
Gt
Bt-1
rBt-1
Tt
Bt-Bt-1
: govt. expenditures
: govt.’s outstanding stock of debt.
: interest payment on outstanding
debt (r:real int. rate)
: taxes (revenues)
: newly issued debt during year t
25
Turkish Government’s Budget
Billion TRL
2000
2001
2002
2003
2004
2005
Revenues
33.3
51.8
76.4
100.2
109.9
134.8
Tax Revenues
26.5
39.8
59.6
84.3
90.1
106.9
6.8
12.0
16.8
15.9
19.8
27.9
Expenditures
46.6
80.4
115.5
140.1
140.2
144.6
Expenditures excl.
İnterest P
26.2
39.3
63.6
81.4
83.7
98.9
Interest Payments (IP)
20.4
41.1
51.9
58.6
56.5
45.7
-13.3
-28.6
-39.1
-39.8
-30.3
-9.8
7.1
12.5
12.8
18.8
26.2
35.9
-12.6
-32.1
-34.4
-41.9
-30.4
-10.4
12.8
32.1
34.4
41.9
30.4
10.4
Foreign Borrowing Net
2.7
-4.4
16.6
2.7
4.0
-1.2
Domestic Borrıowing Net
9.4
23.2
17.5
42.9
30.8
21.3
Other Financing
0.7
13.4
0.3
-3.7
-4.4
-9.7
FDF/GDP (%)
5.7
7.1
4.7
5.3
6.1
7.4
-10.6
-16.2
-14.3
-11.2
-7.1
Other
Budget Balance
Budget Balance excl. IP
(FDF)
Cash Balance
Financing
Budget Deficit / GDP
Source: HM, http://www.mahfiegilmez.nom.tr/
-2.0
26
Turkish Government’s Budget
STOCK of DEBT &
DEBT/GDP (billion dollars)
2002
2009
Total public debt
151.5
301.3
Domestic public debt
94.5
227.3
Foreign public debt
56.8
74.0
Public Debt/GDP
65.7
47.8
CBRT Foreign Debt
22.0
13.6
Private sector foreign debt
43.1
176.3
Private sector foreign debt/GDP
18.7
27.0
USD Exchange rate
1.51
1.50
230.5
630.0
GDP
Source: Mahfi Eğilmez, “Borcumuz Ne Kadar?”
Radikal, 16 Şubat 2010 Salı
27
US Government’s Budget
28