chapter 1 : Money, Banking, and financial Markets
Money - is the stock of items widely used to make payment or money supply, includes :
1. Currency and coins in circulation
2. Checking accounts in depository institutions
3. Other items such as saving accounts, time deposits
central bank - is responsible for the trend or long-run behavior of the money supply
monetary policy
1.Ease Monetary Policy
2.Tight Monetary Policy
Inflation VS Deflation
Inflation - continuing increase in a nation's general price level
Deflation - continuing decline in a nation's general price level
Financial intermediaries - institution as "middle man" for transfer of funds from saver to investor
Interest Rate
Real interest rate - interest rate after adjusting nominal interest rate for expect inflation
Prime loan - is a key interest rate posted by large bank as benchmark for setting bank lending
rate
Key Financial Market
1.Stock Market - claim of owner in individual corporations by stockholders
2.Bond Market - is a debt instrument is issued by government / corporation
3.Foreign Exchange Market - the market which various national currency
Exchange Rate - is a price between country's currency and foreign currency
Appreciations - a single unit of that currency buys more units of these foreign currency
Depreciations - a single unit of that currency buys less units of these foreign currency
Federal Budget Deficits
1.Budget Deficits - is the annual amount by government expenditure more than tax revenue
2.Budget Surplus - is the annual amount by government expenditure less than tax revenue
3.National Debt - budget deficits + budget surplus
Chapter 3 : Financial Markets and Instruments
Financial Markets
1. Direct Capital Markets : Deficit unit sells Financial products to Surplus unit directly.
-When we as surplus unit buy stock or bond , we have claim over firms as deficit unit.
Brokers : sell stock and don't own the product , earn commission
Dealers : own the products and then add up price and sell them.
-get pro fit from different in price called "spread"
Selling Price - Buying Price = Spread
2. Indirect Capital Market (Financial Intermediaries, middle man)
-When we as surplus unit save money with bank as FI mean Savers have claim over Bank called
Secondary claims.
- Bank grant loan to borrowers as deficit unit called Primary Claims.
3 Attributes of Financial Instrument
1. Liquidity : how fast when you can convert thing into cash and no cost to convert at fair price.
-ex. Land is illiquidity
2. Risk : uncertainty
2 type : 1.Default risk : the chance that issuers go bankrupt .
-Government has no default risk
2. Market risk : risk of market price will fall
3.Yield : return
2 type : 1. Interest Yield - return in form of interest, example savings, bond
2. Dividend yield - return in form of dividend, example stocks
#relationship between attributes
- Liquidity and yield relate inversely ex. savings account has high liquidity but low return
-Risk and yield relate positively ex. stocks have high risk and also high return
-Liquidity and risk relate inversely ex. savings account has high liquidity but low risk
Classification of Financial Markets
1. Debt & Equity markets
Debt market : debt instrument = borrowings ex. bond
Equity market : ownership claims ex. stock
2. Primary & Secondary market
Primary market : trade new securities (first hand)
Secondary market : trade second hand securities to other investors
2 types : 1. OSE : Organized stock exchange is the formal market trade via the tangible
location
2. OTC : Over the counter is informal market trading via internet or phone
(No location)
3. Cash & Derivative Markets
Cash market : buy and sell at market price immediately
Derivative market : buyer and seller specified the price, payment and delivery for the future
2 types : 1.Future contract : agreement to buy or sell
2.Optional contract : right to buy or sell without contract ( charge premium)
4. Money and Capital markets
Money market : trade in short-term debt ( <1 year maturity)
1.Commercial paper : issued by well-known companies
2.Negotiated Certificate of Deposit (NCD) : issued by banks
- trade in secondary market
3. T-bills : issued by government , has high liquidity
4.Repurchase agreement (Repo) : issued by banks
- banks sell T-bill to firm and promise to buy back in 14 days
5.Eurodollars : deposit U.S dollars outside U.S
6. Federal funds : issued by banks
- Banks sell federal funds to other bank when it has excess reserves and buy it from
other bank when it has deficit reserves.
- buy and sell at Federal funds rate that set by central bank.
7.Bankers' acceptance ( bank draft)
- check that issued by importer and guaranteed by bank
Capital markets : long-term securities ( >1years)
1. Corporate stock (equity) : ownership claim
-dividend payment depend on firm's profit
- no maturities
2. Corporate bonds (debt )
- pay coupon payment every period
- has maturities
3.Municipal bonds
- issued by state or local government
4.Government notes and bonds
-no default risk ( chance to be bankrupt)
5.Mortgages
-loan for real property
- borrower has to pay "amortized payment" in every period
6. MBS (Mortgage-Backed securities)
-pool of mortgage and then sell new contract t inverter and promise the return and if
bank don't have money to return , investor can sue the bank
Government Securities
- trading through Dealers who own the securities that bought at Bid price and then add up price called
"spread" and sell at Ask price
-Fed use Monetary Policy by trading the government securities
1. Ease monetary policy or Expansionary policy
- Fed buys Gov. Securities back to increase money supply
2. Tight monetary policy or Contractionary policy
-Fed sell Gov. Securities to decrease money supple in the financial market
4 types
T-bills ( S-T securities 3,6,12 months)
-buy or sell from dealer and trade at discount from face value ($1000)
-longer time to maturity higher return to investors
-same maturity : lower price of T-bill provide higher return
Calculation :
1000 − 𝑝
360
Annual rates of
𝑟=
×
1000
𝑑𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
return (discount
rate)
Market
1000 × 𝑟 × 𝑑𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
price(P) 𝑃 = 1000 −
360
T-notes (L-T securities 1-10 years)
T-bonds (L-T securities 10-30 years)
TIPS (Treasury inflation-protected securities)
-protect investors against inflation
ex. if inflation= 5% then $1000 par bond would be $1050
ex. Calculate the price of T-bill that matures in 60 days if it has a discount rate of 6%.
𝑃 = 1000 −
1000 × 𝑟 × 𝑑𝑎𝑦𝑠 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
360
𝑃 = 1000 −
1000 × 0.06 × 60
360
𝑃 = 990
Chapter 4 Financial Intermidiation
What is financial intermidiation ?
is a financial institution that connects surplus (saver) and deficit (borrower) unit
Benefit for saver :
- allows individual savers to diversify (lower risk)
Benefit for borrower :
- low borrowing cost
- borrowers can tailor instruments to best fit their needs
Risk and costs in the absence of intermediation
- Asymmetric information =between two party have unequal information
it give rise to two problem :
1.adverse selection : the bad product , service or parties are more likely to be selected
2.moral hazard : risk that one party to a transaction will undertake activities that are undesirable
Financial intermidiation can ?
- have superior ability deal with asymmetric
- specialise in assessing the credit risk of prospective borrowers
- have access to such private information
There are 3 financial intermediaries
1 depository institutions
2 contractual saving institutions
3 investment-type intermediaries
Depository institutions
- Commercial Bank
sources of fund – Saving and liability
uses of fund – Mortgage and loan
- Saving and loan association : housing bank
sources of fund – saving and time deposit
uses of fund – long- term mortgages
- Mutual Saving Bank : worker class
sources of fund– Saving and time deposit
uses of fund– mortgage
- Credit Union : Worker class, non-profit and free tax
sources of fund – member deposit
uses of fund – grant loan to member
Contractual Saving Institution
- Life insurance
Sources of fund – commission fee and premium
Uses of fund – corporate bond and equity
- Non life insurance
Sources of fund – premium
uses of fund – invest in government security (T-bill)
- Private pension and government fund
Sources of fund — employer and employees contribution
uses of fund — corporate stocks and bonds
Investment Type Financial Intermediary
- Mutual Fund > pool individual fund to diversify risk
Close-end > no additional share and non-redeemable
Open-end > no load fund – redeem and additional share
load fund - pay commission at first
no load fund - pay every period
- Finance Company
sources of fund – sell commercial paper
uses of fund – small loan
Chapter 5: Interest Rate Determination
Interest Rates
 The price paid for borrowing funds, expressed as percent per year.
 Interest rates are important because they affect :
- the level of consumer expenditures on durable goods
- Invested expenditures on plant,equipment and technology
- Borrowing and lending decision
- The monthly payents on mortgages
- Prices of financial instruments
Real Interest Rate = Nominal Interest Rate – Expected Inflation
- The real interest rate is the actual interest rate that would prevail in a hypothetical
world of zero inflation.
- The nominal interest rate is the stated actual interate or unadjusted for inflation.
Individual Sources of Supply and Demand for Loanable Funds in the country
Sources of Supply
- Personal Saving
- Business Saving
- Government Budget Surplus
- Bank Loans
- Foreign lending in the country
Sources of Demand
- Household Credit Purchases
- Business Investment Spending
- Government Budget Deficit
- Foreign Borrowing in the country
Interest rate
Supply
Interest rate
Demand
Factors Shifting Supply and Demand

Inflation Expectation
o Interest rates rise in periods during which people expect inflation to increase.
o Interest rate typically fall when people expect inflation to decline.
o People are less willing to lend because they expect the real value of the principal to
decline so supply shifts left.
o People are much more willing to borrow (rather spend now than later) so demand shifts
right.
o Inflation Expectation effects long term interest rates

Federal Reserve Policy
o To stimulate the economy, the Fed
- encourage banks to expand loans,
- boosting the money supply
- so supply shifts right and interest rates go down
o To restrain economic activity, the Fed
- force banks to reduce their lending
- limiting the money supply
- so supply curve shifts left and interest rates go up

The Business Cycle
o Interest rates have been strongly pro-cyclical:
- rising during the expansion
- falling during the contraction
o This pattern is most evident in short-term interest rates.
o During expansion phase:
- Demand for funds increase (consumption, investment)
- Demand for products increase so inflation goes up
- Fed tries to slow down the growth: tight monetary policy
- Demand curve shift to the right, supply curve shift to the left
- Interest rates go up
o
-

During recession phase:
Demand for funds decrease (consumption, investment)
Demand for products decrease so inflation goes down
Fed tries to boost up the growth: ease monetary policy
Demand curve shift to the left, supply curve shift to the right
Interest rates go down
Federal budget Deficits
o Intuitively, an increase in the federal budget should raise interest rates.
o An increase in borrowing by federal government implies
rightward shift
in the demand curve for loanable funds.
o Most economists agree that deficits lead to higher interest rates.
o Government borrowing increases then demand shifts right and interest rated go up
o Government spending increases then inflation increases and interest rated go up
(Fisher Effect)
o This pattern is most evident in long-term interest rates.
Examples of events shifting supply curve
 Personal saving resulting from demographic changes or thriftiness
 Politic and economic stability in other countries
 The lending standard from banks
Examples of events shifting demand curve
 Business and consumer confidence
 A decline in interest rate in the other countries
Time Value of Money
 Simple Interest Rates
Simple Interest Rate for 1 year
FV = PV + (PV*i)
Simple Interest Rate for years
FV = PV + (PV*i*n)

Compound Interest Rates
FV = PV × (1+i)n
 Future Value (FV)
FV = PV × (1+i)n
FV = PV(FVIFi,n)
 Present Valuv (PV)
PV = FV / (1+i)n


More Frequent Compounding and Discounting
o Future Value
FV = PV × [1+(I/m)]n*m
FV = PV(FVIF(i/m),(n*m))
o Present Value
PV = FV / [1+(I/m)]n*m
PV = FV(PVIF(i/m),(n*m))
- Semiannually (m=2)
- Quarterly
(m=4)
- Monthly
(m=12)
- Daily
(m=365)
Annuity
PMT(Payment)
o FVA
FVA = PMT [{(1+i)n-1}/ I ]
FVA= PMT (FVIFAi,n)
o PVA
PVA = PMT [{1- (1/(1+i)n) }/ I ]
PVA= PMT (PVIFAi,n)
Examples
1. you take out a $1,000 loan for 12 months and it says "1% per month", how much do you
back?
Just use the Future Value formula with "n" being the number of months:
FV = PV × (1+i)n = $1,000 × (1.01)12 = $1,000 × 1.12683 = $1,126.83 to pay back
pay
2. 6% interest with "monthly compounding" does not mean 6% per month, it means 0.5% per month
(6% divided by 12 months), and would be worked out like this:
FV = PV × (1+i/n)n = $1,000 × (1 + 6%/12)12 = $1,000 × (1.005)12 = $1,000 × 1.06168... = $1,061.68 to pay
back
This is equal to a 6.168% ($1,000 grew to $1,061.68) for the whole year.
3. If you wish to accumulate $140,000 in 13 years, how much must you deposit today in an account that
pays an annual interest rate of 14%?
4. What will $247,000 grow to be in 9 years if it is invested today in an account with an annual interest
rate of 11%?
5. How many years will it take for $136,000 to grow to be $468,000 if it is invested in an account with an
annual interest rate of 8%?
6. At what annual interest rate must $137,000 be invested so that it will grow to be $475,000 in 14
years?
7. If you wish to accumulate $197,000 in 5 years, how much must you deposit today in an account that
pays a quoted annual interest rate of 13% with semi-annual compounding of interest?
8. What will $153,000 grow to be in 13 years if it is invested today in an account with a quoted annual
interest rate of 10% with monthly compounding of interest?
9. How many years will it take for $197,000 to grow to be $554,000 if it is invested in an account with a
quoted annual interest rate of 8% with monthly compounding of interest?
10. At what quoted annual interest rate must $134,000 be invested so that it will grow to be $459,000 in
15 years if interest is compounded weekly?
3. n = 13
i = 14
FV = 140000 solve for PV
4. n = 9
i = 11
PV = -247000 solve for FV
5. i = 8
PV = -136000 FV = 468000 solve for n
6. n=14
PV = -137000 FV = 475000 solve for i
7.n = 10
i = 6.5
FV = 197000 solve for PV
8. n = 156
i = 0.833333 PV = -153,000 solve for FV
(answer = $25,489.71)
(answer = $631,835.12)
(answer = 16.06 years)
(answer = 9.29%)
(5 years times 2 comp. periods per year) (13% annually divided by 2 comp. period per year)
(answer = $104,947.03)
(13 years times 12 comp. periods per year)
(10% annually divided by 12 comp. periods per year)
(answer = $558,386.38)
9. i = 0.666667 (8% annually divided by 12 comp. periods per year) PV = -197000
FV = 554000
solve for n (answer on calculator = 155.61)
Since the interest rate was entered as a monthly rate, the answer for n is in months. The number of
years equals the number of months divided by twelve.
Number of years = (155.61)/12 = 12.97 years
10. n = 780 (15 years times 52 comp. periods per year) PV = -134,000
FV = 459,000
solve for i (answer on calculator = 0.157972)
Since the number of periods was entered as weeks, the answer for i is the weekly rate. The annual rate
equals the weekly rate times 52.
Annual rate = (0.157972%)(52) = 8.21%
EAR = 113.65
Bond value
Par or Face Value
The par or face value of a bond is the amount of money that is paid to the bondholders at
maturity. For most bonds the amount is $1000. It also generally represents the amount of
money borrowed by the bond issuer.
Coupon Rate
The coupon rate, which is generally fixed, determines the periodic coupon or interest payments.
It is expressed as a percentage of the bond's face value. It also represents the interest cost of
the bond issue to the issuer.
Coupon Payments
The coupon payments represent the periodic interest payments from the bond issuer to the
bondholder. The annual coupon payment is calculated be multiplying the coupon rate by the
bond's face value. Since most bonds pay interest semiannually, generally one half of the annual
coupon is paid to the bondholders every six months.
Maturity Date
The maturity date represents the date on which the bond matures, i.e., the date on which the
face value is repaid. The last coupon payment is also paid on the maturity date.
Required Return
The rate of return that investors currently require on a bond.
C = coupon payment
n = number of payments
i = interest rate, or required yield
M = value at maturity, or par value
𝒗𝒃 = $R(𝑷𝑽𝑰𝑭𝑨𝐤𝐛,𝐧 ) + $PAR(𝑷𝑽𝑰𝑭𝒌𝒃.𝒏 )
If Kb< coupon rate,bond price > PAR , sold at premium
If Kb> coupon rate,bond price < PAR , sold at discount
If Kb= coupon rate,bond price = PAR , sold at par
The more frequent coupon paymets.the higher bond's price
make 3 adjustments:
1. coupon interest payment = R/m
2.Kb
= Kb/m
3.n
= n*m
Current Yield
𝒀𝒄 = R/P
𝒀𝒎 =
𝑷𝑨𝑹−𝑷
𝒏
𝑷𝑨𝑹+𝑷
𝟐
$𝑹+
Find the price of a semiannual coupon bond given that the coupon rate = 5%, the face value =
1. $1000, the required return = 9%, and there are 18 years remaining until maturity.
2. Find the yield to maturity on a semiannual coupon bond given that the bond price = $1019, the
coupon rate = 14%, the face value = $1000, and there are 2 years remaining until maturity.
3. Find the yield to maturity on a semiannual coupon bond given that the bond price = $1131, the
coupon rate = 7%, the face value = $1000, and there are 9 years remaining until maturity.
4. Find the yield to maturity on a semiannual coupon bond given that the bond price = $1160, the
coupon rate = 12%, the face value = $1000, and there are 24 years remaining until maturity.
5. Find the price of a semiannual coupon bond given that the coupon rate = 10%, the face value =
$1000, the required return = 18%, and there are 6 years remaining until maturity.