Principles of Money, Banking, & Financial Markets, Tenth Edition (with L.S. Ritter and G.F. Udell), Addison-Wesley, 2004.

INTRODUCING MONEY, BANKING AND FINANCIAL MARKETS

Oscar Wilde wrote that a cynic knows the price of everything and the value of nothing. Although that's certainly worthy of further reflection, for our purposes, price and value refer to the same thing: how much a security or financial asset is worth. Financial markets generate prices whenever securities are bought or sold. Financial institutions value financial assets whenever making loans to businesses or consumers. Thus pricing and valuation of financial assets are at the heart of the financial marketplace. One of our objectives is to link the behavior of securities prices, such as for stocks and bonds, to the performance of the economy as a whole, as well as with the behavior of financial institutions and markets.

But first things first. What exactly do we mean by money, banking, and financial markets? The money in money, banking, and financial markets refers not only to the greenbacks we spend, but more broadly to the monetary economy. As you will learn, money plays a key role in the performance of the economy. It not only facilitates transactions among the millions of economic players in the economy, but it represents the principal mechanism through which central banks attempt to influence aggregate economic activity, including economic growth, employment, and inflation. The banking in money, banking, and financial markets refers to banks and other financial intermediaries. A financial intermediary is an institution that takes funds from one group of investors and redeploys those funds by investing in financial assets. Banks serve as the principal caretaker of the economy's money supply and, along with other financial intermediaries, provide an important source of funds for consumers and businesses. The financial markets in money, banking, and financial markets refer to the markets in which financial assets can be traded. Financial markets provide a mechanism for those with excess funds to purchase securities, such as stocks and bonds, issued by those who need funds. Moreover, financial markets provide prices for those stocks and bonds, so that we know whether to conceal or brag about or most recent purchases.

AN OVERVIEW

Money in the modern economy is sometimes viewed as a lubricant that greases the wheels of economic activity. Without money, the transactions that make up our daily economic routine would be unimaginably difficult, and saving and investing would be almost full-time jobs. Money, however, is more than just a lubricant which enables the economy to operate smoothly. Money also plays a key role in influencing the behavior of the economy as a whole and the performance of financial institutions and markets. More specifically, changes in the supply of money and credit can affect how rapidly the economy grows, the level of employment, and the rate of inflation--and these, in turn, can affect the value of financial assets held by individuals and institutions.

Banks play a particularly critical role in the economy. Banks provide a place where individuals and businesses can invest their funds to earn interest with a minimum of risk. Banks, in turn, redeploy these funds by making loans. In this regard, banks are remarkably similar to other financial intermediaries, like finance companies and insurance companies, which also acquire funds from individuals and businesses and pass on these funds to other individuals and businesses. Like financial companies and life insurance companies, banks are particularly well-equipped to invest in the most challenging types of financial investments--loans to individuals and small businesses.

Why are banks singled out for special treatment? As it turns out, most of what we call money in the United States is represented by the deposits issued by banks. Consequently, banks serve as the principal caretakers of the payments system because we write checks on our bank accounts to pay for things we buy. Moreover, because money has linkages to the overall performance of the economy, banks are intimately involved in how the central bank of the Unites States, called the Federal Reserve, influences overall economic activity. In particular, the Federal Reserve directly influences the lending and deposit creation activities of banks. This, in turn, helps determine how much people are willing to save and how much businesses are willing to invest and whether the prices of stocks and bonds go up, down, or sideways in the financial markets.

How does this work? For the complete answer, you have to read the rest of this book! But here's a preview of what you will find. The remaining chapters in Part I set the stage. We define money and look at its relationship with economic performance. Then we'll provide an overview of financial institutions, instruments, and markets and how they serve as a mechanism for the flow of saving and investment. In Part II we examine the performance and behavior of financial markets where funds move directly from those who have funds to those who need funds. We pay special attention to how all types of securities are valued, how interest rates are determined, and how complicated markets, such as derivatives and foreign exchange, actually work. In Part III we look at intermediated markets where funds move between borrowers and lenders via financial intermediaries, such as banks, insurance companies, pension funds, and some institutions you may not have heard of. In Part IV we examine the overall financial system. This will involve looking at the relationship between financial markets and intermediated markets, the regulation of these markets, and an international comparison across different financial systems.

Having examined the financial landscape in Parts II, III, and IV we will then be ready to tackle the issue of overall economic performance. Part V begins this process by discussing the art of central banking. We can then address questions about the linkages among money, inflation, growth, and employment in Part VI. Along the way we'll learn that not everyone agrees on just what these linkages are, so you'll have to make up your own mind about what seems right. Part VI brings us 'round full circle linking monetary policy, prices in the stock and bond market, and the performance of the economy.

WHY STUDY MONEY, BANKING, AND FINANCIAL MARKETS?

Why would you want to study money, banking and financial markets? Will it make you a better person? The answer is: of course! For example, this book will help prepare; you for that fateful moment when someone asks you whether interest rates will go up or down. Not impressed? In addition, you will be able to make sense out of the business section of your favorite newspaper. Still not impressed? Well, another reason for studying money and banking is that it will help you get a job after you graduate. And that should interest everyone! So, let's see what you can do--in money, banking, and financial markets.