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UNIVERSITY OF HAREGIESA

Course title:
Money & Banking

Lecturer
By
Sadiq Mohamed Omer
Chapter One

Introducing Money, Banking,


and Financial Markets
Five key categories of assets:
1. Money
2. Stocks
3. Bonds
4. Foreign exchange
5. Securitized loans
Economists have a general definition of money:
Money is anything that people are willing to accept
in payment for goods and services or to pay off
debts.
The money supply is the total quantity of money in
the economy
Currency consisting of Papers and coins clearly fits
this definition.
To define money merely as currency is much too
narrow for economists because checks are also
accepted as payment for purchases, checking
account deposits are considered money as well.
Wealth: is the total collection of pieces of
property that serve to store value. Wealth
includes not only money but also other assets
such as bonds and stocks, cars, houses etc.
Income: is a flow of earnings per unit of time.
Functions of money
Money has three primary functions in any
economy:
As a medium of exchange
A unit of account
Store of value
 Medium of exchange
 The most important function of money is to
serve as a medium of exchange or as a means
of payment. To be a successful medium of
exchange, money must be commonly accepted
by people in exchange for goods and services.
While functioning as a medium of exchange,
money benefits the society in a number of
ways:
 (a) It overcomes the inconvenience of barter
system (i.e., the need for double coincidence of
wants) by splitting the act of barter into two acts
of exchange, i.e., sales and purchases through
money.
 (b) It promotes transactional efficiency in
exchange by facilitating the multiple exchange
of goods and services with minimum effort and
time,
 (c) It promotes allocation efficiency by
facilitating specialization in production and
trade,
 (d) It allows freedom of choice in the sense that
a person can use his money to buy the things
he wants most, from the people who offer the
best bargain and at a time he considers the
most advantageous.
 : in almost all market transactions in our
economy, money in the form of currency or
checks is a medium of exchange. It is used to pay
for goods and services. The use of money as a
medium of exchange promotes economic
efficiency by eliminating much of the time spent
in exchanging goods and services.
The time spent trying change goods and services is
called transaction cost
 In a barter economy transaction costs are high
because people have to satisfy a double
coincidence of wants they have to find
someone who has a good or service they want
and who also wants the good or service they
have to offer.
 You've probably never thought very much
about money. It is just there. When you want
or need something, you simply take some
money and pay for it. That wasn't always the
way things were done, before money was
invented people used to swap things. This was
called bartering.
Meaning of barter
 To barter is to exchange goods without involving
money
 At first, people used to do direct swaps for what
they needed. Supposing you had a lot of corn, but no
meat, and the farmer down the road had a lot of
meat but no corn. If that was the case then you could
agree on a fair swap, and swap corn for meat. If you
needed meat, but the farmer already had corn, he
might not want any more corn, he may want
something else, perhaps some eggs.
m

If you still wanted the meat, you would have


to find someone who had too many eggs,
and wanted some corn. Of course, this
system meant that people spent all their
days trying to find someone to swap with,
and they weren't able to get anything else
done. That was when people came up with
a better idea.
Instead of a direct swap of one
item for another people came up
with the idea of using one thing to
swap for everything else. This
was the beginning of money.
 The need for money is strong that almost
every society uses it.
For a commodity to function effectively as money it
has to meet several criteria.
It must be easily standardized.
Making it simple to ascertain its value.
 It must be widely accepted
It must be divisible so that it is easy to make
change
It must be easy to carry
It must not deteriorate quickly
 Unit of account: Money serves as a common
measure of value in terms of which the value of
all goods and services is measured and
expressed. By acting as a common or
numerical, money has provided a language of
economic communication. It has made
transactions easy and simplified the problem of
measuring and comparing the prices of goods
and services in the market. Prices are but
values expressed in terms of money
 Money also acts as a unit of account. As a unit
of account, it helps in developing an efficient
accounting system because the values of a
variety of goods and services which are
physically measured in different units (e.g, Kg
metres, litres, etc.) can be added up. This
makes possible the comparisons of various
kinds, both over time and across regions. It
provides a basis for keeping accounts,
estimating national income, cost of a project,
sale proceeds, profit and loss of a firm, etc.
 To be satisfactory measure of value, the
monetary units must be invariable. In other
words, it must maintain a stable value. A
fluctuating monetary unit creates a number
of socio-economic problems. Normally, the
value of money, i.e., its purchasing power,
does not remain constant; it rises during
periods of falling prices and falls during
periods of rising prices.
 Store of value Money, being a unit of
value and a generally acceptable means
of payment, provides a liquid store of
value because it is so easy to spend and
so easy to store. By acting as a store of
value, money provides security to the
individuals to meet unpredictable
emergencies and to pay debts that are
fixed in terms of money. It also provides
assurance that attractive future buying
opportunities can be exploited.
 Money as a liquid store of value facilitates its
possessor to purchase any other asset at
any time. It was Keynes who first fully
realized the liquid store value of money
function and regarded money as a link
between the present and the future. This,
however, does not mean that money is the
most satisfactory liquid store of value. To
become a satisfactory store of value, money
must have a stable value.
 Money also functions as a store of value; it
is a repository of purchasing power over
time. A store of value is used to save
purchasing power from the time income is
received until the time it is spent. Thus
function of money is useful because most
of us do not want to spend our income
immediately upon receiving it, but rather
prefer to wait until we have the time or the
desire to shop
 Transfer of Value:
 Money also functions as a means of
transferring value. Through money, value can
be easily and quickly transferred from one
place to another because money is
acceptable everywhere and to all. For
example, it is much easier to transfer one
thousand shilling through bank draft from
person A to person B in Hasrgiesa than
remitting the same value in commodity terms,
say wheat.
Distribution of National Income
 Money facilitates the division of national
income between people. Total output of the
country is jointly produced by a number of
people as workers, land owners, capitalists,
and entrepreneurs, and, in turn, will have to
be distributed among them. Money helps in
the distribution of national product through
the system of wage, rent, interest and profit.
Maximization of Satisfaction
 Money helps consumers and producers to
maximize their benefits. A consumer
maximizes his satisfaction by equating the
prices of each commodity (expressed in
terms of money) with its marginal utility.
Similarly, a producer maximizes his profit by
equating the marginal productivity of a factor
unit to its price.
 Basis of Credit System:
 Credit plays an important role in the modern
economic system and money constitutes the basis of
credit. People deposit their money (saving) in the
banks and on the basis of these deposits, the banks
create credit.
 Liquidity to Wealth:
 Money imparts liquidity to various forms of wealth.
When a person holds wealth in the form of money,
he makes it liquid. In fact, all forms of wealth (e.g.,
land, machinery, stocks, stores, etc.) can be
converted into money.
 Security A financial asset that can be
bought and sold in a financial market

Financial asset An asset that represents a


claim on someone else for a payment.
financial market A place or channel for buying
or selling stocks, bonds, and other securities
 Stocks, also called equities, are financial
securities that represent partial ownership of a
corporation. When you buy a share of Telesom
stock, you become a Telesom shareholder, and
you own part of Telesom, although only a tiny
part because it has issued millions of shares of
stock
 Dividend A payment that a corporation makes
to its shareholders
 Bond A financial security issued by a
corporation or a government that represents a
promise to repay a fixed amount of money
 Bonds When you buy a bond issued by a
corporation or a government, you are
lending the corporation or the
government a fixed amount of money.
The interest rate is the cost of borrowing
funds (or the payment for lending funds),
usually expressed as a percentage of the
amount borrowed Bonds typically pay
interest in fixed dollar amounts called
coupons.
 Foreign exchange refers to units of foreign
currency. The most important buyers and
sellers of foreign exchange are large banks.
Banks engage in foreign currency
transactions on behalf of investors who want
to buy foreign financial assets.
 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.
 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 markets. One of the objectives of
financial markets 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.
 Money plays a key role in the
performance of the economy. It not only
facilitates transactions among the
millions of the 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.
 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.
 A financial intermediary A financial firm,
such as a bank, that borrows funds from
savers and lends themto borrowers
 Financial intermediary is an institution
that takes funds from one group of
investors and redeploys those funds by
investing in financial asset. 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.
 Definition of bank
 Bank is a financial institution which deals in
debts and credits. It accepts deposits, lends
money and also creates money. It bridges the
gap between the savers and borrowers.

 Banking occupies one of the most important


positions in the modern economic world. It is
necessary for trade and industry. Hence it is
one of the great agencies of commerce.
Modern banking is crucial in developing
modern business and economics.
 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 similar to other financial intermediaries like
finance companies and life insurance, which also
acquire funds from individuals and businesses and
pass these funds to other individuals and businesses
 Commercial bank: Afinancial firm that serves
asa financial intermediary by taking in deposits
and using them to make loans
EVOLUTION OF MONEY

 Money was developed according to


needs & Requirements.
 Main aim was to remove the
shortcomings of the Barter System.
DIFFERENT STAGES OF
EVOLUTION OF MONEY

1. COMMODITY MONEY
2. METALIC MONEY
3. PAPER MONEY
4. CREDIT MONEY
5. ELECTRONIC MONEY
1. COMMODITY MONEY

 When different commodities were used as a


medium of exchange (BARTER SYSTEM)

 Cow , Goats, Axes, Dried Fishes etc were


used as medium of exchange.
1. COMMODITY MONEY

 Barter System had different problem


like:
1. Storing Problem
2. Durability problem
3. Transportation problem
4. Divisibility problem
2. METALLIC MONEY

Coined Metals.
 As a next step, standard coins were
created.
 They had a standard weight & value.
 Problem of un coined metals started here
as well.
3. PAPER MONEY
3. PAPER MONEY

PAPER MONEY
 Refers to the Notes issued by the State
or by the Bank, usually the Central
bank.
 Paper Money can be:
1. Representative Paper Money.
2. Convertible Paper Money.
3. Fait Paper Money.
4. CREDIT MONEY

 Includes Bank money (different


instruments offered by the Banks.)
 Cheques, Drafts, are examples.
 Convenient, Safe and easily convertible
into cash.
 Its like Near Money.
5. ELECTRONIC MONEY
5. ELECTRONIC MONEY

Electronic money (also known as e-money,


electronic cash, electronic currency, digital
money, digital cash or digital currency) refers
to money which is exchanged only
electronically. Typically, this involves use of
computer networks, the internet and digital
stored value systems.