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ECON302: Money, Banking, And Financial Markets

Unit 2: Financial Markets   The loanable funds market is the broad marketplace that coordinates the borrowing and lending decisions of different business firms and households.  It consists of commercial banks, savings and loans, stocks and bonds, and insurance companies.  Loanable funds are supplied as households and firms save money rather than spend it on their own consumption.  The amount of funds supplied at any given time is a function of the fund price, or interest rate.  However, in financial markets, there are two types of interest rates: “nominal interest rates,” which overstate the real cost of borrowing during an inflationary period, and real interest rates, which are adjusted for inflation (or changes in prices).  Real interest rates indicate the real cost to the borrower (and the yield to the lender) in terms of goods and services.  This unit will focus on the capital market, which consists of various marketplaces in which investments (such as stocks and bonds) are bought and sold. 

Unit 2 Time Advisory
This unit should take you 13 hours to complete.

☐    Subunit 2.1: 1.0 hours

☐    Subunit 2.2: 3.5 hours

☐    Subunit 2.3: 3.5 hours

☐    Subunit 2.4: 2 hours

☐    Assessments: 3 hours

Unit2 Learning Outcomes
Upon successful completion of this unit, the student will be able to:
- Describe how financial markets work.

  • Define the concept of interest rate, and identify the interest rate given a specific situation.
  • Distinguish between interest rates and returns, nominal interest rate and real interest rate.
  • Explain how interest rates are determined, and given information, identify the type of rate used and/or determine how a rate will change.
  • Explain why interest rates on securities with the same maturity vary.
  • Explain why and how interest rates on short- and long-term maturities vary.

2.1 Understanding Interest Rates   Note: Interest rates are among the most important variables in the economy.  This subunit explains how interest rates are measured and shows that the interest rate on a bond is not always an accurate measure of how good of an investment it will be.  The most accurate measure of interest rates is yield to maturity.  The concept of yield to maturity reveals that bond prices and interest rates are negatively related, and the longer the maturity of the bond, the greater the change in the price of the bond from a given change in the interest rate will be.  Interest rates are important, because they affect how much people and firms wish to save or borrow.  The terms defined in this subunit will be employed throughout the book.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 4: Understanding Interest Rates” Lecture Notes Link: Pearson Education Canada's version of Frederic S. Mishkin’s “Chapter 4: Understanding Interest Rates” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 4" link to download the presentation. Please review all of the slides for Chapter 4 to cover the topics in sections 2.1.1-2.1.3.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 4: Interest Rates” Link: Money and Banking: “Chapter 4: Interest Rates” (PDF)
     
    Instructions: Please note this reading addresses the material in sections 2.1.1-2.1.3.  When you click on the link above, you will be directed to Chapter 4 “Interest Rates” of an e-book Money and Bankingi.  Please read Chapter 4 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: Youtube: Professor Campbell Harvey's “Understanding Interest Rates, Part I” Link: Professor Campbell Harvey's “Understanding Interest Rates, Part I” (YouTube)
     
    Instructions: Please note this video covers the topics in sections 2.1.1-2.1.3.  When you click on the link above, you will be directed to Professor Campbell Harvey's course video lecture on “Understanding Interest Rates.”   Please watch the video (9:24 minutes) in its entirety.
     
    Note on the Media: The lecturer in this video, Professor Campbell Harvey, teaches Global Financial Management at Duke University.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Assessment: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 4: Understanding Interest Rates”: “Multiple Choice Quiz” Link: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 4: Understanding Interest Rates”: “Multiple Choice Quiz” (HTML)
     
    Instructions: This quiz will assess what you have learned in subunits 2.1.1-2.1.3.  When you click on the link above, you will be directed to Frederic S. Mishkin’s “Chapter 4: Understanding Interest Rates” multiple choice quiz. Please note that the automatic grading function is not available; no answer key is currently available!
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

2.1.1 Measuring Interest Rates   2.1.2 Distinction Between Interest Rates and Returns   2.1.3 Distinction Between Real and Nominal Interest Rates   2.2 The Behavior of Interest Rates   Note: This subunit examines how interest rates are determined and the factors that influence their behavior.  The supply and demand analysis developed here explains why interest rates have had such substantial fluctuations in recent years.  Interest rates fluctuate.  In this subunit, we employ both the bond market and the liquidity preference frameworks to see how a variety of shocks affect interest rates.  We address how a change in the money supply affects the interest rate, both in the near term while other determinants of the interest rate are held constant, and in the long run when other determinants are allowed to adjust to the change in the money supply.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 5: The Behavior of Interest Rates” Lecture Notes Link: Pearson Education Canada's version of Frederic S. Mishkin’s “Chapter 5: The Behavior of Interest Rates” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets. Click on the "Chapter 5" link to download the presentation. Please read all slides for Chapter 5 for information on the material covered in sections 2.2.1-2.2.5.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 5: The Economics of Interest-Rate Fluctuations” Link: Money and Banking: “Chapter 5: The Economics of Interest-Rate Fluctuations” (PDF)

    Instructions: Please note this reading will address topics outlined in 2.2.1-2.2.5.  When you click on the link above, you will be directed to Chapter 5 “The Economics of Interest-Rate Fluctuations” of the e-book Money and Banking.  Please read Chapter 5 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: Vimeo.com: Marketplace’s “Interest Rates” Video Link: Vimeo.com: Marketplace’s “Interest Rates”Video (Adobe Flash)
     
    Instructions: When you click on the link above, you will be directed to Marketplace’s Video Shows on “Interest Rates.”  Please watch this brief video in its entirety for information on the subjects outlined in sections 2.2.1-2.2.5.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

2.2.1 Determinants of Asset Demand   2.2.2 Supply and Demand in the Bond Market   2.2.3 Changes in Equilibrium Interest Rates   2.2.4 Supply and Demand in the Market for Money: Liquidity Preference Framework   2.2.5 Changes in Equilibrium Interest Rates Due to Liquidity Preference Framework   - Assessment: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 5: The Behavior of Interest Rates”: “Multiple Choice Quiz” Link: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 5: The Behavior of Interest Rates”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 2.2.1-2.2.5.  When you click on the link above, you will be directed to Frederic S. Mishkin’s “Chapter 5: The Behavior of Interest Rates” multiple choice quiz.  Please note that the automatic grading function is not available; no answer key is currently available!
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

2.3 The Risk and Term Structure of Interest Rates   Note: The supply and demand analysis of interest rate behavior in the previous section examined the determination of just one interest rate, even though there are many different interest rates in the economy.  This subunit completes the interest rate picture by examining the relationship among interest rates on securities that differ in their riskiness, liquidity, income tax treatment, and term to maturity.  There are many different interest rates.  Due to differences in risk, liquidity, and tax treatment, bonds with the same term to maturity may have different interest rates.  The relationship between these interest rates is known as the risk structure of interest rates.  Bonds with different terms to maturity (but that are otherwise the same) also have different interest rates.  The relationship between these interest rates is known as the term structure of interest rates.

  • Reading: Pearson Education Canada's version of Frederic S. Mishkin’s “Chapter 6: The Risk and Term Structure of Interest Rates” Lecture Notes Link: Pearson Education Canada's version of Frederic S. Mishkin’s “Chapter 6: The Risk and Term Structure of Interest Rates” Lecture Notes (Microsoft PowerPoint)
     
    Instructions:  When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 6" link to download the presentation.  Please read all of the slides for Chapter 6. Please note this slideshow addresses material covered in sections 2.3.1 and 2.3.2. 
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 6: The Economics of Interest-Rate Spreads and Yield Curves” Link: Money and Banking: “Chapter 6: The Economics of Interest-Rate Spreads and Yield Curves” (PDF)

    Instructions: When you click on the link above, you will be directed to Chapter 6 “The Economics of Interest-Rate Spreads and Yield Curve” of the e-book Money and Banking.  Please read Chapter 6 in its entirety for information on the material outlined in sections 2.3.1 and 2.3.2.

    Terms of Use: The text was adapted by The Saylor Foundation under a Creative Commons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Web Media: YouTube: Khan Academy’s “Introduction to the Yield Curve” Link: YouTube: Khan Academy’s “Introduction to the Yield Curve

    Also available in:
    iTunes U
     
    Instructions: Please note this video covers the topics in sections 2.3.1 and 2.3.2.  When you click on the link above, you will be directed to Khanacademy’s video series titled “Introduction to the Yield Curve.”  Please watch this video (9:56 minutes) in its entirety.
     
    Terms of Use: This video is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 United States License.  This video was created by Salman Khan for the Khan Academy.

2.3.1 Risk Structure of Interest Rates   2.3.2 Term Structure of Interest Rates (Yield Curves)   - Assessment: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 6: The Risk and Term Structure of Interest Rates”: “Multiple Choice Quiz” Link: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 6: The Risk and Term Structure of Interest Rates”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 2.3.1 and 2.3.2.  Please complete Mishkin’s multiple choice quiz on “Chapter 6: The Risk and Term Structure of Interest Rates.”  Please note that the automatic grading function is not available; no answer key is currently available!
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

2.4 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis   Note: This subunit discusses theories that explain changes in the stock market.  First, fundamental theories of stock valuation are developed.  Second, the theory of rational expectations is introduced, along with the implications of this theory as applied to financial markets, where it is known as the efficient market hypothesis.  Recently, expectations theory has received great attention as economists have searched for more adequate explanations of the observed behavior of economic variables, such as unemployment, interest rates, and asset prices.  There are a variety of fundamental theories that underlie the valuation of stocks and other securities.  These theories require that we understand how expectations affect stock market behavior, because to value a stock, people must form expectations about a firm's future dividends and the rate to discount future values.  The theory of rational expectations, when applied to financial markets, implies the efficient market hypothesis.  Although the evidence is mixed, the theory of rational expectations is a good place to start analyzing expectations.

  • Reading: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis” Lecture Notes Link: Pearson Education Canada’s version of Frederic S. Mishkin’s “Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis” Lecture Notes (Microsoft PowerPoint)
     
    Instructions: When you click on the link above, you will be directed to a webpage that lists links to lecture notes on specific chapters from Mishkin's The Economics of Money, Banking, and Financial Markets.  Click on the "Chapter 7" link to download the presentation.  Please read all of the slides for Chapter 7 to cover the topics outlined in sections 2.4.1-2.4.3.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Money and Banking: “Chapter 7: Rational Expectations, Efficient Markets, and the Valuation of Corporate Equities” Link: Money and Banking: “Chapter 7: Rational Expectations, Efficient Markets, and the Valuation of Corporate Equities” (PDF)
     
    Instructions: Please note this reading covers material addressed in 2.4.1-2.4.3.  When you click on the link above, you will be directed to Chapter 7 “Rational Expectations, Efficient Markets, and the Valuation of Corporate Equities” of the e-book Money and Banking.  Please read Chapter 7 in its entirety.

    Terms of Use: The text was adapted by The Saylor Foundation under a CreativeCommons-Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensee.

  • Lecture: Yale University: Professor Robert J. Shiller’s “Lecture 6: Efficient Markets vs. Excess Volatility” Link:  Yale University: Professor Robert J. Shiller’s “Lecture 6: Efficient Markets vs. Excess Volatility

    Also available in:
    iTunes U
    Quicktime (Low bandwidth/slow connection)
    MP3 format 
    Transcript (HTML)
     
    Instructions: Please note this video lecture addresses topics in sections 2.4.1-2.4.3.  When you click on the link above, you will be directed to Professor Robert J. Shiller’s “Efficient Markets vs. Excess Volatility” class lecture for his Financial Markets course.  To download this video, you will need to click on the Flash icon or the QuickTime icon in the lower right corner of the webpage.  Please watch it in its entirety.  You may also choose to listen to the audio version (mp3) or read the transcript (html).
     
    Terms of Use: Robert Shiller, Financial Markets (Yale University: Open Yale Courses), http://oyc.yale.edu (Accessed March 2, 2011).  License: Creative Commons BY-NC-SA 3.0. The original version can be found here.

2.4.1 Computing the Price of Common Stock   2.4.2 The Theory of Rational Expectations   2.4.3 The Efficient Market Hypothesis   - Assessment: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis”: “Multiple Choice Quiz” Link: Internet Archive: Pearson Education: Frederic S. Mishkin’s “Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis”: “Multiple Choice Quiz” (HTML)
 
Instructions: This quiz will assess what you have learned in sections 2.4.1-2.4.3.  When you click on the link above, you will be directed to Frederic S. Mishkin’s “Chapter 7: The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis” multiple choice quiz. Please note that the automatic grading function is not available; no answer key is currently available!
 
Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.