JUNIATA COLLEGE



JUNIATA COLLEGE

Accounting, Business and Economics Department

Financial Markets and Institutions

EB 463 01

|Professor Brad Andrew |Office: 814-641-3378 |

|Brumbaugh C205d |E-Mail: Andrew@juniata.edu |

|Office Hours: MWF 10-11 AM |Home Page: |

|TuTh 2:30 PM-3:30 PM | |

|and by appointment | |

| | |

| | |

Course Description:

EB 463 is a course focusing on the study of financial markets and institutions, including in particular the study of monetary policy. Recent developments in both theory and practice have made this a highly dynamic field. For example, traditional conceptions of money must now be broadened to include electronic forms of money. Domestic banking regulations both here and abroad need to be reconsidered in the face of extensive globalization of financial markets. And new forms of global financial regulations may be needed to ensure that international financial markets can function in an orderly and welfare-enhancing way on a sustained basis. The primary objective of this course will be to help students obtain a better understanding of these and other important financial issues facing private citizens and government policy-makers both here in the U.S. and abroad.

Four topic areas will be stressed in EB 463:

1. Fundamentals of Financial Markets

2. Financial Markets (Domestic)

3. Financial Institutions

4. Central Banking and the Conduct of Monetary Policy (the entire 2nd half of semester will be spent on this topic)

Economic tools and concepts will be developed within a unifying analytical framework in order to organize students' thinking about the structure of financial markets and the role of financial institutions, but the real-world application of these tools and concepts will be stressed.

Required Textbook and Materials:

Frederic S. Mishkin, The Economics of Money, Banking, and Financial Markets, 7th edition, Addison-Wesley, 2003.

Warren, Elizabeth and Amelia Warren Tyagi, The Two-Income Trap: Why Middle-Class

Mothers and Fathers Are Going Broke, Basic Books, 2004.

In-Class handouts

Reserve items

Online Materials

Grades:

Grading will included the following components:

|Paper proposal and literature review |5% |

|Final Paper |30% |

|Class Participation |30% |

|Final Exam |35% |

|Total |100% |

Class participation is graded both on quality and quantity. Descriptions of the paper requirements will be provided as the semester progresses. I will record your contributions in a notebook so as to have an accurate record of your participation.

Participation:

I plan to run this course like a seminar. The small size of the class makes this emphasis much easier. Seminars place an important responsibility on you. They require you to be prepared for each class period because each of you will be discussing the topics the day. I will endeavor, as much as possible, to be a discussion leader rather than an instructor. The seminar format also grants you the opportunity to help shape the course. Based upon student interests, we can spend more time on some topics and less on others.

Participation also means keeping track of current events related to class. Please regularly browse the websites of the Wall Street Journal, the Financial Times, The Economist and The Dismal Scientist (see below under commercial sites—they are the first four listed). I’ll ask one or more of you at each class to tell me what is new in the banking and financial news.

Academic Honesty & Integrity Policy:

Ethics are an integral feature of all personal, social, and professional considerations. Thinking ethically and accepting responsibility for one’s actions are essential to personal development. Juniata’s graduates are committed to their intellectual, ethical, professional, and social development throughout life. Students are expected to understand and comply with Juniata’s Academic Honesty & Integrity Policy.

Dropping the Course:

March 4 is the deadline for dropping this course. After this date, you may drop the course with my permission, but only after you have met with me to discuss your situation.

Paper:

You will also be required to write a substantial research paper for this course. It must be at least 15 pages long and contain a substantial quantity and quality of analysis. You may choose any topic, but I must approve it first. The topic must be submitted to me by February 23. Your paper must be ready to submit by noon on April 18. You will present your paper during the last week of classes. We will also discuss each person’s paper.

Important Web Sites:

Each of these websites may be useful for your research or general knowledge related to this course. There are also several useful links on my home page:

Federal Reserve System (U. S.) and U.S. Government Sites

Washington Fed—includes Beige Book, Bernanke testimony, Humphrey-Hawkins, etc.

Links to Fed District Banks

stls.fred/ Federal Reserve Economic Database

Economic Report of the President

International Central Banks

cbanks.htm Bank for International Settlements (BIS) list of every central bank

.br/defaulti.htm Brazilian Central Bank

bundesbank.de/index_e.html Bundesbank (Germany)

bankofengland.co.uk/ Bank of England

ecb.int/ European Central Bank (ECB)

banque-france.fr/gb/home.htm French Central Bank

cbr.ru/eng/ Russian Central Bank

International Organizations (IOs) and Non-Governmental Organizations (NGO’s)

International Monetary Fund (IMF)

World Bank

Organization for Economic Cooperation and

Development

World Trade Organization

Bank for International Settlements

Other International Sites

ernment/gov.htm List of Latin American Governmental Sites

Comprehensive site of International

Economic Issues

Commercial Sites













yahoo.finance



news/com_front.asp

Exchanges

finix.at/fin/selinks.html Links to 145 stock exchanges

Assignments:

*Available online (if item is not at stated web address, then Google it)

**On reserve

***Handout

Be ready to discuss all questions.

Introduction: Basic Issues in Economics, Finance and Macroeconomics

Weeks 1-2: Introduction; The way economists theorize; Review of Macroeconomics

Excerpt from Milton Friedman’s Essays on Positive Economics.***

Ben Bernanke: FRB: Speech on Productivity, January 19, 2005.*



Mishkin, Chapters 1-3 (go through ch. 1 quickly)

Duca, John V., “The Changing Meaning of Money,” The Southwest Economy (Fed – Dallas), Issue 6, 1995, pp. 6-9 (only these pages).*



DeLong, Brad, excerpt on money and Quantity Theory from Macroeconomics, pp. 218-227.***

Valderrama, Diego, “Financial Development, Productivity and Economic Growth”, FRBSF Economic Letter, June 27, 2003.*



Ergungor, O. Emre, “Securitization”, Economic Inquiry, FRB—Cleveland, August 15, 2003.*



1) What are the main points of the Friedman article? Is he convincing?

2) Summarize the Bernanke speech.

3) Why did I assign the Bernanke speech? What is its significance?

4) What is money? What is finance? What are the key items in the first three chapters, in your opinion, and why?

5) Summarize the Duca article.

6) Why did I assign the Duca article? What is its significance?

7) What is the purpose of the DeLong excerpt?

8) Summarize the Valderrama article. What is its significance?

9) Summarize the Ergungor article. What is its significance? How does it “fit” into this section?

10) Consider the chapters and articles as a whole. What links them? Is there any significance to the order? What overall themes are they suggesting?

Financial Markets and Interest Rate Determination

Week 3: Mishkin, Chapter 4

Kwan, Simon, “On the Relation Between Stocks and Bonds – Part I & II,” FRBSF Economic Letter, June 28 and July 5, 1996.*

(Part I)

(Part II)

1) What is the difference between the real interest rate and the nominal interest rate? How do you calculate the real rate?

2) What are the sources of differences in interest rates on various assets?

3) Describe coupon bonds and discount bonds.

4) How are bond prices affected when interest rates rise? Fall? Is your answer different for new bonds vs. old bonds? For discount bonds vs. coupon bonds? Explain your answers.

5) How do interest rates affect stock prices?

6) What is the theorized relationship between stocks and bonds? Why do they have such a relationship?

7) What is the difference between the simple interest rate and annual percentage yield (APY)? How does the number of compounding periods affect APY?

8) What is the Rule of 72?

9) How does inflation affect borrowers and lenders? How could deflation lead to a wave of bankruptcies (deflation almost always occurs during a recession and asset prices [like home prices] often fall)?

10) What is the net present value (or PDV—present day value)? How can PDV analysis be used to determine bond or stock prices?

11) Why are some possible reasons why PDV would give an inadequate or incomplete determination of bond and stock prices?

12) According to Kwan, what is the more complex story of how bond prices, stock prices, inflation and interest rates interact? Be specific and discuss each piece of evidence that he offers.

13) What is the yield to maturity? Why is it important?

Weeks 4-5: Mishkin, Chapters 5-6

Altig, David E. and Ed Nosal, “Why Haven’t Long-term Interest Rates Fallen?” Economic Commentary (Fed – Cleveland), January 1, 2002.*



Mishkin, Chapter 13; Mishkin, Box 1 on p. 225.

Sill, Keith, “The Economic Benefits and Risks of Derivative Securities,” Business Review (Fed – Philadelphia), January/February 1997, pp. 15 – 26.*



McCarthy, Jonathan and Richard W. Peach, “Are Home Prices the Next Bubble?”, Economic Policy Review (Fed – NY), December 2004, pp. 1-17.



1) How are the supply/demand graphs presented in chapter five different from the conventional ones? Explain your answer. Why does the demand curve slope downward? Why does the supply curve slope upward?

2) What are the determinants of asset demand? Asset supply? What causes shifts in each and why? Be prepared to answer questions and draw them on the board. In other words, practice playing with the curves before coming to class.

3) Describe the liquidity preference theory of interest rates. When the money market is in equilibrium, according to this theory, what must be true about the bond market?

4) What causes changes in money supply? Money demand? What will the initial impact on interest rates?

5) What is the Fisher effect?

6) Why may money supply increases have an indeterminate medium-term impact on interest rates?

7) What is the risk structure of interest rates? What is its significance?

8) What is a yield curve? Explain each shape (positive slope, negative slope, no slope).

9) What is the term structure of interest rates? What is its significance?

10) Describe each of the theories that attempt to explain the term structure.

11) Summarize the Altig and Nosal article.

12) Speculate on why long-term interest rates haven’t fallen.

13) If monetary policy is so effective as to be neutral in its impact on long-term interest rates, then what causes changes in long-term interest rates?

14) Why did I have you read the Altig and Nosal article now?

15) What are financial derivatives in general? What are options? How do they differ from futures? From forward contracts?

16) What is hedging? What is one way to hedge in the exchange rate market?

17) What useful purpose do derivatives serve? What are their possible dangers?

18) How do McCarthy and Peach make their argument? What methods do they use? What is the logical structure of their argument?

19) The authors don’t believe that there is a housing bubble. What are the crucial pieces of data that lead them to this conclusion?

Financial Institutions

Week 6: Mishkin, chapter 8

Moreno, Ramon, “What Caused East Asia’s Financial Crisis?” FRBSF Weekly Letter, August 7, 1998.*



Parry, Robert T., “The October ’87 Cash Ten Years Later,” FRBSF Weekly Letter, October 31, 1997.*



Eight Basic Financial Facts/Puzzles that you need to address:

1. Stocks are NOT the most important source of external financing for businesses.

2. Issuing marketable securities (stocks, bonds) is NOT the primary means of finance for businesses.

3. Indirect finance (going through financial intermediaries) is about 20 times more important than direct finance (borrowing directly from lenders).

4. Banks are the most important source of external funds for businesses.

(1.)-(4.), in sum: Businesses get more than 55% of their external funds from loans and 90% of their external funds through debt instruments (See Mishkin, p. 170, Figure 2, "Sources of External Funds": 40% loans, 36% bonds, 15% "other loans," 9% stocks.)

5. The financial sector is one of the most heavily regulated sectors of the economy.

6. Only large, well-established firms issue marketable securities.

7. COLLATERAL (property pledged to the lender in the event that the borrower defaults) is a common feature of debt contracts for both households and businesses.

-- secured debt = debt that is backed by collateral

-- unsecured debt = debt that is NOT backed by collateral

8. Debt contracts tend to be intricate legal documents with substantial restrictions on the behavior

1) What is Moreno’s answer to what caused East Asia’s crisis?

2) What systemic problems contributed to the October 1987 crash? How did the Fed help address those problems with their bailout?

3) What counter-intuitive conclusions does DeYoung come to regarding the merger wave?

4) If you haven’t already, link each of the previous three questions to information problems.

Week 7: Mishkin, chapter 9 (don’t spend time interpreting the “T” accounts, just try to understand intuitively what is happening), pp. 245-253

DeYoung, Robert, “Mergers and the Changing Landscape of Commercial Banking Parts I and II,” Chicago Fed Letter, September 1999 and February 2000.*

(part I)

(part II)

Duca, John V., “The Democratization of America’s Capital Markets,” Economy and Financial Review (Fed – Dallas), 2nd quarter, 2001, pp. 10 – 19.*



1) What is systemic risk, in the context of our banking system? What is the required reserve ratio (RRR)? Why is the RRR so important from the standpoint of systemic risk?

2) What are the four key issues in managing a bank? What are the trade-offs associated with attempting to manage each issue?

3) What is duration analysis? What is gap analysis? Why are both useful to bank management?

4) What is the significance of the equity multiplier? All other things constant, it is beneficial to the owners to have a lower amount of bank capital. Why? Other things equal, it is beneficial from the standpoint of society to have a higher amount of bank capital. Why?

5) Why did adjustable rate mortgages (ARMs) appear in the early 1980s?

6) How does deposit insurance create a moral hazard problem? How does it influence decisions about each bank management issue?

7) How will small banks now compete with the large mega-banks? Will mergers get to the point that when we say we’re “going to the bank”, we actually mean THE BANK (i.e., the only one)?

8) Summarize the Duca article.

9) How has the rise of venture capital and other non-bank financing institutions affected small and medium size business growth? Identify both the potential benefits and costs of this trend.

10) How has the democratization of capital markets affected people’s spending and savings decisions? Their choices for portfolios? Their exposure to diversifiable risk?

11) Why did I have you read the Duca article now?

The Other Side of Financial Markets

Week 9: Warren, Elizabeth and Amelia Warren Tyagi, The Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going Broke, Basic Books, 2004.

1) Describe the research project that provided the data for this book.

2) A key part of their argument is that people have less disposable income now than they did thirty years ago despite having two incomes. Consider both the passages where they study these budgets and the table in the notes section where they construct hypothetical budgets for a family now and thirty years ago. Are their arguments plausible, given their calculations? Are their calculations plausible?

3) Speculate on other reasons why bankruptcy has increased so much in the last twenty years?

4) Do you think that the financial services industry is somewhat responsible for this trend? Explain your answer.

5) Consider bankruptcy law. What are the reasons for its existence? Do you find those reasons compelling? What about the ethics of not having to pay back the money that you borrowed? Do any of your answers from the previous question influence your answer to this one?

6) Reflect on the Duca article from the perspective of this reading.

7) This book is only tangentially related to what we’ve been studying so far. Why did I have you read it now?

Competing Theories in Macroeconomics

Week 10: Mishkin, Chapters 22-24

Greenwald, Bruce, and Joseph Stiglitz, “New and Old Keynesians”, Journal of Economic Perspectives, Winter 1993.* (on JSTOR)

Stark, Tom, and Herb Taylor, “Activist Monetary Policy for Good or Evil? The New Keynesians vs. the New Classicals”, Business Review (FRB—Philadelphia) March/April 1991.*



1) Develop your own questions. Make them good. They will be part of your class participation grade. At least one question must include analyzing some macroeconomic change using IS/LM curves. Submit them to me by 8 AM Monday morning. I will distribute some of them to the class by Monday afternoon.

Central Banking: Overview from the perspective of the US and the EU

Weeks 11-12: Blinder, Alan S., “Central Banking in a Democracy,” Economic Quarterly (Fed –

Richmond), Fall 1996, pp. 1 – 14.*



Mishkin, Frederic S., “What Should Central Banks Do?” Review (Fed – St. Louis) Nov./Dec. 2000, pp. 1 – 13.*



Schinasi, Garry, “Responsibility of Central Banks for Stability in Financial Markets”, IMF Working Paper WP/03/121, June 2003.



Federal Reserve Bank of Minneapolis, “The Fed: Our Central Bank” and “The Fed’s Structure”, Federal Reserve Bank of Minneapolis.*



Federal Reserve Bank of San Francisco, “U.S. Monetary Policy: An Introduction, FRBSF

Weekly Letter, January 1, 1999.*



Mundell, Robert A., “A Theory of Optimum Currency Areas”, American Economic Review, Vol. 51, No. 4 (Sept 1961), 657-665. (available on JStor)

ECB Homepage (read all of the links on the center of the page except “Visiting the ECB in Frankfurt”—we won’t be).



ECB, The Implementation of Monetary Policy in the Euro Area, February, 2004, pp. 1-12, 17-25, 39-60.



ECB, “The Relationship Between Monetary Policy and Fiscal Policies in the Euro Area.” ECB Monthly Bulletin, February, 2003: 37-49; and “Chronology of Monetary Policy Measures of the Euro system”, 91-94.



1) Develop your own questions. Make them good. Submit them to me by 8 AM Monday morning. I will distribute some of them to the class by Monday afternoon. They will be part of your class participation grade.

The Conduct and Effect of Monetary Policy in Developed Countries

Weeks 13-14: McCandless, George T. and Weber, Warren, “Some Monetary Facts,” Quarterly Review (Fed – Minneapolis), Summer 1995, pp. 2 – 11.*



Mishkin, chapters 18 and 21

Altig, David. “What is the Right Inflation Rate?”, Economic Commentary (Fed—Cleveland) September 15, 2003.



Sill, Keith, “Forecasts, Indicators, and Monetary Policy,” Business Review (Fed – Philadelphia), May/June 1999, pp. 3 – 14.*



“Canadian Monetary Policy 1987-1993: John Crow’s Disinflation”, Wilfrid Laurier University, Thomson Publishing, ISBN: 0-538-86921-6

1) Develop your own questions. Make them good (hint: make them build upon previous sections). Submit them to me by 8 AM Monday morning. I will distribute some of them to the class by Monday afternoon. They will be part of your class participation grade.

Developing Countries and Monetary Policy

Weeks 14-16: Mishkin, chs. 19-20

Whitt, Jr. Joseph, “The Mexican Peso Crisis”, Economic Review, FRB-Atlanta, Jan-Feb 1996, 1-20.

ECB, “Exchange Rate Regimes for Emerging Market Economies.” ECB Monthly Bulletin, February 2003: 51-62.



Case Study: “Brazil 2003: Inflation Targeting and Debt Dynamics”, HBS Number: 9-704-028.

1) Develop your own questions. Make them good. Submit them to me by 8 AM Monday morning. I will distribute some of them to the class by Monday afternoon. They will be part of your class participation grade.

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