Financial Assets and Money- Macro 4.1 and 4.3

Summary

In this engaging macroeconomics video by Jacob Clifford, the concept of financial assets is explored, particularly focusing on money, bonds, and stocks. The video explains the functions of money, such as serving as a medium of exchange, unit of account, and store of value. It also contrasts commodity money with fiat money and discusses the money supply classifications like M1 and M2. The distinction between low-liquidity assets like real estate and high-liquidity assets like money in checking accounts is also addressed. Furthermore, the inverse relationship between interest rates and bond prices is explained, rounding out a foundational look at finance and economics.

Takeaways

• 😀 Economists define money as anything generally accepted for goods and services, not just cash.
• 😀 Money has three main functions: medium of exchange, unit of account, and store of value.
• 😀 Commodity money, like gold, has intrinsic value, while fiat money, like cash, has value because we agree it does.
• 😀 A shrewd buck, an example of non-government-issued money, is used to illustrate the concept of money’s value.
• 😀 Most of our money today is digital, with checkable deposits and currency representing the money supply.
• 😀 M1 money includes currency, checkable deposits, and traveler's checks, while M2 includes M1 plus savings accounts, CDs, and money market funds.
• 😀 Assets like stocks and bonds are not considered money because they have low liquidity and take time to convert into cash.
• 😀 Stocks represent ownership in a company, while bonds are IOUs that pay interest, representing loans to corporations or the government.
• 😀 There is an inverse relationship between interest rates and bond prices: as interest rates go up, bond prices go down.
• 😀 The video covers foundational concepts in economics, with a recommendation to study finance for more personal finance-related topics.

Q & A

What are the three functions of money, as explained in the video?

The three functions of money are: 1) Medium of exchange (used to buy goods and services), 2) Unit of account (used to measure the value of goods and services), and 3) Store of value (used to store purchasing power for future use).

What is the difference between commodity money and fiat money?

Commodity money has intrinsic value (e.g., gold), meaning it has value beyond being used as money. Fiat money, like cash, has no intrinsic value and is only valuable because people agree to accept it as money.

What is the relationship between M1 and M2 money supply?

M1 includes currency in circulation, checkable deposits, and traveler's checks—it's highly liquid. M2 includes everything in M1 plus savings accounts, certificates of deposit (CDs), and money market funds, which are less liquid than M1.

What is the significance of liquidity in money supply?

Liquidity refers to how easily an asset can be converted into cash. Cash and checkable deposits are highly liquid, while assets like stocks and bonds are less liquid because they take time to sell and convert into cash.

How do stocks and bonds differ as financial assets?

Stocks represent ownership in a company and can offer higher returns but also come with higher risk. Bonds, on the other hand, are debt instruments where you lend money to corporations or governments in exchange for fixed interest payments, offering lower risk but also lower returns.

What is the inverse relationship between interest rates and bond prices?

When interest rates rise, the price of existing bonds falls because newer bonds offer higher returns. Conversely, when interest rates fall, the price of existing bonds rises because their fixed returns become more attractive.

What is meant by the term 'liquidity' in the context of financial assets?

Liquidity refers to how easily an asset can be converted into cash without affecting its price. For example, cash is highly liquid, while real estate or stocks might take longer to sell and convert to cash.

Why might someone choose to invest in stocks or bonds instead of holding cash?

People may invest in stocks or bonds because they offer higher potential returns compared to keeping cash in a checking account. Stocks and bonds can grow in value over time, providing future gains, whereas cash typically doesn't earn much interest.

What is the role of financial markets in terms of bonds?

Financial markets facilitate the buying and selling of bonds. When you buy a bond, you are essentially lending money to a corporation or government, and in return, they promise to repay you with interest at a set future date.

How do you calculate the price of a bond if interest rates change?

If interest rates increase, the price of existing bonds decreases because newer bonds offer higher returns. If interest rates decrease, the price of existing bonds increases, since their returns are now relatively more attractive.