Money, Finance, and Financial Instruments
Money: Functions and Forms
Money is a commonly accepted medium of exchange used to pay for goods and services. Its functions include serving as a unit of account, a store of value, and a means of deferred payment. The public demands money to buy goods and services and as a store of value. Holding money liquid has an opportunity cost, as it could be used for investments or loans.
Different Forms of Money
- Commodity Money: Physical goods valued for themselves, sometimes used for final consumption (e.g., gold, silver, bronze coins).
- Hard Cash: A type of commodity money with intrinsic value, typically used directly. Drawbacks include potential value distortion and opportunity costs.
- Convertible Paper Money: Documents representing a claim to a commodity (e.g., gold or silver), widely used after money changers issued receipts for deposited metal.
- Fiat Money: Money without intrinsic value, accepted due to government decree and public trust.
- Money Payable: Implies a borrower’s commitment to repay (e.g., checks).
The Money Supply
The money supply includes not only banknotes and coins but also bank deposits. Bank reserves are the amount of money banks must hold as reserves. The European Central Bank (ECB) uses these reserves to conduct monetary policy. The money supply is measured using monetary aggregates:
- M1: Cash + demand deposits
- M2: M1 + savings deposits
- M3: M2 + time deposits
Types of Money
- Legal Tender (Cash): Coins and banknotes issued by central banks (e.g., the ECB). This includes commodity money and fiat money.
- Bank Money: Deposits in banks accepted as payment (demand, savings, and installment deposits).
Financial Instruments
Financial instruments are used to finance activities. Savers (lenders) provide funds to debtors (borrowers). The difference between money paid and received is the interest, and the interest rate is the interest on the total borrowed amount.
Financial Intermediaries
Financial intermediaries mediate between those who want to invest and those who want to borrow. The financial system comprises institutions that facilitate this process.
The Stock Exchange
The stock exchange (stock market) is a place where firms and public institutions raise capital. In Spain, there are four stock exchanges: Madrid, Barcelona, Valencia, and Bilbao.
Stock Exchange Participants
- Suppliers: Companies issuing new shares or selling existing securities.
- Demanders: Investors seeking to acquire securities.
Markets
- Primary Market (Issue Market): For new share issues.
- Secondary Market: For trading existing securities.
Types of Securities
- Fixed Income: Securities with a fixed interest rate.
- Equity: Securities where interest depends on the issuing institution’s profits.
Financial Intermediaries
Types of Financial Intermediaries
- Banks: Can generate money supply through deposits. Examples include the Bank of Spain, private banks, savings banks, credit unions, and rural banks.
- Non-bank Financial Intermediaries: Cannot generate money supply. Examples include the ICO (Instituto de Crédito Oficial), insurance companies, pension funds, mutual funds, and leasing companies.
Non-Bank Intermediaries
- ICO (Instituto de Crédito Oficial): A public institution complementing private intermediaries.
- Insurance Companies: Invest policyholder funds.
- Pension Funds: Supplement social security pensions.
- Mutual Funds: Invest in various assets (fixed income and equity).
- Leasing Companies: Provide equipment or property for rent.
- Factoring Companies: Manage debt collection for other companies.