Chapter 3
What Is Money?
Before becoming immersed in the study of money and banking, the student must understand how
money is defined and measured. The first half of Chapter 3 discusses the definition of money:
how the economist’s definition differs from that of common speech, the functions of money, and
a historical view of how what serves as money has changed over time. The second half of the
chapter describes the tricky issues involved in applying the definition of money in order to
measure it.
This chapter introduces FYI boxes, which highlight dramatic historical episodes, interesting
ideas, and intriguing facts to keep students excited about the material.
MyLab Chapter 3
Financial Derivatives
The treatment of financial derivatives markets (forwards, futures, options, and swaps) in this
book differs markedly from that in other money and banking textbooks. Financial derivatives
are approached from the perspective of managers of financial institutions, and this is why this
material is placed in the financial institutions part of the book. Rather than go into a lot of facts
about these different markets, this chapter focuses on how the markets work and how they can be
used to hedge the risk faced by financial institutions. This approach makes more sense to
students who now clearly see why studying these markets and their operation is relevant.
Other money and banking textbooks tend to give only a cursory treatment of what profits arise
for a holder of an option contract given different market outcomes. They may have a figure
illustrating the profits, but do not give a detailed explanation of how profits are generated. I think
that this is a terrible mistake because students often do not find financial derivatives contracts to
be particularly intuitive, and this is particularly true for the options contract. This chapter takes a
different approach by containing an extensive explanation and discussion of Figure 1, which
outlines the profits and losses that occur on financial options and futures contracts depending on
what happens to the price of bonds. To get the students to understand these contracts and what
their differences are, the instructor needs to carefully walk the students through the numerical
example of Figure 1. My experience in class suggests that unless this is done, many students will
just not understand what these financial derivatives, and particularly options, are all about.