Financial Markets and Institutions
The objective of this course is to describe in detail what financial markets are and how financial institutions operate within them. In doing so, we will learn how financial markets and institutions shape the broader economy. Students will be introduced to the theory, structure, management, and regulation of financial institutions. We will be particularly interested in understanding the interest rate - the economic factors that influence the interest rate, the economic factors that are influenced by the interest rate, and what that means for the economy. In addition, we will learn about the role and effects of government regulation on financial markets, and the risks financial institutions face. By focusing on how and why financial markets and institutions exist, and what financial institutions do, students will also gain insight into the evolution of the industry and a better understanding of how financial institutions promote economic development and efficiency.
Topics Covered
What Do Interest Rates Mean, And What Is Their Role In Valuation?
We kick off this section by deciphering the concept of interest rates and refreshing key time value of money principles. We then draw a clear line between real and nominal interest rates. This exploration sets the stage for students to appreciate the vital role interest rates play within the financial markets.Why Do Interest Rates Change?
Understanding the constant ebb and flow of interest rates is vital given their influence on asset values. This section unravels the underlying mechanisms that incite interest rate fluctuations. We delve into the Theory of Portfolio Choice, recap bond pricing fundamentals, scrutinize the bond market, and explore what triggers shifts in bond supply and demand.How Do Risk and Term Structure Affect Interest Rates?
Building on our understanding of interest rates and their fluctuations, we next explore the factors causing variance in interest rates across different bonds. We dissect the influence of risk structure—how bonds with identical maturities carry differing risks—and term structure—how bonds with the same risk profile have different maturity periods. We examine several stylized facts of the yield curve, and offer several theories that help explain them. The section concludes with a historical investigation into the yield curve's potential as a precursor to economic recessions.Are Financial Markets Efficient?
Is the stock market accurately priced? Can you beat the market? We revisit the first fundamental law of finance and formalize the Efficient Market Hypothesis (EMH). Next, we discuss the prominent arguments for and against EMH, and examine review some empirical findings including CAPM, the excess volatility puzzle, the size effect, and more. We end this section by introducing behavioral economics and behavioral finance. In doing so, students get a primer on psychology and how heuristics (i.e. "the fast thinking brain") can lead to behavioral biases.Why Do Financial Institutions Exist?
The primary function of financial markets is to channel funds from savers to borrowers. In light of this, what role do financial institutions play? Why do we need them at all? We begin by examining what qualities of financial markets give rise to financial institutions - primarily transaction costs and information asymmetry. We study the 'lemon's problem' and take a detour through Game Theory. Highlighting specific challenges individuals and firms confront due to information asymmetry, we conclude by showing how these dynamics influence a firm's capital structure.The Federal Reserve And Monetary Policy
Finalizing our exploration on interest rates, this section delves into the vital role and mechanisms of monetary policy. First, we lay out the structure of the U.S. Federal Reserve System, including its 12 Federal Reserve Banks, the Federal Open Market Committee (FOMC), and the Board of Governors. Next, we define the Federal Reserve's three key objectives — targeting 2% inflation, ensuring low unemployment, and moderating interest rates. Within this framework, we study the specific monetary policy tools that the Federal Reserve uses to achieve its goals with a focus on the central mechanism - the federal funds rate. We conclude by reviewing several recent economic crises in order to solidify our understanding of these monetary policy tools in the broader context of how they are used to ensure stability and efficiency in the economic landscape.Blockchain Technology and Cryptocurrency
This section demystifies blockchain technology, with a keen focus on its initial implementation: Bitcoin. We dissect the underlying mechanics of cryptocurrency, before scrutinizing Bitcoin's economic prospects as an alternative to traditional fiat currencies. Culminating this section, we draw a clear distinction between Bitcoin and Ethereum, emphasizing Ethereum's unique offerings like smart contracts, decentralized applications, and its role in propelling 'Web3'.