Money & The Bank of Canada

Money & The Bank of

Canada

Three criteria of MoneyO A Medium of ExchangeO A Store of ValueO A Unit of Account

Medium of ExchangeO Money is easy to exchange and readily

available

O Money must have a high value relative to its weight and composition.

O   Historically the early form of barter did not provide the transferability and divisibility that makes trading efficient.

O Money must be available in different values and be divisible.

A Store of ValueO Money can be easily stored in a variety of ways for future use.  O The ability to store money allows us to save for larger purchases. O To be stored and saved over time, money must have a relatively stable value. 

O For example, if there is a lot of inflation, money will not be stored and retain little value. O Thus, high periods of inflation also correspond with a lot of uncertainty and angst in the

economy.  

O Liquidity refers to the relative ease with which an asset can be used to make payment.  Money is the most liquid of assets, while a house, for example, is not very liquid because it must be sold before we can liquidate its value.

O Other items can be used as stores of value. For example, gold bullion (or bars) is used by many as a way to keep value. A one ounce bar of gold (size of a loonie) is worth $700.

O  In money market trading, one of the items that is constantly evaluated is the changing value of the Canadian dollar versus other currencies

A Unit of AccountO Money can be used purely for accounting

purposes without having a physical existence of its own.  As well, money allows us to compare the value of goods and services in our economy.  For example, the cost of an XBOX is the same as the cost of a new mountain bike. Knowing the value of goods allows you to compare items and make decisions based on the respective value of things.

O .  

Foreign Exchange Trading

O   In money trading accounts, you trade money from different countries in order to take advantage of increases in the value of other countries’ money. 

O For example, if the Canadian economy is seen as doing well, then the Canadian dollar will go up in relation to the US economy which may be seen as not doing as well.

O Thus, traders who realize this may buy Canadian money with the expectation that the value of the currency will go up. This form of trading has gained popularity in recent years because the government does not charge you taxes on your capital gains

Example of ForexO Satya from the US, has a money trading account. He

feels that the Canadian economy will do well because of its huge exposure to the oil and gas sector.

O As a result, Satya. uses his country’s money (American dollars) to buy Canadian dollars.

O Let’s say Satya bought $100 000 dollars US worth of Canadian dollars at the beginning of the year, and by the end of the year there is a 10% increase of the Canadian dollar compared to the US dollar, then Satya  just made a $10 000 profit to give to him mom.

Bank of CanadaO The Bank of Canada, has been acting as

a monitor for the supply of money in Canada.

O This wholly government-owned institution has been given the mandate to perform four basic functions relating to money and the financial system.

Managing the Money SupplyO The most important role of the Bank of

Canada is to control the amount of money circulating in the economy. 

O The Central Bank sets monetary policy and this policy directly impacts the Canadian banking system and Canadian citizens. While managing the money supply the Bank has three goals:

a. Minimizing inflation in order to preserve the purchasing power of the dollar. 

b.  Maintaining real output of the economy as close as possible to its potential level.

c. Regulating the external value of the Canadian dollar on foreign exchange markets.

The Bankers’ BankO The Bank of Canada holds the deposits of financial

institutions, such as chartered banks and near banks. O These deposits are used for several purposes. The

accounts held by the Bank of Canada are part of their cash reserves.

O These are kept in bank vaults so that sufficient funds are available to meet withdrawal requests from depositors. If cash reserves in banks are low, they can borrow from the Bank of Canada. These advances are charged interest rates at the going ‘’bank rate’’.

Banker to Federal Government

O Banker to Federal Government: In order to conduct the business of taxing, spending and so on, and the federal government needs a bank to manage its transactions and financial assets.   The Bank of Canada completes four main tasks for the government of Canada:

a. The Bank of Canada holds some of the government’s bank deposits and decides where the others are to be held;

b. The Bank of Canada handles the financing of the government’s debt;

c. The Bank of Canada handles the financing of the government’s debt by issuing bonds such as Canada Savings Bonds;

d. The Bank of Canada handles the foreign exchange reserve which is a reserve of several foreign currencies such as the US dollar that is used to intervene in foreign exchange markets to regulate the value of the Canadian dollar. 

Issues CurrencyO The Bank of Canada is responsible for

issuing paper currency as it sees fit.  For example, some periods of the year require more liquid money in the economy. The Bank of Canada also tries to reduce counterfeiting by various means.  

Bank of Canada GoalsO As the business cycle moves through its ups and downs,

the Bank changes its actions to respond to the needs of the economy.  

O For example, if the economy is in a deep recession or trough, the government will ease up interest rates to make money more easily available.

O Tight money is the term used to describe a monetary policy that has high interest rates. In this scenario, credit is difficult to obtain resulting in less money being circulated. 

O Easy money is a term used to describe a monetary policy where interest rates are low; credit is easy to obtain and there is an increase in the money supply (money in circulation).

Interest RatesO Interest rates are very important because they affect the

decisions of all Canadians who are deciding whether to save or borrow money.

O For example, when interest rates are high, fewer Canadians will want to borrow money. As well, higher rates discourage businesses from investing and expanding their businesses.

O Higher interest rates also attract more foreign investors to buy Canadian dollars, thus increasing the value of the Canadian dollar.

O Municipal, provincial and federal budgets are affected, because the higher the interest rates the more interest they must pay on their debt causing them to spend less money on programs that Canadians need and want.

Different Types of Interest Rates

O Prime RateO Bank RateO The Overnight Rate

Prime RateO This is the lowest rate of interest a financial institution offers

to its best customers. It is used as a benchmark for other lending rates that the institution offers to its customers.

O Usually a loan received by an average Canadian is rated `’above prime’’ and tells the consumer how close they are to the best rate possible.

O When getting a mortgage and buying a house, you can save thousands per year by carefully observing mortgage rates that offer deals near the prime rate. Also, it is important to note, that if this rate changes, all other rates received by banks and customers will also change. For example, if the prime rate goes up by 0.25 % all other rates go up by 0.25%.

Bank RateO This is the rate of interest charged by the

bank of Canada to the chartered banks on any loans or advances they receive. The bank rate is usually a quarter point higher than the overnight lending rate (or 0.25%). 

The Overnight RateO Throughout the course of a day, banks will

transfer money to each other, to foreign banks, to large clients, and other counterparties on behalf of clients or on their own account. At the end of each working day, a bank may have a surplus or shortage of funds.

O Banks that have surplus funds or excess reserves may lend them or deposit them with other banks, who borrow from them. The overnight rate is the amount paid to the bank lending the funds.