Financial Markets And The Economy

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Course Information
Discipline(s): 
Economics
Finance
Terms offered: 
Spring
Credits: 
3
Language of instruction: 
English
Contact Hours: 
45
Prerequisites: 
  • A course in economics, especially macroeconomics, is essential.
  • Courses in finance, accounting and/or corporate finance would be advantageous.
Description: 

The objective of this course is to deepen students’ understanding of the functions of financial markets in addition to key linkages between the real economy and the financial sector. This requires an understanding of the instruments traded on the key financial markets and their purpose, elements of security pricing, the most important institutions active on those markets and, finally, how governments attempt to steer the economy by means of policy measures which operate via financial markets. In addition, some of the structural weaknesses in the financial system will be explained, which constitute sources of financial and economic instability, and which can result in widespread market failure.

A core message the course will be that a modern economy cannot function without an efficient financial system; equally, the financial system must be tailored to the needs of the real economy and must not be allowed to become self-serving. By means of case studies, the recent experiences of Iceland, Ireland and Austria will be examined, with reference to other countries such as the United Kingdom and Greece.

After considering the structure of an economy and the interactions of its main sectors, attention will focus on how financial markets reconcile the needs of economic agents. Due to the progress of globalisation, money markets are the most highly integrated financial markets, internationally; hence the need to examine the foreign exchange and Eurocurrency markets, in addition to instruments traded on “domestic” markets. Important considerations include payments imbalances, government borrowing and the activities of multinational banks. As the money market is the channel through which monetary policy operates, it assumes special importance in efforts to stabilise the economy.

Capital markets are also considered, emphasising the financing needs of the corporate sector and the government. Innovative activity, from junk bonds to more recent innovation in securitisation, has frequently ended in grief; nevertheless, has to be viewed as an essential development. Markets for derivative securities will not be dealt with extensively, and the emphasis here will be to understand how the growth of credit derivatives in recent years exacerbated a crisis which originated elsewhere.

The course will include a visit to the currency museum of the Austrian Central Bank.

Attendance policy: 

Attendance at all classes and excursions is mandatory and will be monitored (please note the IES Abroad Vienna policy). 

Learning outcomes: 

By completing this course, students will be able to:

  • Understand the role of the financial system in the domestic, as well as the global, economy, with special emphasis on the Eurozone and Austria. The USA will be used for comparative purposes, where appropriate.
  • Understand the reasons for recurring financial and economic crises: In particular, how national governments do not comply with the constraints of globalisation.
  • Discuss the main instruments traded on financial markets, along with the roles of the principal markets, which are frequently discussed in the financial press.
  • Discuss current trends and developments in the international financial system (e.g. exchange-rate regimes, globalisation and economic integration, trade liberalisation etc.) from a historical perspective.
  • Evaluate critically the arguments of interest groups and culturally accepted prejudices concerning deregulation and free markets.
Method of presentation: 
  • Lectures, which will incorporate class discussion
  • Group presentations on given topics (case study on banking crises)
  • Class excursion to the currency museum of the Austrian central bank 
Field study: 

Excursion: Visit to Austrian Central Bank – Currency Museum

Required work and form of assessment: 
  • A recommended reading assignment is given for each week of class.
  • Additional reading assignments will be given which go beyond the lecture content. Some of this literature is indicated in the ‘additional reading’ section (see below). These books are readable descriptions of “what happened” as opposed to textbooks. However, this will be moderate as the course reading is onerous.
  • Group project on a case study and a presentation of findings, including a written summary hand out.
  • Quizzes and exams.

Forms of Assessment

  • Active participation in class discussions - 10%
  • Two quizzes - 20%
  • Midterm examination - 20%
  • Final examination - 30%
  • Group work and presentation - 20%
content: 
Week Content Reading Assignments
Week 1:
Overview of financial markets
 
  • key concepts (liquidity, leverage, negotiability etc.)
  • financial intermediation between sectors (and other functions)
  • types of markets (direct and indirect markets etc.)
  • sectoral flows-of-funds
  • open economy considerations.
  • Howells & Bain chs. 1+12 (pp. 1 – 27 & 332 – 358)
  • Mishkin: ch. 2 (pp. 23 – 40)              

Supplementary:  

  • Mishkin & Eakins chs. 1+2 (pp. 3 – 9 & 17 – 36)
Week 2: 
Structure of the economy
 
  • aggregate supply-aggregate demand (AS-AD) model of the economy
  • balance of payments
  • real and financial sectors – transmission mechanisms
  • the economy of the Eurozone.
  • Blanchard ch. 7 (pp. 139 – 160)
  • Howells & Bain ch. 2 (pp. 29 – 47)
  • Krugman, Obstfeld, Melitz ch. 13 (pp. 323 – 345)

Supplementary:

 

Week 3:
The special role of interest rates
 
  • yield curves – spot and forward
  • theories of yield curves
  • economic importance of yield curves
  • essence of monetary policy.
  • Choudhry ch. 3 (pp. 67 - 92)
  • Howells & Bain ch. 7 (pp. 201 – 232)
  • Mishkin chs. 4 – 6 (pp. 61 – 78; 120 – 137)

Supplementary: 

  • Valdez & Molyneux ch. 6 (pp. 127 – 137)
Week 4:
Money markets and banking
 
  • Money-market instruments (purpose, pricing)
  • Eurocurrency markets (origins, purpose, pricing, LIBOR, EURIBOR)
  • banks v. non-banks
  • bank balance sheets
  • banking book & trading book
  • A/L management.
  • Hull ch. 2 (pp. 21 – 38)
  • Howells & Bain ch. 10 (pp. 288 – 305)
  • Choudhry chs. 1+2 (pp. 1 – 20; 23 – 65)

Supplementary:     

  • Arnold ch. 9 (pp. 204 – 237)
  • Mishkin and Eakins ch. 9 (pp. 211 – 233)
  • Valdez & Molyneux ch. 6 (pp. 140 – 149)
Week 5:
Monetary policy in the Eurozone (contrast with USA)
  • The market for bank reserves
  • high-powered money and the multiplier
  • instruments of monetary policy
  • Eurozone – reserve auctions, reverse transactions
  • USA – federal funds market
  • federal funds rate v. EONIA.
  • Midterm
  • Mishkin chs. 16+17 (pp. 374 – 385; 393 – 403)
  • ECB ch. 4 (pp. 93 – 116)            

Supplementary: 

  • Mishkin & Eakins ch. 9 (pp. Appendix ch. 8, ref. week 2)
Week 6:
The International financial system
 
  • Exchange rates and exchange-rate regimes
  • the foreign-exchange market
  • problems (balance of payments – stability - persistent imbalances and crisis).
  • Howells & Bain chs. 8+9 (pp. 243 – 258; 261 – 285)
  • Mishkin chs. 20+21 (pp. 462 – 483; 487 – 510)

Supplementary:

  • Mishkin & Eakins chs. 13+14 (pp. 305 – 319; 337 – 355
  • Krugman, Obstfeld, Melitz ch. 20  (pp. 587 – 610)
Week 7:
The stock market and financing of corporations
 
  • corporate investment decision criteria
  • the stock market and corporate finance (investment banks and IPOs)
  • organisation of stock exchanges
  • stock pricing
  • rational expectations
  • efficient-markets hypothesis.
  • Howells & Bain ch. 6 (pp. 149 – 199)
  • Mishkin ch. 7 (pp. 141 – 163)

Supplementary:    

  • Arnold chs. 12+13 (pp. 300 – 361)
  • Mishkin & Eakins ch. 11 (pp. 259 – 275)
Week 8:
Bond markets and financing economic activity
 
  • bond pricing/yields; market participants (corporations, governments, foreign sector)
  • principal features of treasuries and corporate bonds
  • innovations in the bond market (junk bonds, mortgage bonds, ABS, securitisation).
  • Arnold chs. 10+11 (pp. 242 – 290)
  • Mishkin & Eakins ch. 10 (pp. 237 – 256)

Supplementary:

  • Valdez & Molyneux ch. 6 (pp. 149 – 165)
Week 9:
The clients of the financial system and the need for regulation in the European Union
 
  • government
  • corporate sector
  • household sector
  • foreign sector
  • can the financial sector lay golden eggs?
  • need for regulation (asymmetric information, moral hazard)
  • regulatory measures (Basel, banking union)
  • Howells & Bain chs. 11+12+13 (pp. 308 – 398)

Supplementary:

  • Mishkin & Eakins ch. 24 (pp. 617 – 634) 
  • Arnold ch. 18 (pp. 477 – 490)        
Week 10:

Case Study – Anatomy of banking crises in Iceland, Ireland and Austria

  • Class presentations based on internet research and recommended articles.
  • Final Exam
 

Required Reading: This is indicated for each week, usually but not always from the principal textbooks. Students are expected to read this material.

Supplementary Reading: This is additional material. Some of it may be a substitute for the required material, although from a different perspective. However, some of this material expands the treatment of the subject matter. 

 

 

Required readings: 

Required Reading: This is indicated for each week, usually but not always from the principal textbooks. Students are expected to read this material.