Chapter 16. The Financial System.
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1 Chapter 16 The Financial System
2 Learning Objectives 1 Understand the financial system. 5 Evaluate financial institutions List the various types of securities. Discuss financial markets. Understand the stock markets Explain the role of the Federal Reserve System. Describe the regulation of the financial system. Describe the global perspective of the financial system.
3 The Financial System The financial system is the process by which money flows from savers to users.
4 Understanding the Financial System Financial System Savers Users Financial Institutions Financial Markets Savings is a function of many variables. Funds can be transferred between users and savers directly or indirectly.
5 Types of Securities Securities Financial instruments Obligations on the part of the issuer Businesses and governments Provide rate of return to purchasers Money market instruments Bonds Stock
6 Money Market Instruments Short-term debt securities Issued by governments, financial institutions, and corporations Investors are paid interest for the use of their funds Generally low-risk U.S. Treasury bills, commercial paper, and bank certificates of deposit
7 Bonds Government Bonds Bonds sold by the U.S. Department of the Treasury Municipal Bonds Bonds issued by state or local governments Revenue bonds are used toward a project that will produce revenue, general obligation bonds are not Corporate Bonds A diverse group and often vary based on the collateral
8 Types of Bonds
9 Bond Ratings Price is determined by risk and interest rate. Several firms rate bonds Standard & Poor s (S&P) Moody s Investment-grade Speculative/Junk
10 Standard and Poor s Bond Ratings Highest AAA Investment grade AA A BBB BB Speculative grade B CCC CC Lowest C
11 Stocks Common stock ownership claims in corporations Vote on major company decisions Cash dividends Price appreciation Preferred stock stockholders who receive preference in the payment of dividends
12 Convertible Securities Stockholder has the right to exchange the bond or preferred stock for a fixed number of shares of common stock.
13 Financial Markets Primary market firms and governments issue securities and sell them initially to the public When a firm offers a stock for sale to the general public for the first time Secondary market collection of financial markets in which previously issued securities are traded among investors
14 Understanding Stock Markets Stock market (exchange) market in which shares are bought and sold by investors, such as the New York Stock Exchange.
15 Stock Exchanges The New York Stock Exchange the Big Board is the most famous and one of the oldest stock markets in the world. More than 3,000 stocks are listed on the NYSE. The NASDAQ Stock Market the second largest stock market. Over 5,000 companies have their stocks listed on Nasdaq, but many are smaller firms. Other U.S. Stock Markets: The American Stock Exchange/AMEX Regional stock exchanges Foreign markets
16 ECNs and the Future of Stock Markets ECNs Electronic Communication Networks The 4 th market Buyers and sellers meet in a virtual market and exchange with one another Take place on INET or Archipelago INET and Archipelago have been purchased by NASDAQ and the NYSE
17 Investor Participation in the Stock Market Investors use brokerage firms to: 1. Establish an account 2. Enter orders 3. Trade stock The brokerage firm executes the trade on behalf of the investor, charging a fee for the order. Market order Limit order
18 Financial Institutions Commercial Banks Savings Banks and Credit Unions Non-depository Institutions
19 Financial Institutions
20 Electronic Banking An increasing amount of funds move through electronic funds transfers (EFTs). Millions of businesses and consumers now pay bills and receive payments electronically. Most employers directly deposit employee paychecks. Social Security and other federal payments are made each year electronically. Most banks now offer customers debit cards More than 3/5 of American households use some online banking.
21 Federal Deposit Insurance Corporation Enacted by the Banking Act of 1933 Restored public confidence in the banking system Before deposit insurance, runs were common as people rushed to withdraw their money from the bank Deposit insurance shifts the risk of bank failures from individuals to the FDIC
22 Savings Banks and Credit Unions Offer a variety of consumer services 80+% of their loans are real estate loans Credit unions are cooperative financial institutions owned by depositors/members Credit unions are created to serve consumers Insured by National Credit Union Administration (NCUA), which functions the same as the FDIC
23 Nondepository Financial Institutions Insurance Companies Pension Funds Finance Companies Mutual Funds
24 The Role of the Federal Reserve The Federal Reserve Created In 1913 Central bank of the United States Regulates commercial banks Performs banking-related activities for the U.S. Department of Treasury Provides services for banks Sets monetary policy
25 Organization of the Federal Reserve 12 Federal reserve districts Own federal reserve bank District banks are run by a nine-member board of directors The board of governors is the governing body Politically independent Federal Open Markets Committee (FOMC) sets most policies concerning monetary policy and interest rates
26 Check Clearing and the Fed Americans still write billions of paper checks. The process by which funds are transferred from the check writer to receiver is a multiple-step process managed and cleared by the Fed. The Check Clearing for the 21st Century Act is making this process more electronic.
27 Monetary Policy Controlling supply of money and credit Measures of the money supply: M1 & M2 The Fed requires banks to maintain reserves Set the discount rate Open market operations
28 M1 & M2
29 Tools Used by the Federal Reserve to Regulate the Growth in the Money Supply
30 Regulation of the Financial System Bank regulation Government regulation of the financial markets (SEC) Industry self-regulation Rules of conduct by professional organizations like National Association of Securities Dealers Market surveillance
31 The Financial System: A Global Perspective The financial system is more connected. Financial institutions are more global. Only 2 of the 20 largest banks in the world are U.S. institutions. Most nations have a central bank.
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