Part 6

Financing the Enterprise

© 2015 McGraw-Hill Education.

CHAPTER 14 Accounting and Financial Statements

CHAPTER 15 Money and the Financial System

CHAPTER 16 Financial Management and Securities Markets

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Learning Objectives

LO 15-1 Define money, its functions, and its characteristics.

LO 15-2 Describe various types of money.

LO 15-3 Specify how the Federal Reserve Board manages the money supply and regulates the American banking

system.

LO 15-4 Compare and contrast commercial banks, savings and loan associations, credit unions, and mutual savings banks.

LO 15-5 Distinguish among nonbanking institutions such as insurance companies, pension funds, mutual funds, and finance companies.

LO 15-6 Investigate the challenges ahead for the banking industry.

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Money in the Financial System

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Fiat money is a paper money not readily convertible to a precious metal such as gold Gained full acceptance during the Great Depression

in the 1930s In the U.S., paper money is really a government “note” or

promise, worth the value specified on the note

Finance • The study of money; how it’s made, how it’s lost, and how it’s

managed

Money (Currency) • Anything generally accepted in exchange for goods and services

Functions of Money

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• Medium of exchange

• Trading one good or service for another of similar value

• Inefficient because not always divisible and can be complicated in multiple-party transactions

Before fiat money, the

trade of goods and services

was accomplished

through bartering

Functions of Money

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• Money serves as a common standard or yardstick of the value of goods and services

Measure of Value

• Money serves as a way to accumulate wealth (buying power) until it is needed

• The value of stored money is directly dependent on the health of the economy

Store of Value

Characteristics of Money

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To be used as a medium of exchange,

money must have:

• Acceptability

• Divisibility

• Portability

• Stability

• Durability

• Difficult to counterfeit

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• The U.S. government redesigns currency in order to stay ahead of counterfeiters and protect the public

• DID YOU KNOW? Around 75 percent of counterfeit currency is found and destroyed before it ever reaches the public

Costs to Produce Pennies and Nickels

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Types of Money

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Checking Account (Demand Deposit)

• Money stored in an account at a bank or other institution that can be withdrawn without advance notice

Savings Accounts (Time Deposits)

• Accounts with funds that usually cannot be withdrawn without advance notice

Paper Money and Coins

A Check

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Types of Money

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Money Market Accounts

• Accounts that offer higher interest rates than standard bank rates but with greater restrictions

Certificates of Deposit (CDs)

• Savings accounts that guarantee a depositor a set interest rate over a specified interval as long as the funds are not withdrawn before the end of the period—six months or one year for example

Types of Money

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Popular substitute for cash payments because of their convenience, easy access to credit, and acceptance by merchants around the world

Credit CARD (Card Accountability Responsibility and Disclosure) Act was passed into law in 2009 To regulate the practices of credit card companies that

were coming under attack by consumers

Important to all companies and cardholders

Credit Cards

• Means of access to preapproved lines of credit granted by a bank or finance company

Types of Money

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Debit Card

• A card that looks like a credit card but works like a check

• Using it results in a direct, immediate, electronic payment from the cardholder’s checking account to a merchant or third party

Traveler’s Checks, Money Orders, and Cashier’s Checks

• Common forms of “near” money• Guaranteed as cash

The American Financial System

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Federal Reserve Board (The Fed)

•Guardian of the American financial system•Independent agency of the federal government•Established in 1913 to regulate the nation’s banking and financial industry

The Federal Reserve System

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Four Major Functions

•Controls the money supply with monetary policy•Regulates financial institutions•Manages regional and national check-clearing procedures•Supervises the federal deposit insurance of commercial banks in the Federal Reserve system

Monetary Policy

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Monetary Policy

•The means by which the Fed controls the amount of money available in the economy•Aims to keep supply and demand in balance to avoid inflation/deflation

Mobile Money Transfer (M-PESA)

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In developing economies, the financial infrastructure is not well supported.

Many people in these areas have had to travel many hours by foot or train to retrieve their money for everyday purchases such as food.

M-PESA was created to alleviate this problem.

It uses mobile phones, which have become widespread in developing economies, to make money transfers.

All that is required of the user is their national ID or passport information, and they can send or receive money within a matter of minutes.

Fed Tools for Regulating the Money Supply

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Federal Reserve

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• One of the roles of the Federal Reserve is to use its policies to keep money flowing

• Money is the lifeblood of the economy

• If banks become too protective of their funds and stop lending money, the economy can grind to a halt

Four Main Monetary Policy Tools

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1. Open Market Operations

• Decisions to buy or sell U.S. Treasury bill in the open market• Buying securities increases money in supply and vice versa

2. Reserve Requirements

• Percentage of deposits a bank must hold in reserve• Has a strong effect on the economy and not used often

3. Discount Rates

• Rate of interest the Fed charges to loan money to banking institutions• Lowering discount rate encourages borrowing and expands money supply and vice versa

4. Credit Controls

• Authority to establish and enforce credit rules

Other Regulatory Functions of the Fed

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Regulating Member Banks

•Establishes and enforces banking rules that affect monetary policy and competition•Has authority to approve bank mergers

Check Clearing

•National check processing through check clearinghouses

Depository Insurance

•Supervises the federal insurance funds that protect the deposits in member banking institutions

Banking Institutions

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Commercial Banks

• Largest and oldest of all financial institutions, relying mainly on checking and savings accounts

• Loan to businesses and individuals

Savings and Loan Associations (S&Ls—also called “thrifts”)

• Primarily offer savings accounts and make long-term loans for residential mortgages

• Most have merged with commercial banks

Banking Institutions

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Credit Unions• Financial institutions owned and controlled by

depositors• Usually having a common employer, profession, trade

group, or religionMutual Savings Banks

• Similar to S&Ls, but owned by depositors• Found mostly in New England

New hybrid bank institutions perform multiple functions

Insurance for Banks

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Federal Deposit Insurance Corporation (FDIC)

• Insures personal accounts up to $250,000

National Credit Union Association (NCUA)

• Regulates and charters credit unions• Insures deposits through its National Credit Union

Insurance Fund• Similar to the FDIC

Bank Failures

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Bank Failures

• More than 380 banks have failed between 2009 - 2011

• Consumers’ money protected by FDIC

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JPMorgan Chase is the second largest commercial bank in the United States behind Bank of America

Is the World Bank Serious about Sustainability?

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• The World Bank raises money through donations, bond sales, and shareholder support

• The money is used to provide loans and other financial assistance to developing countries

• Realizing that funding certain projects could negatively affect the environment the World Bank adopted policies to assess the sustainability of proposed projects

• The World Bank must juggle both the human and environmental impacts when determining which projects to fund

• The World Bank has taken steps to curb climate change and support renewable energy

Nonbanking Institutions

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Diversified Firms

• Traditionally non-financial firms that have expanded into the financial field

Insurance Companies

• Businesses that protect their clients against losses from specified risks

Pension Funds

• Managed investment pools to provide retirement income for members

Nonbanking Institutions

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Mutual Fund

• Investment company that pools investor money and invests in large numbers of diversified securities

Brokerage Firm

• Buy and sell securities for clients and provide other services

Investment Bank

• Underwrites new issues of securities for corporations, states and municipalities needed to raise money in capital markets

Finance Companies

• Businesses that offer short-term loans at substantially higher interest rates than banks

Hedge Funds

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Hedge funds are large pools of money that are managed and used to invest in activities that promise a high return on investment High minimum initial investment requirement Only the wealthy are able to be involved Similar to mutual funds except hedge fund investments can

be high risk Increases the chances of a higher return on investment

Main point of contributing to a hedge fund

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State Farm Insurance allows users to input their information on its website to receive an auto insurance quote quickly and conveniently

Electronic Banking

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Electronic Funds Transfer (EFT)

• Any movement of funds by means of an electronic terminal, telephone, computer, or magnetic tape

Automated Teller Machines (ATM)• The most familiar form of electronic banking, which

dispenses cash, accepts deposits, and allows balance inquiries and cash transfers from one account to another

Electronic Banking

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Automated Clearinghouses (ACHs)

• A system that permits payments such as deposits or withdrawals to be made to and from a bank account by magnetic computer tape

Online Banking

• Bank at home or anywhere/anytime• 62% of adults list Internet banking as their preferred

banking method

Cost of Borrowing Poses a Threat to Brazilian Consumers

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The Brazilian economy has been booming in recent years, creating a growing middle class and consumers are spending and using credit like never before

The central bank of Brazil has increased interest rates

Credit cards have an annual interest rate of 238% on average, whereas the cost of borrowing for personal loans is 85% for retailers and 47% for banks

Higher interest rate tend to deter spending

Inflation in Brazil has risen significantly, which in turn increases the cost of borrowing

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• However, hackers have stolen millions from banking customers by tricking them into visiting websites and downloading malicious software that gives the hackers access to their passwords

• Computers and handheld devices have made online banking extremely convenient

Future of Banking

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Advances in technology are challenging and changing the banking industry

During 2007-2008, the financial markets collapsed under the weight of declining housing prices, subprime mortgages (mortgages with low-quality borrowers) and risky securities backed by these subprime mortgages Future of the structure of the banking system is in the

hands of the U.S. Congress Dodd-Frank Wall Street Reform and Consumer Protection

Act – Intent of the act is to eliminate the ability of banks to create this type of problem in the future

Mobile Money Transfer (M-PESA)

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In developing economies, the financial infrastructure is not well supported.

Many people in these areas have had to travel many hours by foot or train to retrieve their money for everyday purchases such as food.

M-PESA was created to alleviate this problem.

It uses mobile phones, which have become widespread in developing economies, to make money transfers.

All that is required of the user is their national ID or passport information, and they can send or receive money within a matter of minutes.

Discussion

? What are the six characteristics of money? Explain how the U.S. dollar has those six characteristics.

? Discuss the four economic goals the Federal Reserve must try to achieve with its monetary policy.

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