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The Financial System
http://www.wileybusinessupdates.com
Chapter
16
Outline the structure and importance of the financial system.
List the various types of securities.
Define financial market, and distinguish between primary and secondary financial markets.
Describe the characteristics of the major stock exchanges.
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Learning Objectives
Discuss the organization and functioning of financial institutions.
Explain the functions of the Federal Reserve System and the tools it uses to control the supply of money and credit.
Evaluate the major features of regulations and laws affecting the financial system.
Describe the global financial system.
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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.
Understanding the Financial System
Securities Financial instruments
Obligations on the part of the issuer
Businesses and governments
Provide rate of return to purchasers
Types of Securities
Money market instruments
Bonds
Stock
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
Money Market Instruments
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
Bonds
Price is determined by risk and interest rate.
Several firms rate bonds Standard & Poor’s (S&P) Moody’s
Investment-grade Speculative/Junk
Bond Ratings
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
Stocks
Stockholder has the right to exchange the bond or preferred stock for a fixed number of shares of common stock.
Convertible Securities
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
Financial Markets
Stock market (exchange)– market in which shares are bought and sold by investors, such as the New York Stock Exchange.
Understanding Stock Markets
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
Stock Exchanges
ECNs– Electronic Communication Networks The 4th 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
ECNs and the Future of Stock Markets
Investors use brokerage firms to:1. Establish an account2. Enter orders3. Trade stock
The brokerage firm executes the trade on behalf of the investor, charging a fee for the order.
Market order Limit order
Investor Participation in the Stock Market
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 1/3 of American households use
some online banking.
Electronic Banking
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
Federal Deposit Insurance Corporation
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
Savings Banks and Credit Unions
Insurance Companies
Pension Funds
Finance Companies
Mutual Funds
Nondepository Financial Institutions
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
The Role 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
Organization of the Federal Reserve
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.
Check Clearing and the Fed
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
Monetary Policy
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
Regulation of the Financial System