1. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter Fifteen Money and the Financial System

2. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Money in the Financial System Finance –The study of money: how it’s made, how it’s lost, and why. Money –Anything generally accepted in exchange for goods and services.

3. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Functions of Money Medium of Exchange: Accepted as payment for products and resources. Measure of Value: Single standard for assigning and comparing values of products and resources. Store of Value: Means of retaining and accumulating wealth.

4. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Characteristics of Money Acceptability Divisibility Portability Stability Durability Difficulty to Counterfeit

5. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Facts About Money The Life Expectancy of Paper Money: –$11.5 years –$52 years –$103 years –$204 years –$509 years –$1009 years FAST FACT: There is about $525 billion of US currency in circulation, and about two-thirds is held outside of the US. Source: “Fedpoint 1: How Currency Gets Into Circulation,” Federal Reserve Bank of New York – Publications, September 18, 2001, p. 1-2.

6. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Money Near Money –Savings account –Money market account –Certificate of deposit –Credit card –Debit card –Traveler’s check –Money order –Cashier’s check Checking Accounts –Check –NOW Account

7. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. A Check Clearing number Bank number Regional bank number This gets put on when the check clears. It represents the dollar amount, in this case, $250.00. Check number Account number Clearing number Bank number Check sum (a number used to verify that everything is correct)

8. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Facts About Checks About 13 million US households do not have checking accounts. 180 million checks are cashed annually in 3,700 check-cashing stores for a value of $55 billion. 85% of checks cashed are payroll checks and the average check is about $300. Source: Calmetta Coleman, “Altering Course, Banks Welcome Check Cashers,” Wall Street Journal, July 6, 2001, p. B1.

9. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Facts About Credit Cards MasterCard and Visa are the 2 major credit cards. American Express is the dominant Travel &Entertainment credit card Americans hold over $675 billion in credit card debt. Source: Emily Thornton, Heather Timmons, and Joseph Weber, “Who Holds the Cards?,” Business Week, March 19, 2001, p. 90.

10. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Facts About Debit Cards A debit card looks like a credit card but works like a check. A debit card gives a direct, immediate electronic payment to a merchant from the cardholder’s checking account. They lack credit, offer no “grace period,” and provide no paper trail of transactions.

11. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The American Financial System The Federal Reserve System Banking Institutions

12. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Federal Reserve System ©

13. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Functions of the Federal Reserve Board To control the money supply with monetary policy To regulate financial institutions To manage regional and national check- clearing procedures To supervise the federal deposit insurance of commercial banks in the Federal Reserve system

14. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Federal Reserve’s Monetary Policies 1.Open Market Operations 2.Reserve Requirements 3.Discount Rate 4.Credit Controls

15. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Fed Tools for Regulating the Money Supply Buy government securitiesThe money supply increases; economic activity increases. Sell government securitiesThe money supply decreases; economic activity slows down. Raise discount rateInterest rates increase; the money supply decreases; economic activity slows down. Lower discount rateInterest rates decrease; the money supply increases; economic activity increases. Activity Effect on the Money Supply and the Economy

16. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Fed Tools for Regulating the Money Supply Increase reserve requirementsBanks make fewer loans; the money supply declines; economic activity slows down. Decrease reserve requirements Banks make more loans; the money supply increases; economic activity increases. Activity Effect on the Money Supply and the Economy

17. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Fed Tools for Regulating the Money Supply Relax credit controlsMore people are encouraged to make major purchases, increasing economic activity. Restrict credit controls People are discouraged from making major purchases, decreasing economic activity. Activity Effect on the Money Supply and the Economy

18. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. The Check Clearing Process The Austin Bank adds $120.00 to Acme’s bank account. Suzy smith receives the canceled check from her bank in Chicago at the end of the month The Chicago Federal Reserve Bank electronically transmits $120.00 to the Dallas Federal Reserve Bank, which credits the Austin bank’s account for $120.00. Ms. Smith’s bank authorizes the Chicago Federal Reserve Bank to deduct $120.00 from its account. The Austin bank deposits the check in its account at the Federal Reserve Bank in Dallas. The Federal Reserve Bank in Dallas electronically transmits the check to the Federal Reserve Bank of Chicago. The Federal Reserve Bank of Chicago forwards the check to Ms. Smith’s bank in Chicago, which deducts the $120.00 from her account. Suzy Smith a student from Chicago, writes a check to Acme University Books in Austin, TX, for $120.00 for her textbooks. Acme deposits her check in its account in Austin, TX, bank. Day 1 Day 2Day 3

19. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Banking Institutions Common Banking Institutions: –Commercial Banks –Savings and Loan Associations –Credit Unions –Mutual Savings Banks

20. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Non-Banking Institutions Typical Non-Banking Institutions: –Insurance Companies –Pension Funds –Mutual Funds –Money Market Funds –Brokerage Firms –Non-Financial Firms –Finance Companies

21. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Electronic Banking ATM ETF ACHs Home Banking

22. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. ATM Facts The top 5 ATM owners are Bank of America, Wells Fargo, E-Trade Bank, American Express, and Bank One. The average ATM withdrawal is $60. ATM customers spend 20-25% more than non- ATM customers. 60% of Americans ages 25-34 use ATMs 8 times a month. The most popular day for ATM usage is Friday. Source: “ATM Fact Sheet,” Press Room: ATMfacts 2001, September 18,2001.

23. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Changes in Commercial Banking Mergers Now offer insurance, brokerage & investment banking services Large banks have offices in more states Internet banking Globalization of banking Foreign ownership of domestic banks – “Megabanks”

24. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Solve the Dilemma 1.List the various types of U.S. financial institutions and the primary functions of each. 2.What services of each financial institution is Hill’s new company likely to need? 3.Which single financial institution is likely to best meet Hill’s small company’s needs now?

25. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Explore Your Career Options In what industries are economists likely to be asked to provide economic projections?

26. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Additional Discussion Questions and Exercises 1.Look at Figure 15.2 in your textbook and determine in which of the 12 Federal Reserve Districts you are located. What is the nearest Federal Reserve bank city or Federal Reserve branch city? 2.What is meant by a demand deposit? 3.Why have credit cards become a popular substitute for money? 4.What are the advantages of automated teller machines (ATMs) for customers? For banks?

27. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 15 Quiz 1.Most paper currency is lightweight; the weight of money ` applies to which characteristic of money? a.durability b.stability c.divisibility d.portability 2.The percentage of deposits that a banking institution must hold in reserve, either in the bank itself or in a Federal Reserve Bank, and not loan to businesses or individuals is the a.discount rate. b.reserve requirement. c.M1. d.depository insurance.

28. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Chapter 15 Quiz 3.The largest of all banking institutions in the United States are a.savings and loan associations. b.commercial banks. c.credit unions. d.mutual savings banks. 4.The failure of the savings and loan associations and the problems in some commercial banks were caused primarily by a.high government taxes on banking institutions. b.bad real estate loans. c.failure of students to repay college loans. d.electronic funds transfer.

29. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Multiple Choice Questions about the Video 1.The difference between a secured bond and a debenture is that a.a secured bond has specific assets pledged against the money borrowed while a debenture does not. b.a secured bond has fixed assets pledged against the money borrowed while a debenture has short-term assets pledged against the money borrowed. c.a secured bond is a high risk debt security while a debenture is a low risk debt security. d.a secured bond is always secured by land while a debenture is always secured by equipment.

30. McGraw-Hill/Irwin © 2003 The McGraw-Hill Companies, Inc., All Rights Reserved. Multiple Choice Questions about the Video 2. Which of the following statements best describes the tax treatment for interest and dividend payments? a.Interest is paid after taxes. b.Interest is a tax-deductible expense. c.Dividends are a tax-deductible expense. d.All are correct.