1. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 1 Introducing Money and the Financial System

2. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-2 Topics in Financial Decisions Financial system and economy connections Financial markets Financial institutions Money Economic approach

3. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-3 Financial System and the Economy Financial system –A network of markets and institutions to bring savers and borrowers together Savers and borrowers –3 groups of potential savers and borrowers are households, businesses, and governments Financial instruments –Assets & liabilities

4. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-4 Financial Services provided by the financial system Risk sharing –Borrowers & savers reduce the uncertainty to which they are exposed Liquidity –A measure of how readily one asset can be converted to cash Information –The financial system gathers information about borrowers’ circumstances so individual savers do not need to search for prospective borrowers

5. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-5 Financial Markets Transfers funds from savers to borrowers International capital market (lending & borrowing across national boundaries) is growing rapidly Asset prices communicate information

6. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-6 Financial Institutions Intermediaries between borrowers and savers Deposit insurance crisis (1980’s and early 1990’s) and recent reforms Loans from financial institutions account for the majority of funds borrowers raise (rather than the stock and bonds markets, as seen in Figure 1.1)

7. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-7 Figure 1.1 Sources of Funds for Nonfinancial Businesses: Markets Versus Institutions

8. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-8 Money Defined as anything that people are willing to accept in payment for goods & services or to pay off debts. Money supply: total quantity of money in the economy

9. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-9 Money in the U.S. Federal Reserve System –The central bank in the United States –Collects data on various measures of the money supply Monetary policy –The management of the money supply and its links to prices, interest rates, and other economic variables Monetary theory –Explores the relationships linking changes in the money supply to changes in economic activity and prices

10. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 1-10 Economic Analysis as a Tool Explain current developments & events Predict future developments & events Developing an economic approach Applying an economic approach