Part 6 Financing the Enterprise McGraw-Hill/Irwin Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.

CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 Financial Management and Securities Markets APPENDIX D Personal Financial Planning 15-2

Learning Objectives LO 15-1Define money, its functions, and its characteristics LO 15-2Describe various types of money LO 15-3Specify how the Federal Reserve Board manages the money supply and regulates the American banking system LO 15-4Compare and contrast commercial banks, savings, and loan associations, credit unions, and mutual savings banks LO 15-5Distinguish among nonbanking institutions such as insurance companies, pension funds, mutual funds, and finance companies LO 15-6Investigate the challenges ahead for the banking industry LO 15-7Recommend the most appropriate financial institution for a hypothetical small business 15-3

Enter the World of Business Will the Yuan Become the Next Global Currency? China is increasing efforts to make the yuan a global currency China has begun to allow other countries to trade in the yuan An increase in Yuan trading and investment would help buffer China against the dollar’s decrease in value Making the yuan a global currency could be beneficial for business as well Demand among foreign businesses for trading and investing in the yuan is not high, and the yuan must be convertible to be used as a major currency in the foreign reserves China was reluctant to do this in the past, keeping its currency rates lower than market value in a highly criticized move ? Why would an increase in yuan trading be beneficial to China? ? Why would an increase in yuan trading beneficial to businesses? ? What are some of the challenges involved with increasing yuan trading? 15-4

Money in the Financial System  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 15-5

Functions of Money 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 15-6

Functions of Money 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 15-7

For centuries people on the Micronesian island of Yap have used giant round stones, like the ones shown here, for money The stones aren’t moved, but their ownership can change 15-8

Characteristics of Money To be used as a medium of exchange, money must have: Acceptability Divisibility Portability Stability Durability Difficult to counterfeit 15-9

The Life Expectancy of Paper Currency 15-10

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 15-11

Costs to Produce Pennies and Nickels 15-12

Types of Money 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 15-13

A Check 15-14

Types of Money 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 15-15

Types of Money  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 Credit CARD (Card Accountability Responsibility and Disclosure) Act  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 15-16

High interest rates on credit cards and the most recent recession have led the bulk of Americans to reduce credit card balances for the first time in years

Types of Money 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 15-18

The American Financial System Guardian of the American financial system Independent agency of the federal government Established in 1913 to regulate the nation’s banking and financial industry Federal Reserve Board (The Fed) 15-19

The Federal Reserve System 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 Four Major Functions 15-20

Federal Reserve System 15-21

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 Monetary Policy 15-22

Fed Tools for Regulating the Money Supply 15-23

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 15-24

Four Main Monetary Policy Tools 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 15-25

Other Regulatory Functions of the Fed 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 15-26

Banking Institutions 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 15-27

Banking Institutions Credit Unions Financial institutions owned and controlled by depositors Usually having a common employer, profession, trade group, or religion Mutual Savings Banks Similar to S&Ls, but owned by depositors Found mostly in New England  New hybrid bank institutions perform multiple functions 15-28

Insurance for Banks 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 15-29

Bank Failures More than 380 banks have failed between Consumers’ money protected by FDIC Bank Failures 15-30

JPMorgan Chase is the second largest commercial bank in the United States behind Bank of America 15-31

Going Green Is the World Bank Serious about Sustainability? 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 ? Describe what the World Bank does. Why is it important? ? Why is sustainability becoming a major issue for the World Bank? ? Do you feel that the World Bank should make sustainability a priority? 15-32

Nonbanking Institutions 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 15-33

Nonbanking Institutions 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 15-34

Leading Diversified Financial Services Firms 15-35

State Farm Insurance allows users to input their information on its website to receive an auto insurance quote quickly and conveniently 15-36

Consider Ethics and Social Responsibility Cost of Borrowing Poses a Threat to Brazilian Consumers 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 ? Why are Brazilians having difficulty with borrowing and paying back debt? ? Do you feel that it is ethical for banks to charge such high rates for borrowing? ? What would you suggest as a way to reduce the debt problems that Brazilian consumers are facing? 15-37

Electronic Banking 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 15-38

Facts about ATM Use 15-39

Electronic Banking 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 15-40

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 15-41

Future of Banking  Advances in technology are challenging and changing the banking industry  During , 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 15-42

Solve the Dilemma Seeing the Financial Side of Business Dr. Stephen Hill, a successful optometrist, has developed a truly scratch-resistant and lightweight lens Hill has decided to invest his life savings and open Hill Optometrics to manufacture and market his invention Hill is uncertain about the “finance side” of business and the various functions of different types of financial institutions in the economy Despite having read mounds of brochures from various local and national financial institutions, Hill is still somewhat unclear about the merits and capabilities of each type of financial institution ? List the various types of U.S. financial institutions and the primary function of each. ? What services of each financial institution is Hill’s new company likely to need? ? Which single financial institution is likely to be best able to meet Hill’s small company’s needs now? Why? 15-43