The Financial System Chapter 16

Understand the financial system. List the various types of securities. Discuss financial markets. Understand the stock markets. 1 Learning Objectives Evaluate financial institutions. Explain the role of the Federal Reserve System. Describe the regulation of the financial system. Describe the global perspective of the financial system

The financial system is the process by which money flows from savers to users. The Financial System

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 Bonds, Stocks, Money Market Instruments Obligations on the part of the issuer Businesses and governments Provide rate of return to purchasers Types of Securities

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

Types of Bonds

Price is determined by risk and interest rate. Several firms rate bonds Standard & Poor’s (S&P) Moody’s Fitch Investment-grade Speculative/Junk Bond Ratings

Standard and Poor’s Bond Ratings

Common stock– basic form of corporate ownership Vote on major company decisions Cash dividends Price appreciation Preferred stock– stockholders who receive preference in the payment of dividends Stocks

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 2,300 companies’ stocks are listed on the NYSE. The NASDAQ Stock Market– the second largest stock market. Over 3,6000 companies have their stocks listed on Nasdaq, but many are smaller firms. Foreign markets Stock Exchanges

Investors use brokerage firms to trade and sell 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

Commercial Banks Savings Banks and Credit Unions Non-depository Institutions Financial Institutions

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. Many consumers do some or all of their banking online 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 FDICFDIC Federal Deposit Insurance Corporation

Offer a variety of consumer services Not a major lender to small businesses Credit unions are cooperative financial institutions owned by depositors/members By law, credit union members must share similar occupations, employers, or memberships in certain organization, effectively capping the size. Savings Banks and Credit Unions

Insurance Companies Pension Funds Finance Companies Mutual Funds Nondepository Financial Institutions

The Federal ReserveFederal 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

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

Tools Used by the Federal Reserve to Regulate the Growth in the Money Supply

Bank regulation Government regulation of the financial markets (SEC)SEC Regulation of the Financial System

The financial system is more connected. Financial institutions are more global. Only 3 of the 20 largest banks in the world are U.S. institutions. Most nations have a central bank. The Financial System: A Global Perspective