1. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Part 6 Managing Financial Resources

2. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. Chapter 17 Financial Management and Institutions

3. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-3 Chapter Objectives 1.Identify the functions performed by a firm’s financial managers. 2.Describe the characteristics a form of money should have and list the functions of money. 3.Explain each of the various measures of the money supply. 4.Explain how a firm uses funds. 5.Compare the two major sources of funds for a business. 6.Identify the likely sources of short- and long-term funds. 7.Describe the financiaCommercialand the major financial institutions. 8.Explain the functions of the Federal Reserve System and the tools it uses to control the money supply. 9.Describe the global financial environment.

4. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-4 The Role of the Financial Manager Finance—business function of planning, obtaining, and managing a company’s funds in order to accomplish its objectives in the most effective possible way. Finance manager—employee responsible for developing and implementing the firm’s financial plan and for determining the most appropriate sources and uses of funds.

5. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-5 The Role of the Financial Manager Chief financial officer—top finance executive of a corporation; usually reports directly to the firm’s CEO. VP for Financial Management Treasurer Controller All address the risk-return trade-off

6. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-6 Organizational Structure of the Finance Function

7. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-7 The Role of the Financial Manager The Financial Plan Document specifying the funds a firm will need for a period of time, the timing of inflows and outflows, and the most appropriate sources and uses of funds.  What funds will the firm require during the appropriate period of operations?  How will it obtain necessary funds?  When will it need more funds?

8. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-8 Characteristics and Functions of Money Characteristics of Money Money—anything generally accepted as payment for goods and services.

9. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-9 Characteristics and Functions of Money Characteristics of Money Divisibility—Ability to be broken down into smaller units Portability—Ability to be easily moved from place to place Durability—Ability to survive repeated usage over time

10. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-10 Characteristics and Functions of Money Characteristics of Money Difficulty in Counterfeiting—Currency should be hard for anyone, other than the government, to produce Stability—Should maintain a relatively stable value

11. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-11 The New Color of Money

12. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-12 Characteristics and Functions of Money Basic Functions of Money

13. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-13 The Money Supply The money supply consists of coins and currency as well as financial assets that also serve as a medium of exchange (traveler’s checks, bank checking accounts, other so- called demand deposit accounts, and credit union share draft accounts)

14. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-14 Components of M1

15. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-15 The Money Supply Another, broader definition of the money supply is the M2 M2—includes the M1 plus a number of other financial assets that are almost as liquid as cash, but do not serve directly as a medium of exchange These assets include various savings accounts, certificates of deposit and money market mutual funds

16. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-16 Why Organizations Need Money Organizations require funds to run day-to-day operations, compensate employees and hire new ones, pay for inventory, make interest payments on loans, pay dividends to shareholders, and purchase property, facilities, and equipment

17. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-17 The Financial Planning Process

18. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-18 Why Organizations Need Money Generating Funds from Excess Cash Many financial managers invest the majority of their firms’ excess cash balances in marketable securities The most popular marketable securities include:  U.S. Treasury bills  Commercial paper  Repurchase agreements  Certificates of deposit

19. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-19 Sources of Funds Debt capital—funds obtained through borrowing. Equity capital—funds provided by the firm’s owners when they reinvest earnings, make additional contributions, or issue stock to investors.

20. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-20 Debt and Equity Capital: Two Basic Sources of Funds

21. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-21 Comparison of Debt and Equity Capital

22. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-22 Sources of Funds Short-Term Sources of Funds Short-term sources of funds are repaid within one year Major sources of short-term funds include:  Trade credit  Short-term loans  Commercial paper

23. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-23 Sources of Funds Long-term Sources of Funds Long-term sources are repaid over many years Three common sources of long-term funds are:  Long-term loans  Bonds—certificates of indebtedness sold to raise long-term funds for a corporation or government agency  Equity financing—acquired by selling stock in the company or reinvesting company earnings

24. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-24 Sources of Funds Long term Sources of Funds Public Sale of Stock and Bonds  Sales of stocks and bonds represent a major source of funds for corporations  They provide cash inflows for the issuing firm and either a share in its ownership or a specified rate of interest and repayment at a stated time

25. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-25 Sources of Funds Long term Sources of Funds Private Placements—stock or bond issues sold to a small, select group of large investors such as pension funds and life insurance companies Venture Capitalists—raise money from wealthy individuals and institutional investors and invest these funds in promising firms

26. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-26 Sources of Funds Long term Sources of Funds Leverage—technique of increasing the rate of return on an investment by financing it with borrowed funds  The key to managing leverage is ensuring that the company’s earnings remain larger than its interest payments, which increases the leverage on the rate of return on shareholders’ investment

27. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-27 How Leverage Works

28. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-28 The Financial System and Financial Institutions Financial System—process by which funds are transferred from savers to users.

29. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-29 Overview of the Financial System and Its Components

30. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-30 The Financial System and Financial Institutions Depository Institutions—financial institutions that accept deposits that can be converted into cash demand.

31. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-31 The Financial System and Financial Institutions Commercial Banks Largest and probably most important financial institutions Approximately 7,900 commercial banks in the U.S. Total Assets: $7.1 trillion Down from over 18,000 in 1985

32. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-32 The Financial System and Financial Institutions Commercial Banks How Banks Operate  Banks raise funds by offering checking and savings accounts  They then pool these deposits and lend most of them out to consumers and businesses

33. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-33 Types of Outstanding Bank Loans

34. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-34 The Financial System and Financial Institutions Commercial Banks Electronic Banking More and more funds are moving through Elections Funds Transfer Systems (EFTS) EFTS—computerized systems for conducting financial transactions over electronic links  Includes automatic teller machines (ATMs), debit or check cards, and direct deposit of paychecks

35. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-35 The Financial System and Financial Institutions Commercial Banks Online Banking  Regular online bank users now 1 out of every 5 U.S. households  Projected to grow to 1 in 3 households by 2010  Two types of online banks: Internet-only banks Traditional bricks and mortar banks with Web sites

36. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-36 The Financial System and Financial Institutions Bank Regulation Who Regulates Banks?  State chartered banks are regulated by the appropriate state banking authorities  Most are federally insured, and also subject to FDIC regulation  Federally chartered banks are regulated by the Federal Reserve, the Federal Deposit Insurance Corporation, and the Comptroller of the Currency

37. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-37 The Financial System and Financial Institutions Bank Regulation Federal Deposit Insurance  Deposits are insured by the FDIC up to a set amount – currently $100,000  Federal deposit insurance was enacted by the Banking Act of 1933 to restore public confidence in the banking system

38. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-38 The Financial System and Financial Institutions Bank Regulation Recent Changes in Banking Laws  Congress recently passed a law that allows banks to enter into the securities and insurance businesses  In return, other financial services firms are now allowed to offer banking services

39. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-39 The Financial System and Financial Institutions Savings Banks and Credit Unions Savings banks and credit unions are also important financial institutions They offer many of the same services as commercial banks A series of crises cause many of the predecessors of savings banks to merge with financially stronger institutions Credit Unions are cooperative financial institutions, owned by their depositors, all of whom are members

40. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-40 The Financial System and Financial Institutions Nondepository Financial Institutions Accept funds from businesses and households, much of which they then invest  Insurance Companies  Pension Funds  Finance Companies

41. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-41 The Federal Reserve System Central bank of the United States. Has four basic responsibilities: Regulating commercial banks Performing banking-related activities for the U.S. Treasury Servicing member banks Monetary policy

42. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-42 The Federal Reserve System Organization of the Federal Reserve System Nation is divided into 12 federal reserve districts, each with its own Federal Reserve Bank Each district Bank supplies banks within its district with currency and facilitates the clearing of checks District banks are run by a nine-member board of directors

43. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-43 The Federal Reserve System Governing body of the Fed is the Board of Governors The board consists of seven members, appointed by the president and confirmed by the Senate The Fed is designed to be politically independent  Fed Governors are appointed to 14-year terms – staggered so that a president could not appoint a majority during a single term Federal Open Markets Committee (FOMC)

44. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-44 The Federal Reserve System Check Clearing and the Fed Clearing of a check—process by which funds are transferred from the Check writer to the recipient If both the writer in the recipient have accounts at the same bank, a check will clear in house If both have accounts at banks in the same town, the two banks may clear the check directly with one another If one has an account with a bank in a state different than the other, the check will likely be cleared through the Federal Reserve system

45. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-45 A Check’s Journey through the Federal Reserve System

46. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-46 The Federal Reserve System Monetary Policy Monetary Policy—managing the growth rate in the supply of money and credit, usually through the use of interest rates. Fed’s job is to ensure that the money supply grows at an appropriate rate allowing the economy to expand and inflation to remain in check

47. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-47 The Federal Reserve System Monetary Policy If money supply grows too slowly economic growth will slow, unemployment will increase, and the risk of recession will increase If the money supply grows to rapidly, inflationary pressures build

48. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-48 Federal Reserve Tools

49. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-49 U.S. Financial Institutions: A Global Perspective Major U.S. banks have extensive international operations, with offices that lend money and accept deposits from customers worldwide Only three of the 20 largest banks are U.S. institutions The others are based in France, Germany, Holland, Japan, Switzerland, and the UK

50. Copyright © 2005 by South-Western, a division of Thomson Learning, Inc. All rights reserved. 17-50 Virtually all nations have some sort of central bank, similar to the U.S. Federal Reserve. Iraq’s central banking system collapsed with the fall of Saddam Hussein. Its old central bank printed and distributed money at the dictator’s bidding. Currently, three different currencies are circulating in the country—one of which is the U.S. dollar.