1. Global Issue #3 GLOBAL FINANCE

2. LEARNING OBJECTIVES 1.To understand the functions performed and the roles played by the system of financial markets and institutions in the global economy. 2.To explore several key terms and concepts of the money and capital markets. 3.To discover how important the financial system is in increasing our standard of living, generating new jobs, and building our savings to meet tomorrow’s financial needs.

3. LEARNING OBJECTIVES 1.To understand the functions performed and the roles played by the system of financial markets and institutions in the global economy. 2.To explore several key terms and concepts of the money and capital markets. 3.To discover how important the financial system is in increasing our standard of living, generating new jobs, and building our savings to meet tomorrow’s financial needs. Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers.

4. FIGURE 1. LEHMAN BROTHERS STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) $80 Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com $18 4 cents

5. FIGURE 2. GENERAL MOTORS CORPORATION STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com $40 4 cents $5 $1

6. FIGURE 3. CITIGROUP, INC. STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) $55 $2.68 $26 Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com

7. FIGURE 4. AMERICAN INTERNATIONAL GROUP STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) $1,450 0 $1,000 $600 $22 Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com

8. FIGURE 5. FANNIE MAE STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com $50 $22 20 cents

9. FIGURE 6. FREDDIE MAC STOCK, 2007-2011 (IN DOLLARS AND VOLUME TRADED) $70 31 cents $63 $32 Source: Yahoo Finance http://finance.yahoo.com retrieved August 19, 2011.http://finance.yahoo.com

10. 10 Source: Benn Steil, Lessons of the Financial Crisis, CFR, March 2009 The financial crisis was abruptly transmitted to emerging markets in September 2008.

12. Global Financial Crisis: 2007-Now  Deepest crisis since the Great Depression of 1929  In the epicenter of the crisis, in the United States, unemployment increased from 7 million in December 2007 to 16 million in October 2010 (18%) WHO CARES – HOW DOES IT AFFECT ME?

13. Interest Rates the proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding. a weaker domestic currency stimulates exports and makes imports more expensive. Conversely, a strong domestic currency hampers exports and makes imports cheaper. FINANCE BASICS

15. Table 2. Distribution of Wealth in the United States, 2007, by Type of Asset (in percentages) __________________________________________________________________ Investment AssetsTop 1% Top 10% Bottom 90% __________________________________________________________________ Stocks and mutual funds 49.3 89.4 10.6 Financial securities 60.6 98.5 1.5 Trusts 38.9 79.4 20.6 Business equity 62.4 93.3 6.7 Non-home real estate 28.3 76.9 23.1 __________________________________________________________________ Total for group 49.7 87.8 12.2 __________________________________________________________________ Source: Edward N. Wolff, “ Recent Trends in Household Wealth in the United States: Rising Debt and the Middle Class Squeeze, ” Working Paper No. 589 (March 2010), p. 51.

17. WHY BORROW $ ? Governments borrow so that it can enable higher spending without having to increase taxes. 1.Taxes. Revenues are less than predicted. 2.Fiscal stabilizers. In a recession, government tax revenues fall (e.g. people earn less so pay less income tax). Also the government have to spend more on unemployment benefits. Therefore, in an economic downturn, borrowing rises. 3.Investment. …For example, building schools, hospitals, better roads. This investment can give a return on the investment which helps to boost productive capacity and increase economic growth. 4.Political. The biggest tendency to borrow comes from political pressures. Voters generally like to hear the promise of lower taxes and increasing spending. A manifesto to tackle a budget deficit (higher taxes and lower spending) is unlikely to be popular. 5.War. During a war, government spending is stretched leading to higher borrowing. The highest rates of borrowing occurred during the two world wars.

18. The gap between labor and capital grew bigger From 1820 to 1970, every decade U.S. workers experienced a rising level of wages. Even though workers have been more productive every year, in the 1970s this came to an end; real wages stopped rising and they have never resumed since HOW DID ALL THIS HAPPEN?

21. Large Corporations get $$$  MA MA  Banks Banks  lend $$$ to consumers (because wages weren’t enough!) Consumers  Invest abroad (outsource) Invest Abroad  Unemployment (need loans even more)

26.  Real assets are tangible things owned by persons and businesses  Residential structures and property  Major appliances and automobiles  Office towers, factories, mines  Machinery and equipment  Financial assets are what one individual has lent to another  Consumer credit  Loans  Mortgages  The household is the primary provider of funds to businesses and government.  Households must accumulate financial resources throughout their working life times to have enough savings (pension) to live on in their retirement years REAL VERSUS FINANCIAL ASSETS

27. The Financial System

28.  The financial system is the collection of markets, institutions, laws, regulations, and techniques through which bonds, stocks, and other securities are traded, interest rates are determined, and financial services are produced and delivered around the world.  The primary task of the financial system is to move scarce loanable funds from those who save to those who borrow to buy goods and services and to make investments in new equipment and facilities, so that the global economy can grow and the standard of living can increase.

29.  The basic function of the economic system is to allocate scarce resources – land, labor, management skill, and capital – to produce the goods and services needed by society.  The global economy generates a flow of production in return for a flow of payments.  The circular flow of production and income is interdependent and never ending.

30. Land and other natural resources Labor and managerial skills Capital equipment Flow of production Flow of payments Goods and services sold to the public Flows within the Global Economic System

31. Producing units (mainly business firms and governments) Consuming units (mainly households)

32.  In most economies around the world, markets carry out the complex task of allocating resources and producing goods and services.  The marketplace determines what goods and services will be produced and in what quantities through their prices.  Markets also distribute income by rewarding superior producers with increased profits, higher wages, and other economic benefits. THE ROLE OF MARKETS IN THE GLOBAL ECONOMIC SYSTEM

33.  There are essentially three types of markets within the global economic system.  The factor markets allocate the factors of production to the owners of productive resources.  Consuming units use most of their income from factor markets to purchase goods and services in product markets.  The financial markets channel savings to those individuals and institutions needing more funds for spending than are provided by their current incomes. TYPES OF MARKETS

34. Producing units (mainly business firms and governments) Flow of production Flow of payments Consuming units (mainly households) Flow of funds (savings) Flow of financial services, income, and financial claims Financial markets Product markets Factor markets Flow of incomes Productive services Goods and services Flow of payments for consumption and taxes Flow of incomes Productive services Types of Markets

35.  The financial markets make possible the exchange of current income for future income and the transformation of savings into investment so that production, employment, and income can grow.  The suppliers of funds to the financial system can expect not only to recover their original funds but also to earn additional income as a reward for waiting and for assuming risk. THE FINANCIAL MARKETS AND THE FINANCIAL SYSTEM: CHANNEL FOR SAVINGS AND INVESTMENT

36. THE GLOBAL FINANCIAL SYSTEM Demanders of funds (mainly business firms and governments) Flow of loanable funds (savings) Flow of financial services, incomes, and financial claims Suppliers of funds (mainly households)

37.  Savings function. The global system of financial markets and institutions provides a conduit for the public’s savings.  Wealth function. The financial instruments sold in the money and capital markets provide an excellent way to store wealth.  Liquidity function. Financial markets provide liquidity for savers who hold financial instruments but are in need of money.  Credit function. Global financial markets furnish credit to finance consumption and investment spending.  Payments function. The global financial system provides a mechanism for making payments for goods and services.  Risk protection function. The financial markets around the world offer businesses, consumers, and governments protection against life, health, property, and income risks.  Policy function. The financial markets are a channel through which governments may attempt to stabilize the economy and avoid inflation. FUNCTIONS PERFORMED BY THE GLOBAL FINANCIAL SYSTEM AND THE FINANCIAL MARKETS

38.  The money market may be subdivided into Treasury bills, certificates of deposit (CDs), bankers’ acceptances, commercial paper, federal funds and Eurocurrencies.  The capital market may be subdivided into mortgage loans, tax- exempt (municipal) bonds, consumer loans, Eurobonds and Euronotes, cor  In open markets, financial instruments are sold to the highest bidder, and they can be traded as often as is desirable before they mature. In negotiated markets, the instruments are sold to one or a few buyers under private contract.  Financial capital is raised when newly issued securities are sold in the primary markets. Security trading in the secondary markets then provides liquidity for the investors.  porate stock, and corporate notes and bonds. TYPES OF FINANCIAL MARKETS WITHIN THE GLOBAL FINANCIAL SYSTEM

39.  In the spot market, assets or financial services are traded for immediate delivery (usually within two business days).  Contracts calling for the future delivery of financial instruments are traded in the futures or forward market.  Contracts granting the right to buy or sell certain securities at specified prices within a certain period are traded in the options market. TYPES OF FINANCIAL MARKETS WITHIN THE GLOBAL FINANCIAL SYSTEM

40.  Credit, the Common Commodity. The shifting of borrowers among markets helps to weld the parts of the global financial system together and to bring the credit costs in the different markets into balance with one another.  Speculation and Arbitrage. Speculators who watch for profitable arbitrage opportunities help to maintain consistent prices among the markets.  Perfect and Efficient Markets. There is some research evidence suggesting that financial markets are closely tied to one another due to their near perfection and efficiency.  In the real world however, market imperfection and information asymmetry exist. FACTORS TYING ALL FINANCIAL MARKETS TOGETHER

41.  The global financial system is rapidly changing.  In particular, there are trends toward the deregulation of financial institutions and services, the harmonization of regulations, and global integration, leading to more intense competition as well as the development of new financial services. THE DYNAMIC FINANCIAL SYSTEM

42. 1.an overview of the global financial system – its role in the world’s economy and its basic characteristics. 2.the forces that shape interest rates and the prices of financial instruments. 3.the money market and its principal instruments and institutions (including the central bank). 4.commercial banks, credit unions, savings and loan associations, money market funds, insurance companies, pension funds, mutual funds, and other financial-service firms. 5.role of governments – federal, state, and local – within the global financial system. 6.financial activities of nonfinancial business firms and consumers. 7.international financial system and future trends in global finance.