Chapter
16
The Financial System
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Learning Objectives
1
Understand the financial
system.
5
2
List the various types of
securities.
6
3
Discuss financial markets.
7
4
Understand the stock
markets.
8
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
The financial system is the process by
which money flows from savers to users.
Understanding 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.
Types of Securities
Securities
Financial instruments
Obligations on the part of the issuer
Businesses and governments
Provide rate of return to purchasers
Money market instruments
Bonds
Stock
Money Market Instruments
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
Bonds
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
Types of Bonds
Bond Ratings
Price is determined by risk and interest rate.
Several firms rate bonds
Standard & Poor’s (S&P)
Moody’s
Investment-grade
Speculative/Junk
Standard and Poor’s Bond Ratings
Highest
AAA
Investment grade
AA
A
BBB
BB
B
CCC
CC
Lowest
C
Speculative grade
Stocks
Common stock– ownership claims in
corporations
Vote on major company decisions
Cash dividends
Price appreciation
Preferred stock– stockholders who receive
preference in the payment of dividends
Convertible Securities
Stockholder has
the right to
exchange the
bond or preferred
stock for a fixed
number of shares
of common stock.
Financial Markets
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
Understanding Stock Markets
Stock market (exchange)– market in
which shares are bought and sold by
investors, such as the New York Stock
Exchange.
Stock Exchanges
The New York Stock Exchange– the Big Board is
the most famous and one of the oldest stock
markets in the world. More than 3,000 stocks are
listed on the NYSE.
The NASDAQ Stock Market– the second largest
stock market. Over 5,000 companies have their
stocks listed on Nasdaq, but many are smaller
firms.
Other U.S. Stock Markets:
The American Stock Exchange/AMEX
Regional stock exchanges
Foreign markets
ECNs and the Future of Stock
Markets
ECNs– Electronic Communication Networks
The 4th market
Buyers and sellers meet in a virtual market and exchange
with one another
Take place on INET or Archipelago
INET and Archipelago have been purchased by
NASDAQ and the NYSE
Investor Participation in the Stock
Market
Investors use brokerage firms to:
1. Establish an account
2. Enter orders
3. Trade stock
The brokerage firm executes the trade on
behalf of the investor, charging a fee for the
order.
Market order
Limit order
Financial Institutions
Commercial Banks
Savings Banks and Credit Unions
Non-depository Institutions
Financial Institutions
Electronic Banking
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.
Most banks now offer customers debit cards
More than 3/5 of American households use some
online banking.
Federal Deposit Insurance
Corporation
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 FDIC
Savings Banks and Credit Unions
Offer a variety of consumer services
80+% of their loans are real estate loans
Credit unions are cooperative financial
institutions owned by depositors/members
Credit unions are created to serve consumers
Insured by National Credit Union Administration
(NCUA), which functions the same as the FDIC
Nondepository Financial
Institutions
Insurance Companies
Pension Funds
Finance Companies
Mutual Funds
The Role of the Federal Reserve
The Federal 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
Organization of the Federal
Reserve
12 Federal reserve districts
Own federal reserve bank
District banks are run by a nine-member board
of directors
The board of governors is the governing body
Politically independent
Federal Open Markets Committee (FOMC)
sets most policies concerning monetary policy
and interest rates
Check Clearing and the Fed
Americans still write billions of paper checks.
The process by which funds are transferred
from the check writer to receiver is a
multiple-step process managed and cleared
by the Fed.
The Check Clearing for the 21st Century Act
is making this process more electronic.
Monetary Policy
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
M1 & M2
Tools Used by the Federal Reserve to
Regulate the Growth in the Money Supply
Regulation of the Financial System
Bank regulation
Government regulation of the financial markets
(SEC)
Industry self-regulation
Rules of conduct by professional organizations like
National Association of Securities Dealers
Market surveillance
The Financial System: A Global
Perspective
The financial system
is more connected.
Financial institutions
are more global.
Only 2 of the 20
largest banks in the
world are U.S.
institutions.
Most nations have a
central bank.