ch16 The Financial System

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The Financial System

Chapter 16


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Outline the structure and importance ofthe financial system.

List the various types of securities.

Define financial market, and distinguishbetween primary and secondary financialmarkets.

Describe the characteristics of the majorstock exchanges.

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Learning ObjectivesDiscuss the organization andfunctioning of financial institutions.

Explain the functions of the FederalReserve System and the tools it

uses to control the supply of moneyand credit.

Evaluate the major features ofregulations and laws affecting thefinancial system.

Describe the global financial system.

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The financial system is the process by

which money flows from savers to users.

The Financial System


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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


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Securities

Financial instruments

Obligations on the part of the issuer

Businesses and governments

Provide rate of return to purchasers

Types of Securities

Money market instruments Bonds

Stock


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Short-term debt securities Issued by governments, financial institutions, and

corporations

Investors are paid interest for the use oftheir funds

Generally low-risk

U.S. Treasury bills, commercial paper, andbank certificates of deposit

Money Market Instruments


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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


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Types of Bonds


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Price is determined by risk and interest rate.

Several firms rate bonds

Standard & Poors (S&P) Moodys

Investment-grade

Speculative/Junk

Bond Ratings


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Bond Ratings


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Stockholder has

the right to

exchange the

bond or preferredstock for a fixed

number of shares

of common stock.

Convertible Securities


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Primary market firms and governmentsissue securities and sell them initially to thepublic

When a firm offers a stock for sale to the generalpublic for the first time

Secondary market collection of financialmarkets in which previously issuedsecurities are traded among investors

Financial Markets


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Stock market (exchange) market inwhich shares are bought and sold by

investors, such as the New York StockExchange.

Understanding Stock Markets


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The New York Stock Exchange the Big Board isthe most famous and one of the oldest stockmarkets in the world. More than 3,000 stocks arelisted on the NYSE.

The Nasdaq Stock Market the second largeststock market. Over 5,000 companies have theirstocks listed on Nasdaq, but many are smallerfirms.

Other U.S. Stock Markets: The American Stock Exchange/AMEX

Regional stock exchanges

Foreign markets

Stock Exchanges


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ECNs

Electronic Communication Networks The 4th market

Buyers and sellers meet in a virtual market and exchangewith one another

Take place on INET or Archipelago

INET and Archipelago have been purchased byNasdaq and the NYSE

ECNs and the Future of StockMarkets


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Investors use brokerage firms to:

1. Establish an account

2. Enter orders

3. Trade stock

The brokerage firm executes the trade onbehalf of the investor, charging a fee for the

order. Market order

Limit order

Investor Participation in the StockMarket


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Commercial Banks

Savings Banks and Credit Unions

Non-depository Institutions

Financial Institutions


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Financial Institutions


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An increasing amount of funds move throughelectronic funds transfers (EFTs).

Millions of businesses and consumers now paybills and receive payments electronically.

Most employers directly deposit employeepaychecks.

Social Security and other federal payments aremade each year electronically.

Most banks now offer customers debit cards More than 1/3 of American households use some

online banking.

Electronic Banking


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Enacted by the Banking Act of 1933

Restored public confidence in the bankingsystem

Before deposit insurance, runs were commonas people rushed to withdraw their moneyfrom the bank

Deposit insurance shifts the risk of bankfailures from individuals to the FDIC

Federal Deposit InsuranceCorporation
http://fdic.gov/http://fdic.gov/


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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

Savings Banks and Credit Unions

N d i Fi i l


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Insurance Companies

Pension Funds

Finance Companies

Mutual Funds

Nondepository FinancialInstitutions


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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

The Role of the Federal Reserve

O i ti f th F d l
http://www.federalreserve.gov/http://www.federalreserve.gov/


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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 policyand interest rates

Organization of the FederalReserve


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Americans still write billions of paper checks.

The process by which funds are transferredfrom the check writer to receiver is a

multiple-step process managed and clearedby the Fed.

The Check Clearing for the 21st Century Actis making this process more electronic.

Check Clearing and the Fed


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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


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M1 & M2


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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

Regulation of the Financial System

Th Fi i l S t A Gl b l
http://www.sec.gov/http://www.sec.gov/


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The financial systemis more connected.

Financial institutions

are more global. Only 3 of the 30

largest banks in theworld are U.S.

institutions. Most nations have a

central bank.

The Financial System: A GlobalPerspective


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ch16 The Financial System

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