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Chapter 3

Overview of the Financial System

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Purpose of the Financial System

• Provides channels to transfer funds from savers to borrowers.

• Savers are suppliers of funds.• Borrowers are demanders of funds.• Financial markets issue claims on borrowers

directly to savers.• Financial intermediaries act as go-betweens by

holding a portfolio of assets and issuing claims to savers.

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Figure 3.1 Moving Funds Through the Financial System

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Figure 3.2 Key Services Provided by the Financial System

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Key Services Provided by the Financial System

• Risk sharing by allowing savers to hold many assets

• Liquidity, which is the ease with which an asset can be exchanged for money

• Information about borrowers and returns on financial assets

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Financial Markets

• Primary markets are those in which newly issued claims are sold to initial buyers.

• Secondary markets are those in which previously issued claims are resold.

• Risk-sharing, liquidity, and information services are provided in secondary markets.

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Types of Secondary Financial Markets

• Maturity: money and capital markets

• Trading places: auction and over-the-counter markets

• Settlement: cash or derivative

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Financial Intermediaries’ Tasks

• Match savers and borrowers

• Provide risk-sharing, liquidity, and information services

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Competition and Change

• Financial innovation results from change.

• Ease of communicating information has allowed for greater financial integration.

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Goals of Financial Regulation

• Provision of information• Maintenance of financial stability• Controlling the money supply• Encouraging particular activities (like home

ownership)• Regulation affects the ability of financial

markets and institutions to provide risk-sharing, liquidity, and information services, as seen in Table 3.1

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Table 3.1 Regulation of Financial Institutions and Markets in the United States