The Financial System

1. Chapter 17 The Financial System

2. Learning Goals Outline the structure and importance of the financial system. List the various types of securities. Define financial market, and distinguish between primary and secondary financial markets. Describe the characteristics of the major stock exchanges. Discuss the organization and functioning of financial institutions. Explain the functions of the Federal Reserve System and the tools it uses to control the supply of money and credit. Evaluate the major features of regulations and laws affecting the financial system. Describe the global financial system. 1 5 6 2 3 7 4 8

3. The Financial System The financial system is the process by which money flows from savers to users.

4. 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.

5. 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

6. 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

7. 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.

8. 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

9. Stocks • Common stock – ownership claims in corporations. • Vote on major company decisions • Cash dividends • Price appreciation • Preferred stock – stockholders with preference in the payment of dividends.

10. Convertible Securities Stockholder has the right to exchange the bond or preferred stock for a fixed number of shares of common stock.

11. 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.

12. Understanding Stock Markets Stock market (exchange) – market in which common stocks are traded, such as the New York Stock Exchange.

13. 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 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

14. 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 NYSE

15. Investor Participation in the Stock Markets • Investors use brokerage firms, they: • Establish an account • Enter orders • Trade stock • The brokerage firm executes the trade on behalf of the investor, charging a fee for the order • Market Order • Limit Order

16. Financial Institutions • Commercial Banks • Savings Banks and Credit Unions • Non-depository Institutions

17. Electronic Banking • An increasing amount of funds move through electronic funds transfer (EFTs). • Millions of businesses and consumers now pay bills and receive payments electronically. • Most employees directly deposit employee paychecks. • Social security and other federal payments are made each year electronically. • Automated Teller Machines (ATMs) continue to grow in popularity. • More than 1/3 of American households use some online banking.

18. Federal Deposit Insurance • Enacted by the Banking Act of 1933 • Restore 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

19. Savings Banks and Credit Unions • Offer a variety of consumer services • 85% of their loans are real estate loans • Credit unions are cooperative financial institutions that are 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

20. Non Depository Financial Institutions • Insurance Companies • Pension Funds • Finance Companies

21. The Role of the Federal Reserve • Created In 1913 • Central bank of the United States • Regulate commercial banks • Perform banking-related activities for the U.S. Department of Treasury • Providing services for banks • Setting monetary policy

22. 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.

23. 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 • The multiple-step process is managed and cleared by the FED. • The Check Clearing for the 21st Century Act is making this process more electronic.

24. Monetary Policy • 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

25. M1 & M2 Graphic

26. Regulation of the Financial System • Bank Regulation • Government Regulation of the Financial Markets • Industry Self-Regulation • Rules of conduct by professional organizations like National Association of Securities Dealers • Market Surveillance

27. The Financial System: A Global Perspective • The financial system is more connected. • Financial institutions are more global. • Only 3 of the 30 largest banks in the world are US institutions. • Most nations have a central bank.