THE PAYMENTS

SYSTEM
PAYMENTS SYSTEM

The web of arrangements that allow for the

exchange of goods and services, as well as
assets, among different people

Money - heart of payments system

1. COMMODITY AND FIAT MONEY
● Commodity - ✅
○ Usable in some form
○ Could be made into standardized
quantities
○ Durable
○ High value relative to size and weight
○ Divisible into small units
1. COMMODITY AND FIAT MONEY
● Fiat - ✅
○ First country to issue - China during the
7th century
○ 1656, Johan Plamstruck, a Swede -
founded the Stockholm Banco, five years
later he issued Europe’s first paper money
1. COMMODITY AND FIAT MONEY

Reasons of willingness to accept FIAT MONEY

as payment for debt:
1. We believe we can use them in the future
2. Law says we must accept them
2. CHECKS

● Not money, not legal tender

● Just an instruction for the bank to take funds
from your account and transfer them to the
person or firm whose name you have written
in the “Pay to the order of” line.
 2. CHECKS (Path)
1 2 3 4 5

Hand a paper The merchant The merchant’s The check is Your bank debits
check from your deposits the bank sends an transferred from your account by
bank to a check or an electronic image of the bank that sent the amount of the
merchant in electronic image the check through it in to the bank check. Your bank
exchange for of the check into the check-clearing on which it is has several days
groceries. the merchant’s system of your written - your to send the check
bank and the bank along with the bank. back through the
merchant’s other millions of system if you
account is images of checks have insufficient
credited. to be processed funds in your
that night. account.
3. ELECTRONIC PAYMENTS (E-payments)
● Debit card - works the same way as a check
in that it provides the bank instructions to
transfer funds from the cardholder’s account
directly to a merchant’s store
● Credit card - promise by a bank to lend the
cardholder money with which to make
purchases
3. ELECTRONIC PAYMENTS (E-payments)
● Electronic fund transfers - movements of
funds directly from one account to another
○ Automated clearing-house transaction
(ACH) - used for recurring payments such
as paychecks and utility bills
4. E-MONEY

● Can be used to pay for purchases on the

Internet or via mobile phone
● A form of a private money - not issued or
guaranteed by the government, not for
paying taxes
 FINANCIAL
INSTRUMENTS
Financial Instrument

Written legal obligation of one party to

transfer something of value, usually money, to
another party at some future date, under
specified conditions
“Legal obligation”

● Subject to government enforcement

● A person CAN BE COMPELLED
● Without enforcement of the specified terms,
financial instruments would not exist
“One party to transfer something of value,
usually money, to another party

● Party - person, company or government

● Specifies that a payment will be made
“At some future date”

Can be a specific date or when something

happens
“Specified conditions”

● Upon the happening of an event

● Possible contingencies under which one
party is required to make a payment to
another
Uses of financial Instrument

1. Means of payment - purchase of goods or

services
2. Store of value - transfer of purchasing power
into the future
3. Transfer of risk
Characteristics of financial Instrument

1. STANDARDIZATION - most of the financial

instruments are homogeneous
2. INFORMATION - financial instruments
communicate information
Classes of financial instrument
UNDERLYING INSTRUMENTS - also known as
primitive securities, used by savers/lenders to
transfer resources directly to
investors/borrowers. Through these, the
financial system improves the efficient
allocation of resources in the real economy
Classes of financial instrument
DERIVATIVE INSTRUMENTS - their value and
payoffs are “DERIVED” from the behavior of the
underlying instruments
- Specify a payment to be made between the
person who sells the instrument and the
person who buys it
Value of financial instrument

1. SIZE of the payment that is promised

2. WHEN the promised payment is to be made
3. LIKELIHOOD that the payment will be made
4. CIRCUMSTANCES under which the payment
is to be made
Examples of financial instruments
Financial instruments used primarily as stores of value
1. Bank loans - borrower obtains resources in
exchange for payment in the future
2. Bonds - a corporation or government promises to
make payments in the future
3. Home mortgages
Collateral - term to describe specific assets a
borrower pledges in case of nonpayment
Foreclosure - process when lender takes the
collateral
Examples of financial instruments
Financial instruments used primarily as stores of value
4. Stocks - holder owns a small piece of the firm and is
entitled to part of its profits
5. Asset-backed securities - shares in the returns or
payments arising from specific assets
Mortgage-backed securities - most prominent;
bundle a large number of mortgages into a pool
in which shares are then sold
Examples of financial instruments
Financial instruments used primarily to transfer risk
1. Insurance contracts - primary purpose is to assure
the payments will be made under particular, and
rare circumstances
2. Future contracts - agreement between two parties
to exchange a fixed quantity of a commodity or an
asset at a fixed price on a set future date
Examples of financial instruments
Financial instruments used primarily to transfer risk
3. Options - derivative instruments whose prices are
based on the value of some underlying asset; Give
the holder the right, but not the obligation, to buy or
sell a fixed quantity of the underlying asset
4. Swaps - agreements to exchange two specific cash
flows at certain times in the future