>>>>>>>>

Chapter 17

The Financial System

1 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.

5 Discuss the organization and

functioning of financial institutions.

6 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.

4 Describe the characteristics of the

major stock exchanges.

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

 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.

 Securities
Financial instruments Obligations on the part of the issuer
Businesses and Governments

Provide rate of return to purchasers

Money Market Instruments Bonds Stock

 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

 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.

 Price is determined by risk and interest rate. Several firms rate bonds
Standard & Poors (S&P) Moodys

Investment-grade Speculative/Junk

 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.

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

 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.

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

 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

 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

Investors use brokerage firms, they:

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

 Commercial Banks Savings Banks and Credit Unions Non-depository Institutions

 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.

 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

 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

 Insurance Companies Pension Funds Finance Companies

 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

 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.

 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.

 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

 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

 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.