Adeyl Khan, Faculty, BBA, NSU
The Financial SystemChapter 17
Adeyl Khan, Faculty, BBA, NSU
The Financial System
The financial system is the process by which money flows from savers to users.
Adeyl Khan, Faculty, BBA, NSU
Understanding the Financial SystemFinancial 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.
Adeyl Khan, Faculty, BBA, NSU
Types of Securities
Securities Financial instruments Obligations on the part of the issuer
Businesses and Governments Provide rate of return to purchasers
Money Market InstrumentsBondsStock
Adeyl Khan, Faculty, BBA, NSU
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-riskU.S. Treasury bills, commercial paper, and bank certificates of deposit
Adeyl Khan, Faculty, BBA, NSU
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.
Adeyl Khan, Faculty, BBA, NSU
Bond Ratings
Price is determined by risk and interest rate.Several firms rate bonds
Standard & Poor’s (S&P) Moody’s
Investment-gradeSpeculative/Junk
Adeyl Khan, Faculty, BBA, NSU
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.
Adeyl Khan, Faculty, BBA, NSU
Convertible SecuritiesStockholder has the
right to exchange the bond or preferred stock for a fixed number of shares of common stock.
Adeyl Khan, Faculty, BBA, NSU
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.
Adeyl Khan, Faculty, BBA, NSU
Understanding Stock Markets
Stock market (exchange) – market in which common stocks are traded, such as the New York Stock Exchange.
Adeyl Khan, Faculty, BBA, NSU
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
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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
Adeyl Khan, Faculty, BBA, NSU
Investor Participation in the Stock MarketsInvestors 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
Adeyl Khan, Faculty, BBA, NSU
Financial Institutions
Commercial BanksSavings Banks and Credit UnionsNon-depository Institutions
Adeyl Khan, Faculty, BBA, NSU
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.
Adeyl Khan, Faculty, BBA, NSU
Federal Deposit Insurance
Enacted by the Banking Act of 1933Restore public confidence in the banking systemBefore deposit insurance, runs were common as people rushed to withdraw their money from the bankDeposit insurance shifts the risk of bank failures from individuals to the FDIC
Adeyl Khan, Faculty, BBA, NSU
Savings Banks and Credit Unions
Offer a variety of consumer services85% of their loans are real estate loansCredit 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
Adeyl Khan, Faculty, BBA, NSU
Non Depository Financial Institutions
Insurance CompaniesPension FundsFinance Companies
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The Role of the Federal Reserve
Created In 1913Central bank of the United StatesRegulate commercial banksPerform banking-related activities for the U.S. Department of TreasuryProviding services for banksSetting monetary policy
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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 independentFederal Open Markets Committee (FOMC) sets most policies concerning monetary policy and interest rates.
Adeyl Khan, Faculty, BBA, NSU
Check Clearing and the Fed
Americans still write billions of paper checks.The process by which funds are transferred from the check writer to receiverThe multiple-step process is managed and cleared by the FED.The Check Clearing for the 21st Century Act is making this process more electronic.
Adeyl Khan, Faculty, BBA, NSU
Monetary Policy
Supply of money and creditMeasures of the money supply: M1 & M2The FED requires banks to maintain reserves.Set the discount rateOpen Market Operations
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M1 & M2 Graphic
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Regulation of the Financial System
Bank RegulationGovernment Regulation of the Financial MarketsIndustry Self-Regulation
Rules of conduct by professional organizations like National Association of Securities Dealers Market Surveillance
Adeyl Khan, Faculty, BBA, NSU
The Financial System:A Global PerspectiveThe 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.
Adeyl Khan, Faculty, BBA, NSU27
Adeyl Khan, Faculty, BBA, NSU
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.
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