Chapter 1- Money and the Finanial System

8/13/2019 Chapter 1- Money and the Finanial System

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CHAPTER 1: INTRODUCING MONEYAND THE FINANCIAL SYSTEM


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LEARNING OBJECTIVES

! Key components of the financial system! Identify the five parts of the Financial system! The purpose of financial markets and financial institutions! The process of financial intermediation! The primary function of a central bank! Why the money supply is a very important component of theeconomy

! The five core principals of Money and Banking


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Financial Assets

! Economists divide financial assets into those that aresecurities and those that arent.

! A security is a financial asset that can be bought andsold in a financial market.

! Financial markets are places or channels for buying orselling stocks, bonds, and other securities.


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Financial Assets

! Five key categories of financial assets:1. Money2. Stocks3. Bonds4. Foreign Exchange5. Securitized loans


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Financial Assets - Money

! Money: Anything that is generally accepted in paymentfor goods and services to pay off debts

! The money supply is the total quantity of money in theeconomy


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Financial Assets - Stocks

! Stocks are financial securities that represent partialownership of a firm, also called equities

! Dividend: A payment that a corporation makes to itsshareholders


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Financial Assets - Bonds

! Bond: A financial security issued by a corporation or agovernment that represents a promise to repay a fixedamount of money

! Interest rate: The cost of borrowing funds (or the paymentfor lending funds), usually expressed as a percentage ofthe amount borrowed


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Financial Assets Foreign Exchange

! To buy foreign goods and services or foreign assets, adomestic business or a domestic investor must firstexchange domestic currency for foreign currency.

! Foreign exchange: Units of foreign currency.! Bank often engage in foreign currency transactions on

behalf of investors and business firms


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Financial Institutions

! The financial system matches savers and borrowers throughtwo channels:

(1) Banks and other financial intermediariesFinancial intermediary: A financial firm, such as abank, that borrows funds from savers and lends themto borrowers

(2) Financial markets

Funds flow from lenders to borrowers indirectly throughfinancial intermediaries, such as banks, or directlythrough financial markets, such as the New York StockExchange.


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Moving Funds through the Financial System


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! Financial Intermediaries! Commercial Bank: A financial firm that serves as a

financial intermediary by taking in deposits and usingthem to make loans

! Households rely on borrowing money from banks topurchase big ticket items

! Firms rely on banks to meet their short- and long-term needsfor credit.! Some financial intermediaries, such assaving and loans,

savings banks, and credit unions, are legally distinct frombanks


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! Nonbank Financial Intermediaries! Insurance companiesInsurance companies collect premiums from customers then

invest the premiums to obtain the funds necessary to pay claimsand other costs.

! Pension fundsPension funds invest contributions from workers and firms in

stocks, bonds, and mortgages to earn the money necessary tomake pension benefit payments


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! Nonbank Financial Intermediaries!

Mutual fundsA mutual funds obtains money by selling shares to investors andinvests the money in a portfolio of financial assets.

Portfolio A collection of assets, such as stocks and bonds

! Hedge fundsHedge funds are similar to mutual funds but typically have no

more than 99 wealthy investors and make riskier investments.

! Investment banksInvestment banks concentrate on providing advice to firmsissuing stocks and bonds or considering mergers with other firms


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The Central Bank and other FinancialRegulators

! Vietnamese agencies that regulate the financial system:! The State Bank of Vietnam (Central banks in other countriesor the Federal Reserve System in the US)! State Securities Commission of Vietnam!

! The central bank influences three very importantvariables in the economy:

! Inflation! Business cycles! Interest rates


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What is the Federal Reserve?

TheFederal Reserve is the central bank of the UnitedStates; usually referred to as

the Fed.

Established by Congress in 1913 to deal with bankingproblems.

Original role: Serve as a lender of last resort.! Topic 1: Insights into State Bank of Vietnam


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What Does the Fed Do?

! The Fed is responsible for monetary policy. Monetary policy refers tothe actions the Federal Reserve takes to manage the money supply

and interest rates to pursue macroeconomic policy objectives.

! The Fed Is divided into 12 districts.! The main policymaking body of the Fed is the Federal Open Market

Committee (FOMC).

!Chairman: Ben Bernanke from 2006 present

! The FOMC meets eight times per year. During these meetings, theFed decides on a target for the federal funds rate.

! Federal funds rate: The interest rate that banks charge each otheron short-term loans.


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The Federal Reserve System


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What does the Financial System Do?

! The financial system provides three services to savers andborrowers: risk sharing, liquidity and information.

! Risk sharing! Risk is the chance that the value of financial assets will

change relative to what you expect.

! Diversification: Splitting wealth among many different assetsto reduce risk.

! Risk sharing: A service the financial system provides thatallows savers to spread and transfer risk.


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What does the Financial System Do?

! Liquidity! Liquidity: The ease with which an asset can be exchanged

for money.

! Financial markets and intermediaries help make financialassets more liquid.

! Information!

Information: Facts about borrowers and about expectationsof returns on financial assets.

! Financial markets convey information to both savers andborrowers by determining the prices of stocks, bonds andother securities.


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Five Parts of the Financial System

1. Money! To pay for purchases and store wealth

2. Financial Instruments! To transfer resources from savers to investors and to transfer risk to those best

equipped to bear it.

3. Financial Markets! Buy and sell financial instruments

4. Financial Institutions! Provide access to financial markets, collect information and provide services

5. Central Banks! Monitor financial institutions and stabilize the economy


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1. Money

!To pay for purchases

! To store wealth! Evolved from gold and silver coins to paper money to

todays electronic funds transfers

! Traditional Paycheck system vs. ATM Withdrawals! Mailed transactions vs. E-banking


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3. Financial Markets

! To buy and sell financial instruments quickly andcheaply

!evolved from coffeehouses to tradingplaces (Stock exchanges) to electronicnetworks.

!Transactions are much more cheaper now!Markets offer a broader array of financial

instruments than were available even 50years ago


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4. Financial Institutions.

! Provide access to financial markets! Banks evolved from Vaults and developed into

deposits- and loans-agency

! Todays banks are more like financial supermarketsoffering a huge assortment of financial productsand services for sale.! Access to financial markets! Insurance! Home- and car-loans! Consumer credit! Investment advice


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5. Central Banks

!Monitors financial Institutions

! stabilizes the Economy! control the availability of money and

credit in such a way as to ensure

1.

low inflation,2. high growth, and3. the stability of the financial system.


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Five Core principles of Money andBanking

1. Timehas value

2. Riskrequires compensation

3. Informationis the basis for decisions

4. Marketsdetermine prices and allocation resources

5. Stabilityimproves welfare


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1. Time has value! Time affects the value of financial instruments! Interest payments exist because of time properties of

financial instruments

2. Risk requires compensation! In a world of uncertainty, individuals will accept risk only if

they are compensated in some form.

3. Information is the basis for decisions! The collection and processing of information is the basis of

foundation of the financial system.


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4. Markets determine prices and allocate resources

! The placeswhere buyers & sellers meetare the core of theeconomic system

5. Stabilityimproves welfare.

! A stable economy reduces risk and improves everyoneswelfare


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Chapter 1- Money and the Finanial System

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