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Chapter 1

Introducing Money and the Financial System

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Topics in Financial Decisions

• Financial system and economy connections• Financial markets• Financial institutions• Money• Economic approach

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Financial System and the Economy

• Financial system– A network of markets and institutions to bring savers and

borrowers together

• Savers and borrowers– 3 groups of potential savers and borrowers are households,

businesses, and governments

• Financial instruments– Assets & liabilities

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Financial Servicesprovided by the financial system

• Risk sharing– Borrowers & savers reduce the uncertainty to which they are

exposed

• Liquidity – A measure of how readily one asset can be converted to cash

• Information– The financial system gathers information about borrowers’

circumstances so individual savers do not need to search for prospective borrowers

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Financial Markets

• Transfers funds from savers to borrowers• International capital market (lending &

borrowing across national boundaries) is growing rapidly

• Asset prices communicate information

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Figure 1.1 Sources of Funds for Nonfinancial Businesses: Markets Versus Institutions

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Money

• Defined as anything that people are willing to accept in payment for goods & services or to pay off debts.

• Money supply: total quantity of money in the economy

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Money in the U.S.

• Federal Reserve System– The central bank in the United States– Collects data on various measures of the money supply

• Monetary policy– The management of the money supply and its links to prices,

interest rates, and other economic variables• Monetary theory

– Explores the relationships linking changes in the money supply to changes in economic activity and prices

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Economic Analysis as a Tool

• Explain current developments & events• Predict future developments & events• Developing an economic approach• Applying an economic approach