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Chapter 17
The Financial System
1 Outline the structure and
importance of the financial
system.
2
3
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.
7
4 Describe the characteristics of the
major stock exchanges.
8
Evaluate the major features of
regulations and laws affecting the
financial system.
Describe the global financial
system.
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 & Poor’s (S&P)
– Moody’s
• 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.