Chapter Fifteen
Money and
the Financial System
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Money in the
Financial System
• Finance
– The study of
money: how it’s
made, how it’s
lost, and why.
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• Money
– Anything generally
accepted in
exchange for goods
and services.
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The Functions of Money
Medium of Exchange: Accepted as payment
for products and resources.
Measure of Value: Single standard for
assigning and comparing values of products
and resources.
Store of Value: Means of retaining and
accumulating wealth.
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The Characteristics
of Money
•
•
•
•
•
•
Acceptability
Divisibility
Portability
Stability
Durability
Difficulty to Counterfeit
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Facts About Money
• The Life Expectancy of Paper Money:
–
–
–
–
–
–
$1
$5
$10
$20
$50
$100
1.5 years
2 years
3 years
4 years
9 years
9 years
Source: “Fedpoint 1: How Currency Gets Into
Circulation,” Federal Reserve Bank of New York –
Publications, September 18, 2001, p. 1-2.
FAST FACT:
There is about $525 billion of US currency in circulation,
and about two-thirds is held outside of the US.
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Types of Money
• Checking
Accounts
– Check
– NOW Account
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• Near Money
– Savings account
– Money market
account
– Certificate of deposit
– Credit card
– Debit card
– Traveler’s check
– Money order
– Cashier’s check
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A Check
Clearing
number
Bank number
Regional
bank number
Clearing
number
Bank
number
Account
number
Check sum (a number
used to verify that everything
is correct)
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Check
number
This gets put on when the
check clears. It represents the
dollar amount, in this case,
$250.00.
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Facts About Checks
• About 13 million US households do
not have checking accounts.
• 180 million checks are cashed
annually in 3,700 check-cashing
stores for a value of $55 billion.
• 85% of checks cashed are payroll
checks and the average check is about
$300.
Source: Calmetta Coleman, “Altering Course, Banks Welcome
Check Cashers,” Wall Street Journal, July 6, 2001, p. B1.
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Facts About
Credit Cards
• MasterCard and Visa are the 2 major credit
cards.
• American Express is the dominant Travel
&Entertainment credit card
• Americans hold over $675 billion in credit
card debt.
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Source: Emily Thornton, Heather Timmons, and Joseph Weber, “Who Holds
the Cards?,” Business Week, March 19, 2001, p. 90.
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Facts About Debit Cards
• A debit card looks like a credit card
but works like a check.
• A debit card gives a direct, immediate
electronic payment to a merchant from
the cardholder’s checking account.
• They lack credit, offer no “grace
period,” and provide no paper trail of
transactions.
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The American
Financial System
• The Federal Reserve System
• Banking Institutions
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The Federal Reserve System
©
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The Functions of the
Federal Reserve Board
• To control the money supply with monetary
policy
• To regulate financial institutions
• To manage regional and national checkclearing procedures
• To supervise the federal deposit insurance
of commercial banks in the Federal Reserve
system
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The Federal Reserve’s
Monetary Policies
1. Open Market Operations
2. Reserve Requirements
3. Discount Rate
4. Credit Controls
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Fed Tools for Regulating
the Money Supply
Activity
Effect on the Money Supply
and the Economy
Buy government securities
The money supply increases;
economic activity increases.
Sell government securities
The money supply decreases;
economic activity slows down.
Raise discount rate
Interest rates increase; the money
supply decreases; economic activity
slows down.
Lower discount rate
Interest rates decrease; the money
supply increases; economic activity
increases.
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Fed Tools for Regulating
the Money Supply
Activity
Effect on the Money Supply
and the Economy
Increase reserve requirements
Banks make fewer loans; the money
supply declines; economic activity
slows down.
Decrease reserve requirements
Banks make more loans; the money
supply increases; economic activity
increases.
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Fed Tools for Regulating
the Money Supply
Activity
Effect on the Money Supply
and the Economy
Relax credit controls
More people are encouraged to
make major purchases, increasing
economic activity.
Restrict credit controls
People are discouraged from
making major purchases,
decreasing economic activity.
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The Check Clearing Process
Day 1
Suzy Smith a student from Chicago,
writes a check to Acme University
Books in Austin, TX, for $120.00 for
her textbooks. Acme deposits her
check in its account in Austin, TX, bank.
The Austin Bank adds $120.00
to Acme’s bank account. Suzy
smith receives the canceled check
from her bank in Chicago at the
end of the month
The Austin bank deposits the check
in its account at the Federal
Reserve Bank in Dallas.
The Chicago Federal Reserve Bank
electronically transmits $120.00 to
the Dallas Federal Reserve Bank,
which credits the Austin bank’s
account for $120.00.
The Federal Reserve Bank in Dallas
electronically transmits the check to
the Federal Reserve Bank of
Chicago.
Ms. Smith’s bank authorizes the
Chicago Federal Reserve Bank to
deduct $120.00 from its account.
The Federal Reserve Bank of
Chicago forwards the check to
Ms. Smith’s bank in Chicago, which
deducts the $120.00 from her
account.
Day 3
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Day 2
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Banking Institutions
Common Banking Institutions:
–
–
–
–
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Commercial Banks
Savings and Loan Associations
Credit Unions
Mutual Savings Banks
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Non-Banking Institutions
Typical Non-Banking Institutions:
–
–
–
–
–
–
–
Insurance Companies
Pension Funds
Mutual Funds
Money Market Funds
Brokerage Firms
Non-Financial Firms
Finance Companies
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Electronic Banking
•
•
•
•
ATM
ETF
ACHs
Home Banking
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ATM Facts
• The top 5 ATM owners are Bank of America,
Wells Fargo, E-Trade Bank, American Express,
and Bank One.
• The average ATM withdrawal is $60.
• ATM customers spend 20-25% more than nonATM customers.
• 60% of Americans ages 25-34 use ATMs 8 times a
month.
• The most popular day for ATM usage is Friday.
Source: “ATM Fact Sheet,” Press Room: ATMfacts 2001, September 18,2001.
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Changes in
Commercial Banking
• Mergers
• Now offer insurance, brokerage & investment
banking services
• Large banks have offices in more states
• Internet banking
• Globalization of banking
• Foreign ownership of domestic banks –
“Megabanks”
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Solve the Dilemma
1.
2.
3.
List the various types of U.S. financial
institutions and the primary functions of
each.
What services of each financial institution
is Hill’s new company likely to need?
Which single financial institution is likely
to best meet Hill’s small company’s
needs now?
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Explore Your Career Options
In what industries are economists likely
to be asked to provide economic
projections?
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Additional Discussion Questions
and Exercises
1. Look at Figure 15.2 in your textbook and determine in
which of the 12 Federal Reserve Districts you are
located. What is the nearest Federal Reserve bank
city or Federal Reserve branch city?
2. What is meant by a demand deposit?
3. Why have credit cards become a popular substitute for
money?
4. What are the advantages of automated teller machines
(ATMs) for customers? For banks?
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Chapter 15 Quiz
1. Most paper currency is lightweight; the weight of money `
applies to which characteristic of money?
a. durability
b. stability
c. divisibility
d. portability
2. The percentage of deposits that a banking institution must hold
in reserve, either in the bank itself or in a Federal Reserve
Bank, and not loan to businesses or individuals is the
a. discount rate.
b. reserve requirement.
c. M1.
d. depository insurance.
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Chapter 15 Quiz
3. The largest of all banking institutions in the United States are
a. savings and loan associations.
b. commercial banks.
c. credit unions.
d. mutual savings banks.
4. The failure of the savings and loan associations and the
problems in some commercial banks were caused primarily by
a. high government taxes on banking institutions.
b. bad real estate loans.
c. failure of students to repay college loans.
d. electronic funds transfer.
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Multiple Choice Questions
about the Video
1. The difference between a secured bond and a debenture is that
a. a secured bond has specific assets pledged against the
money borrowed while a debenture does not.
b. a secured bond has fixed assets pledged against the money
borrowed while a debenture has short-term assets pledged
against the money borrowed.
c. a secured bond is a high risk debt security while a debenture
is a low risk debt security.
d. a secured bond is always secured by land while a debenture
is always secured by equipment.
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Multiple Choice Questions
about the Video
2. Which of the following statements best describes the tax
treatment for interest and dividend payments?
a. Interest is paid after taxes.
b. Interest is a tax-deductible expense.
c. Dividends are a tax-deductible expense.
d. All are correct.
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