14th edition

1. Chapter 16
The Financial System

2. Learning Objectives
1 Outline the structure and importance of 5 Discuss the organization and
the financial system. functioning of financial institutions.
2 List the various types of securities. 6 Explain the functions of the Federal
Reserve System and the tools it
3 Define financial market, and distinguish uses to control the supply of money
between primary and secondary financial and credit.
markets.
7 Evaluate the major features of
4 regulations and laws affecting the
Describe the characteristics of the major
stock exchanges. financial system.
8 Describe the global financial system.

3. The Financial System
s The financial system is the process by
which money flows from savers to users.

4. Understanding the Financial System
s Financial System
s Savers
s Users
s Financial Institutions
s Financial Markets
s Savings is a function of
many variables.
s Funds can be transferred
between users and savers
directly or indirectly.

5. Types of Securities
s Securities
s Financial instruments
s Obligations on the part of the issuer
s Businesses and governments
s Provide rate of return to purchasers
s
Money market instruments
s
Bonds
s
Stock

6. Money Market Instruments
s Short-term debt securities
s Issued by governments, financial institutions, and
corporations
s Investors are paid interest for the use of
their funds
s Generally low-risk
s U.S. Treasury bills, commercial paper, and
bank certificates of deposit

7. Bonds
s Government Bonds
s Bonds sold by the U.S. Department of the
Treasury
s Municipal Bonds
s Bonds issued by state or local governments
s Revenue bonds are used toward a project that will
produce revenue, general obligation bonds are not
s Corporate Bonds
s A diverse group and often vary based on the
collateral

8. Types of Bonds

9. Bond Ratings
s Price is determined by risk and interest rate.
s Several firms rate bonds
s Standard & Poor’s (S&P)
s Moody’s
s Investment-grade
s Speculative/Junk

10. Bond Ratings

11. Stocks
s Common stock– ownership claims in
corporations
s Vote on major company decisions
s Cash dividends
s Price appreciation
s Preferred stock– stockholders who receive
preference in the payment of dividends

12. Convertible Securities
s Stockholder has
the right to
exchange the
bond or preferred
stock for a fixed
number of shares
of common stock.

13. Financial Markets
s Primary market– firms and governments
issue securities and sell them initially to the
public
s When a firm offers a stock for sale to the general
public for the first time
s Secondary market– collection of financial
markets in which previously issued
securities are traded among investors

14. Understanding Stock Markets
s Stock market (exchange)– market in
which shares are bought and sold by
investors, such as the New York Stock
Exchange.

15. Stock Exchanges
s 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 the NYSE.
s The Nasdaq Stock Market– the second largest
stock market. Over 5,000 companies have their
stocks listed on Nasdaq, but many are smaller
firms.
s Other U.S. Stock Markets:
s The American Stock Exchange/AMEX
s Regional stock exchanges
s Foreign markets

16. ECNs and the Future of Stock Markets
s ECNs– Electronic Communication Networks
s The 4th market
s Buyers and sellers meet in a virtual market and exchange
with one another
s Take place on INET or Archipelago
s INET and Archipelago have been purchased by
Nasdaq and the NYSE

17. Investor Participation in the Stock
Market
s Investors use brokerage firms to:
1. Establish an account
2. Enter orders
3. Trade stock
s The brokerage firm executes the trade on
behalf of the investor, charging a fee for the
order.
s Market order
s Limit order

18. Financial Institutions
s Commercial Banks
s Savings Banks and Credit Unions
s Non-depository Institutions

19. Financial Institutions

20. Electronic Banking
s An increasing amount of funds move through
electronic funds transfers (EFTs).
s Millions of businesses and consumers now pay
bills and receive payments electronically.
s Most employers directly deposit employee
paychecks.
s Social Security and other federal payments are
made each year electronically.
s Most banks now offer customers debit cards
s More than 1/3 of American households use some
online banking.

21. Federal Deposit Insurance Corporation
s Enacted by the Banking Act of 1933
s Restored public confidence in the banking
system
s Before deposit insurance, runs were common
as people rushed to withdraw their money
from the bank
s Deposit insurance shifts the risk of bank
failures from individuals to the FDIC

22. Savings Banks and Credit Unions
s Offer a variety of consumer services
s 80+% of their loans are real estate loans
s Credit unions are cooperative financial
institutions owned by depositors/members
s Credit unions are created to serve consumers
s Insured by National Credit Union Administration
(NCUA), which functions the same as the FDIC

23. Nondepository Financial Institutions
s Insurance Companies
s Pension Funds
s Finance Companies
s Mutual Funds

24. The Role of the Federal Reserve
s The Federal Reserve
s Created In 1913
s Central bank of the United States
s Regulates commercial banks
s Performs banking-related activities for the U.S.
Department of Treasury
s Provides services for banks
s Sets monetary policy

25. Organization of the Federal Reserve
s 12 Federal reserve districts
s Own federal reserve bank
s District banks are run by a nine-member board
of directors
s The board of governors is the governing body
s Politically independent
s Federal Open Markets Committee (FOMC)
sets most policies concerning monetary policy
and interest rates

26. Check Clearing and the Fed
s Americans still write billions of paper checks.
s The process by which funds are transferred
from the check writer to receiver is a
multiple-step process managed and cleared
by the Fed.
s The Check Clearing for the 21st Century Act
is making this process more electronic.

27. Monetary Policy
s Controlling supply of money and credit
s Measures of the money supply: M1 & M2
s The Fed requires banks to maintain reserves
s Set the discount rate
s Open market operations

28. M1 & M2

29. Regulation of the Financial System
s Bank regulation
s Government regulation of the financial markets
(SEC)
s Industry self-regulation
s Rules of conduct by professional organizations like
National Association of Securities Dealers
s Market surveillance

30. The Financial System: A Global
Perspective
s The financial system
is more connected.
s Financial institutions
are more global.
s Only 3 of the 30
largest banks in the
world are U.S.
institutions.
s Most nations have a
central bank.