Copyright 2013 Pearson Education Inc Publishing as Prentice
Copyright © 2013 Pearson Education, Inc. Publishing as Prentice Hall The Financial System www. wileybusinessupdates. com Chapter 16 Copyright © 2017 John Wiley & Sons, Inc.
Learning Objectives 2 1 2 Understand the financial system. List the various types of securities. 3 Discuss financial markets. 4 Understand the stock markets. 5 Evaluate financial institutions. 6 7 8 Explain the role of the Federal Reserve System. Describe the regulation of the financial system. Describe the global perspective of the financial system. Copyright 2017 John Wiley & Sons, Inc.
The Financial System 3 Made up of households, businesses, government, financial institutions, and financial markets The process by which money flows from savers to users Some individuals and businesses (savers) have incomes greater than expenditures and invest to earn rate of return from their savings Businesses (users) in need of capital might turn to a lender Copyright 2017 John Wiley & Sons, Inc.
Understanding the Financial System 4 Financial System Savers Those with surplus funds Users Spending needs exceed income to create deficit Financial Institutions Financial Markets Copyright 2017 John Wiley & Sons, Inc.
Transferring Funds Between Savers and Users 5 Funds are transferred between savers and users directly or indirectly A direct transfer means that the user raises the needed funds directly from savers. A school district selling bonds to investors The other way in which funds can be transferred indirectly is through financial institutions Borrowing from a bank – a bank pays depositors interest for the use of their money, and charges borrowers interest Copyright 2017 John Wiley & Sons, Inc.
Types of Securities 6 Securities, also called financial instruments, represent obligations on the part of the issuers Issuers can be businesses or government Purchasers seek an expected or stated return on the funds invested or loaned Three categories of securities: Money Market Instruments – debt security Bonds – debt security Stocks – units of ownership in a company Copyright 2017 John Wiley & Sons, Inc.
Money Market Instruments 7 Short-term debt securities are issued by: Governments Financial institutions Corporations Mature within one year from date of issue Issuer pays interest to investors for use of funds Low risk Examples: U. S. Treasury bills, commercial paper, and bank certificates of deposit Copyright 2017 John Wiley & Sons, Inc.
Bonds 8 Government Bonds sold by the U. S. Department of the Treasury Municipal Bonds issued by state or local government Revenue bonds are used toward a project that will produce revenue, General obligation bond proceeds pay for a project that will not produce any revenue Corporate Bonds Secured Unsecured Copyright 2017 John Wiley & Sons, Inc.
Types of Bonds 9 Copyright 2017 John Wiley & Sons, Inc.
Bond Ratings 10 Two factors determine the price of a bond: Risk Interest rate Bond rating is used by investors to evaluate the riskiness of a bond Several firms rate bonds Standard & Poors (S&P), Moody’s, and Fitch Bonds with low risk levels are AAA Junk bonds, with ratings of BB or below, attract investors by offering higher rates of return and higher risk Copyright 2017 John Wiley & Sons, Inc.
Standard & Poor’s Bond Ratings 11 Copyright 2017 John Wiley & Sons, Inc.
Stocks 12 Common Stock Basic form of corporate ownership Purchasers are owners of a corporation Voting rights on major company policies Owners hope for price appreciation or a cash dividend Stock quote: price of a specific stock and performance information Called a ticker symbol, each stock has a unique identifier of letters Dividend yield is the percentage return on the dividend calculated as annual dividends per share divided by price per share Price/earnings ratio is calculated by dividing the current stock price by earnings per share over the last year Copyright 2017 John Wiley & Sons, Inc.
Stocks 13 Copyright 2017 John Wiley & Sons, Inc.
Stocks 14 Stock split: occurs when a corporation decides to divide its existing shares of stock into multiple shares A stock’s market value is the price at which the stock is currently selling Preferred Stockholders who receive preference in the payment of dividends Convertible Securities Stockholder has the right to exchange the bond or preferred stock for a fixed number of shares of common stock. Copyright 2017 John Wiley & Sons, Inc.
Financial Markets 15 Securities are issued and traded in financial markets. Primary Market When a firm or government offers a stock or security 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. Copyright 2017 John Wiley & Sons, Inc.
Understanding Stock Markets 16 Stock markets represent companies that list stocks for public investors to buy and sell Exchanges consist of the infrastructure that facilitates the trading of those equity securities, or stocks In these markets, shares are bought and sold by investors. The New York Stock Exchange (NYSE) and the NASDAQ , the two largest stock markets in the world, are in the United States. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks on the NYSE and NASDAQ. Copyright 2017 John Wiley & Sons, Inc.
Stock Exchanges 17 The New York Stock Exchange founded in 1792 one of the oldest and biggest stock exchanges in the world 2, 800 companies are listed on the NYSE NASDAQ - National Association of Securities Dealers Automated Quotation The NASDAQ Composite is an index of more than 3, 000 stocks listed on the exchange a global electronic marketplace where securities are bought and sold Other U. S. Stock Markets: The American Stock Exchange, Regional Stock exchanges, and foreign markets
ECNs and the Future of Stock Markets 18 Electronic Communication Network refers to the direct trading of exchange-listed stocks off the floor of the exchange (NYSE) or outside of networks (NASDAQ) The fourth stock market Buyers and sellers meet in a virtual stock market, and trade directly with one another Open to smaller, individual investors through markets called ECNs Copyright 2017 John Wiley & Sons, Inc.
Investor Participation in the Market 19 Most investors use the services of a broker or an online brokerage firm to buy and sell stocks. Investors establish an account Orders are entered to trade stocks The brokerage firm executes the trade on behalf of the investor for a fee Types of orders Market order – broker obtains the highest price when selling and the lowest price when buying Limit Order – a price ceiling is set when buying, or a price floor when selling Copyright 2017 John Wiley & Sons, Inc.
Financial Institutions 20 An intermediary efficiently transferring funds between savers and borrowers Without financial institutions, prospective borrowers would have to negotiate terms with each saver individually Classified as: Depository Institutions – commercial banks that accept deposits that customers can withdraw on demand Nondepository Institutions – life insurance companies, mutual funds, and pension funds Copyright 2017 John Wiley & Sons, Inc.
Largest Commercial Banks by Assets and Branches 21 Copyright 2017 John Wiley & Sons, Inc.
Commercial Banks 22 Commercial Banks – offer a wide range of checking and savings accounts, loans, credit cards, securities and insurance Largest and most important financial institution in the United States Approximately 5, 309 commercial banks hold assets of $15. 7 trillion Copyright 2017 John Wiley & Sons, Inc.
Distribution of Outstanding Commercial Bank Loans 23 Copyright 2017 John Wiley & Sons, Inc.
Electronic Banking 24 Increasingly, funds are moved through electronic transfer systems (ETFs) ETFs are computerized systems for conducting financial transactions electronically Businesses and individuals pay bills and receive payments electronically The Automated Teller Machine, or ATM, an original form of electronic banking, continues to proliferate Debit cards—also called checkcards—allow customers to pay for purchases directly from their checking or savings account Online banking - internet only banking and brick and mortar banks with online banking sites. Copyright 2017 John Wiley & Sons, Inc.
Federal Deposit Insurance Corporation 25 Enacted by the Banking Act of 1933 to restore public confidence in the banking system Commercial bank deposits are insured by a federal agency, the FDIC If a bank fails, insured depositors are paid up to $250, 000 Runs were common before deposit insurance A run occurs when many people attempt to withdraw money from a bank all at once Copyright 2017 John Wiley & Sons, Inc.
Depository Institutions 26 Savings Banks – originally established to make home loans, offer many of the same services as commercial banks Credit Union – not for profit cooperative financial institutions owned by their member depositors Copyright 2017 John Wiley & Sons, Inc.
Nondepository Institutions 27 Insurance companies – accept risk in exchange for premium payments, which they invest Pension funds – set up by employers, they provide retirement benefits to workers. Invest heavily in assets Finance companies – consumer and commercial companies offer short term loans to borrowers who pledge tangible assets Mutual Funds – intermediaries that raise money from investors by selling shares Exchange traded funds or ETFs combine characteristics of mutual funds and stocks Copyright 2017 John Wiley & Sons, Inc.
Nondepository Institutions 28 Life insurance companies such as New York Life are a major source of financing for businesses. Considered a nondepository financial institution, insurance companies obtain funds from consumers and businesses and invest most of the money. Copyright 2017 John Wiley & Sons, Inc.
The Role of the Federal Reserve 29 Created in 1913 -- called “The Fed” for short Central bank of the United States Regulates commercial banks Acts as the bankers’ bank for members Performs banking-related activities for the U. S. Department of Treasury Sets monetary policy Provides wire transfer facilities, clears checks, replaces worn out currency, lends banks money Copyright 2017 John Wiley & Sons, Inc.
Organization of the Federal Reserve 30 12 Federal reserve districts, each with its own district bank District banks are run by a nine-member board of directors headed by a president The Board of Governors is the governing body of the Federal Reserve Bank – consisting of 7 members, a chair and a vice chair appointed by the president Federal Open Market Committee (FOMC) consists of 12 members and sets most policies concerning monetary policy and interest rates Copyright 2017 John Wiley & Sons, Inc.
Monetary Policy 31 The Fed’s most crucial job is: controlling the supply of money and credit maintaining a balance of growth to allow the economy to expand, and inflation to remain in check. If the money supply grows too slowly, economic growth will slow, unemployment will increase, and there is an increased risk of a recession If the money supply grows too rapidly, inflationary pressures will build. Policy tools are used to increase or decrease interest rates Copyright 2017 John Wiley & Sons, Inc.
Breakdown of M 1 and M 2 32 Two common measures of money supply: M 1 - currency in circulation and balances in bank checking accounts M 2 - M 1 plus some balances in some savings accounts and money market mutual funds Copyright 2017 John Wiley & Sons, Inc.
Federal Reserve Policy Tools 33 Reserve Requirements Banks are required to maintain reserves equal to a percent of deposits A change in reserves impacts the amount banks have available to lend The Discount Rate or interest rate at which loans are made to member banks An increase slows the growth rate (more expensive for banks to borrow) A decrease has the opposite effect Open Market Operations controls the money supply through the purchase and sale of U. S. Treasury securities Copyright 2017 John Wiley & Sons, Inc.
Tools Used by the Federal Reserve 34 Copyright 2017 John Wiley & Sons, Inc.
How the Financial Crisis Unfolded 35 The precursor to the financial crisis of 2007– 2008 was a flood of irresponsible mortgage (home) lending The crisis, which could have been avoided, was the result of “high risk, complex financial products; undisclosed conflicts of interest; and the failure of regulators, credit rating agencies, and the market itself to rein in the excesses of Wall Street A flood of liquidity in the economy and policies encouraging home ownership provided further incentives for banks to provide easy money loans to borrowers with poor credit who were already at high financial risk But when the housing bubble burst in late 2007, the value of investments tied to housing and real estate also plummeted The American Recovery and Reinvestment Act of 2009, referred to as the Stimulus, was signed into law to save and create jobs and to provide financial assistance to those most affected by the financial crisis Copyright 2017 John Wiley & Sons, Inc.
Regulation of the Financial System 36 The financial system is subject to government regulation and oversight Banks are heavily regulated to ensure public confidence in the banking system Government regulation of the financial markets is performed through the Securities and Exchange Commission (SEC) Dodd-Frank Wall Street Reform and Consumer Protection Act Industry Self-Regulation by professional organizations and market surveillance Copyright 2017 John Wiley & Sons, Inc.
Regulation of the Financial System 37 The Securities and Exchange Commission is charged with regulating financial markets. Its website, featured here, is a good source of information for would-be investors. Copyright 2017 John Wiley & Sons, Inc.
A Global Perspective of the Financial System 38 The global financial system is increasingly interconnected Financial Institutions have become a global industry U. S. banks have international operations All nations have a central bank of sorts Before the Brexit vote, a sculpture of the euro in Frankfurt, Germany—the symbol for the European Union’s currency —shows 12 yellow stars. The stars represent the initial EU member countries—which included the United Kingdom. Copyright 2017 John Wiley & Sons, Inc.
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