Fin 3244 Test 1 Summer Deborah Peterson Chapter 1 Introducing Money and the Financial System The flow of money is what fuels the financial system During the economic crisis that began in 2007 disrupted and cut off the flow of funds to many areas in the U S More than 8 million jobs lost and unemployment rose above 10 Key Components of the Financial System Asset anything with value owned by a firm A financial asset is a financial claim Ex A bank checking account is a claim you have against the bank to pay you an amount of money o A security is a tradable financial asset which means it can be traded in the Financial markets are places for buying and selling stocks bonds and other securities financial market such as the New York Stock Exchange 5 key financial assets are o Money o Stocks o Bonds o Foreign Exchange o Securitized Loans Money is anything that people will accept in exchange for a good or service o Money supply is the total amount of money in the economy Stocks or equity are financial securities that represent a partial ownership in of a corporation o Selling ownership of the company increases its financial capital o The firm usually keeps part of its profits as retained earnings and pays the remainder to shareholders as dividends which are typically paid every quarter Bonds are issued by a corporation or government When you buy a bond you are giving this corporation or government a fixed amount of money o The interest rate is the cost of borrowing that money It is usually expressed as a percentage of the amount borrowed o Bonds that mature in a year are short term bonds o Bonds that mature in more than one year are long term bond Foreign exchange refers to units of foreign currency To buy or sell product from or to a foreign country you must first exchange the U S dollars for the other currency o Banks are also involved in foreign currency transaction on behalf of firms that want to import and export goods or to invest in foreign factories Securitized Loans are loans that have been converted into securities or securitized Before this was possible loans could not be sold in financial markets o For example A mortgage loan for buying a house can be securitized by bundling it with other mortgages to form a security called a mortgage backed security which functions like a bond An investor can buy a mortgage baked security and the bank will collect the interest payments and give it to that investor A financial liability is a financial claim owed by a person or a firm The borrower of a loan views the loan as a financial liability and the bank views it as a financial asset Financial Institutions The financial system offers two channels for lenders and borrowers 1 Banks and other financial intermediaries and 2 financial markets o Money flows from these lenders to borrowers indirectly through financial intermediaries such as banks or directly through financial markets such as the New York Stock Exchange Commercial Banks are play a key role in the financial system because they take deposits from households and invest them through loans or by buying securities Nonbank financial intermediaries include savings and loans savings banks credit unions insurance companies pension funds mutual funds hedge funds and investment banks o Insurance companies specialize in writing contracts to protect policyholders from risk of financial losses from particular events such as car accidents or fires They collect premiums and then invest them to collect funds to pay the claims of policyholders o Pension funds these funds take investment contributions from workers and firms and invest it in stocks bonds and mortgages to earn the money necessary to pay off pension benefits o Mutual funds obtains money by selling shares to investors The fund then invests the money in a portfolio of assets like stocks and bonds and charges a small management fee My buying shares in a mutual fund investors can lower their risk since mutual funds hold a large number of stocks or bonds o Hedge funds is similar to a mutual fund in that it accepts money in return for investing However a mutual fund typically has no more than 99 investors whom are all wealthy individuals or institutions Hedge funds make riskier investments and charge higher fees to their investors o Investment banks concentrate on providing advice to firms issuing stocks and bonds or considering mergers Also engage in underwriting where they guarantee a price to a firm issuing stocks and bonds and then make a profit by selling them at a Financial markets are channels for buying and selling stocks bonds and other higher price securities o A primary market is where stocks bonds and other securities are sold for the first time which is called an initial public offering IPO o A secondary market is where investors buy and sell already existing securities The Federal Reserve and Other Financial Regulators The Securities and Exchange Commission SEC regulates financial markets The Federal Deposit Insurance Corporation FDIC insures deposits in banks The Office of the Comptroller of the Currency regulates federally chartered banks The Federal Reserve System Which is the central bank of the United Stated o The federal reserve system has now gone beyond its original purpose of lender of last resort to now being responsible for monetary policy o Monetary policy is management of money supply and interest rates to pursue specific microeconomic policy objectives o Federal Funds Rate is the interest rate that banks charge each other on short term loans The Financial System transfer risk Risk sharing a service that the financial system provides that allows savers to spread and Diversification Splitting wealth among many different assets to reduce risk Liquidity the ease with which an asset can be exchanged for money Information facts about borrowers and about expectations of returns on financial assets Bubble an unsubstantial increase in the price of a class of assets Chapter 2 Interest Rates and Rates of Return Interest charged on loans is for the opportunity cost of lending money The interest is compensation for o Inflation o Default risk chance that the borrower will not pay back the loan o Opportunity cost of waiting to spend the money until loan is repaid Interest rates are important because most financial transactions involve payments in the Principal is the amount of the initial investment Future value is the value at some time of an investment made today Compounding
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