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FSU FIN 3244 - Chapter 1

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Chapter 1- Three major components of the financial system:o Financial assetso Financial institutionso The Federal Reserve and other financial regulators- An asset is anything of value owned by a person or a firm. - A Financial asset is a financial claim, which means that if you own a financial asset, youhave a claim on someone else to pay you moneyo Economist divide financial assets into those that are securities and those that isn’t.o A security is tradable, which means that it can be bought and sold in a financial market- Financial markets are places or channels for buying and selling stocks, bonds, and other securities, such as the New York stock exchange.- Financial assets include give key categories:o Moneyo Stockso Bondso Foreign exchangeo Securitized loans- Moneyo Money is anything that people are willing to accept in payment for goods and services or to pay off debtso The money supply is the total quantity of money in the economy- Stockso They’re also called equities, are financial securities that represent partial owner ship of a corporationo Firms keep some of their profits as retained earnings and pay the remainder to shareholders in the form of dividends, which are payments corporations typically make every quarter.- Bondso When you buy a bond issued by a corporation or a government, you are lending the corporation or the government a fixed amount of money. o The interest rate is the cost of borrowing funs, usually expressed as a percentage of the amount borrowed.o When a bond matures, the seller of the bond repays the principle.- Foreign Exchangeo Many investors buy financial assets issued by foreign governments and firms.o Foreign exchange refers to units of foreign currency.o The most important buyers and sellers of foreign exchange are large banks.- Securitized Loanso Loans that banks could sell on financial markets became securities, so the process of converting loans into securities is known as securitization.o Note that what a saver views as financial asset a borrower views as financial liability.- The financial system matches savers and borrowers through two channels:o Banks and other financial intermediarieso Financial marketso These two channels are distinguished by how funds flow from savers, to borrowers and by the financial institutions involved.o Funds flow from lenders to borrowers indirectly through financial intermediaries, such as banks, or directly through financial markets, such as the New York stock exchange. o If you borrow from a bank, it is called indirect finance because the bank is not lending its own fun directly to youo If you buy stock from a firm, it is called direct finance because the funds are flowing directly from you to the firm.- Commercial banks are the most important financial intermediaries.- Some financial intermediaries such as saving and loans, savings banks, and credit unions are legally distinct from bank. They fulfill a similar function in the financial system by channeling funds from savers to borrowers- Financial markets are places or channels for buying and selling stocks, bonds, and other securities.o Today most securities trading takes place electronically between dealers linked bycomputers.o Economists make a distinction between primary markets and secondary markets.o A primary market is a financial market in which stocks, bonds, and other securities are sold for the first time.o A secondary market is a financial market in which investors buy and sell already existing securities.- The fed has several agencies that are devoted to regulating the financial systemo The Securities and Exchange Commission (SEC) which regulates financial marketso The Federal Deposit insurance Corporation (FDIC) which insures deposits in bankso The Federal Reserve System which is the central bank of the United States. - The Federal Reserve is the central bank of the US.o Country’s central bank act as a lender of last resort and make short term loans thatprovide banks with funds to pay out to their depositors.o The Fed is now responsible for monetary policy.o Monetary policy refers to the action of the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives.o These policy objectives include high levels of employment, low rate of inflation, high rate of growth, and the stability in the financial system.- Economists believe there are three key services that the financial system provides to savers and borrowers: risk sharing, liquidity, and information.- Risk Sharingo Risk is the chance that the value of financial assets will change relation to what you expecto Most individual savers seek a steady return on their assets rather than erratic swings between high and low earning.o The financial system provides risk sharing by allowing savers to hold many assets.o This makes savers more willing to buy stocks, bonds and other financial assets. This in turn increases the ability of borrowers to raise funds in the financial system- Liquidityo The ease with which an asset can be exchanged for money.o Savers view the liquidity of financial assets as a benefit.o Financial markets and intermediaries help make financial assets more liquid.o The process of securitization has made it possible to buy and sell securities based on loans.- Informationo A third service of the financial system is the collection and communication of information.o The profits the bank earns on its loans are partly compensation to it for investing in information gatheringo Financial markets convey information to both savers and borrowers by determining the prices of stocks, bonds, and other securities.o The incorporation of available information into asset prices is an important feature of well-functioning financial marketsChapter 2- Interest rate has to cover the opportunity cost of supplying credit.- To cover opportunity cost, interest rate act aso Compensation for inflationo Compensation for default risk- the chance that the borrower will not pay back the loano Compensation for the opportunity cost of waiting to spend money- For example when lenders believe that inflation will be high, they will charge more interest.- Lenders will also charge more interest to borrowers who seem more likely to default/- Most financial transaction involve payments in the future- The interest rate provides a means of answering questions because it provides a link between the financial present and the financial future.- For instance, suppose


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