Chapter 1 Three major components of the financial system o Financial assets o Financial institutions o 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 you have a claim on someone else to pay you money o 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 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 market o Money o Stocks o Bonds o Foreign exchange o Securitized loans Money o Money is anything that people are willing to accept in payment for goods and services or to pay off debts o The money supply is the total quantity of money in the economy Stocks o They re also called equities are financial securities that represent partial owner ship of a corporation o 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 Bonds o 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 Exchange Securitized Loans o 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 o 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 intermediaries o Financial markets o 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 you o 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 computers o Today most securities trading takes place electronically between dealers linked by 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 system o The Securities and Exchange Commission SEC which regulates financial o The Federal Deposit insurance Corporation FDIC which insures deposits in markets banks o 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 that provide 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 o Risk is the chance that the value of financial assets will change relation to what o 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 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 o 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 Risk Sharing you expect assets Liquidity on loans Information o A third service of the financial system is the collection and communication of information in information gathering o The profits the bank earns on its loans are partly compensation to it for investing o 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 markets Chapter 2 Interest rate has to cover the opportunity cost of supplying credit To cover opportunity cost interest rate act as o Compensation for inflation o Compensation for default risk the chance that the borrower will not pay back the loan interest o Compensation for the opportunity cost of waiting to spend money For example when lenders believe that inflation will be high they will charge more 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 that you need to borrow 15000 from your bank to buy a car Consider
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