Chapter 1 Introducing money and the financial system During the recession of 07 09 the unemployment rate was above 10 and over 8 million jobs were lost Financial asset is an asset that represents a claim on someone else for a payment o in a checking account you have a claim against them to pay you back the amount that is in your account it is not physically yours but you have a claim against it financial asset that can be bought and sold in financial market it is tradable Security between firms and companies Financial markets securities security place or channel for buying or selling stocks bonds and other o New York Stock Exchange a place where you can buy a stock like Apple as a Not all assets are securities you can t sell your bank account like you could as stock Five key assets Money stocks bonds foreign exchange securitized loans anything that people are willing to accept in payment for goods and o Money services or to pay off debts Money supply also known as equities these are financial securities and show a partial total quantity of money in the economy o Stock ownership of a certain corporation when you buy a stock you become a shareholder o Financial capital funds that are available to the firm Selling a stock increases financial increases capital in exchange for increasing the number of the firm s owners Dividends a payment that a corporation makes to their shareholders this usually happens every quarter Bond repay a fixed amount of money promise to repay you A financial security issued by a corporation or the government that promises to o Basically you are lending a certain amount of money to them and this is their a percentage of an amount borrowed it is the cost of borrowing the Usually a bond it is when a firm pays someone a fixed amount for interest interest rate funds Coupons bond matures in one year or less Short term bond bond that takes more than a year to mature Long term bond Foreign Exchange Units of foreign currency This is important for firms like large banks that want to import or export a good or service or invest physical assets like a factory in other countries Securitization securities therefore making it tradable in the financial market converting loans and other financial assets that are not tradable into This is very important used throughout the other chapters o An example would be taking a mortgage and turning it into a mortgage backed security making it function like a bond With a mortgage backed security the bank that originally had the mortgages will still financial claim owed by a person or a firm collect interest on them they then send the interest to the financial firm that then distributes it to the investors of the security Financial Liability There are two different types of markets 1 banks and financial intermediaries funds flow from lenders to borrowers indirectly through one of them 2 financial markets think NYSE Indirect finance checking or saving deposits into the bank In a financial system funds are channeled from savers to borrowers and they channel returns back to savers Commercial Banks funds the bank lend you come from other people who have made like when you buy as stock funds go directly from you to the firm The most important intermediary Direct finance o Take in deposits from a household or firm and the investing most of those deposits by making a loan to households or firms or by buying securities Bank loans fill the gap between the time a company must pay for things inventory payroll and when they receive revenue from selling their goods Many firms rely heavily on loans It is costly for investors to gather information on a small company therefore a small business cannot sell stocks or bonds and must rely on loans instead o In the 2000 s small businesses and households were receiving loans from national banks but by 07 they were defaulting this caused national banks to stop giving out loans and restrict a lot that they did give out Nonbank financial intermediaries way in the sense that they take deposits and make loans legally distinct from banks but operate in the same o A k a savings and loans savings banks credit unions insurance companies pension funds mutual funds hedge funds investment banks they write contracts to protect policy holders from the risk of financial loss Insurance due to an event fire auto accident etc Pension fund contribution from workers is invested into stocks bonds and mortgages This gives them the money necessary to pay pension benefit payments during workers retirement they make their money by selling shares to investors a collection of assets stocks bonds Mutual funds o portfolio When a firm that issues a stock or bond declares bankruptcy the stock bond loses all of Hedge funds its value but the effect on the portfolio is usually small but they usually reap a higher reward Investment banks do not take in deposits or loan out money to households investors are charged higher fees and they are riskier than mutual funds o Underwriting buy a stock bond from a firm at a certain price and then turning around and selling the same stock bond at a higher price hoping to profit by buying and selling securities o Proprietary Trading Financial Markets buying and selling stocks bonds and other securities o Most trading takes place electronically like NASDAQ linked by computers Such as over the counter trading Primary market the first time secondary market Regulating the financial system financial market where stocks bonds and other securities are sold for investors buying and selling existing securities mostly trading o Securities and exchange commission SEC o Federal deposit insurance corporation FDIC regulates financial markets insures deposits in banks insures deposits in banks up to 250K per account Handles bank failures by closing the bank and paying off depositors or by purchasing and controlling the bank while finding another bank that will buy it Closing it is a last resort they try to keep it open as long as they can o Office of the controller of the currency o Federal reserve system Central bank of the U S established in 1913 by regulates federally chartered banks congress Monetary policy to pursue macroeconomic policy objectives actions the Fed takes to manage the money supply and interest rates o Includes high levels of employment low rates of inflation high rates of growth and stability in the financial system Federal Open Market Committee FOMC Federal funds rate interest rate that banks
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