CHAPTER 1 3 components of financial system Financial assets Financial institutions Federal reserve and financial regulators where buy and sell stocks bonds and other securities Financial market Financial asset financial claim meaning someone owes you money Ex Money owes me from bank not a security b c can t be bought or sold Includes securities tradable assets bought or sold in market Five categories of assets Money Stocks Bonds Foreign Exchange Securitized loans Money Stocks Bonds anything people are willing to accept in payment for goods or services or pay off debts Money supply total quantity of money in economy Aka equities Partial ownership of a company Purchasing makes you a partial shareholder Similar to adding a partner get more and more owners Shareholders have legal claim to profits which is why dividends are paid to shareholders Lending corporation money Interest also known as coupon Can be bought or sold so it is a security Foreign Exchange Units of foreign currency When Sony buys tv s from Japan they must exchange US to yen first Banks often take care of transactions for investors Securitized loans Loans that banks can sell in financial markets to become securities Ex A bank may grant a mortgage and then sell the mortgage to a gov sponsored enterprise or a financial firm forms a mortgage backed security The bank receives the interest payment and then sends it to the company who purchased the loan for them to distribute to investors It is a win win because the bank still charges fees to the company who purchased Financial liability involved with borrower Ex I take out car loan from bank bank sees it as an asset A R and liability to me because I owe the bank Financial Institutions Saver lender Funds flow from savers lenders to borrowers through financial intermediaries For ex Loan from bank or through financial markets like NY stock exchange Loan from bank for car is known as indirect finance It is indirect because the bank is not directly loaning you it s own personal money It is loaning you money from someone s savings or checking s Direct financing is when I buy stock because the money came straight from me to the company Savers and borrows can be households firms govs domestic or foreign Financial Intermediaries Commercial banks are most important Make an impact because they make loans buy securities like bonds securitized loans Making the Connection Banks used to be small as a result of gov regulations Banks used to loan to a smaller region b c banks knew more about local Changed b c regulations meant small businesses got loans from larger banks businesses who had fixed guidelines Banks eventually loosened up thinking that they would make more money on interest pmnts to offset defaulted loans granted more loans and ended up losing more money Loan losses were largest since great depression Small businesses struggled once banks tightened up Nonbank Financial Intermediaries Ex Savings and loans savings banks credit unions insurance companies pension funds mutual funds hedge funds investment banks they are legally distinct from banks Insurance companies collect premiums which they then invest by lending money to other people This helps them pay off their costs claims Pension funds use retirement money for investing Mutual funds are when people invest in a portfolio of financial assets of stocks bonds Less risky for small investors b c if a company goes bankrupt there are likely plenty of other stocks to keep the mutual fund balanced Financial Markets Whereas if the small investor invested solely in the company that went bankrupt then it would be a much more devastating loss Hedge fund are similar to mutual funds but typically have no more than 99 investors of wealthy individuals institutions Make riskier investments and have higher fees Investment banks are more based on advisement Engage in underwriting where they sell stocks at a higher price Most securities are traded through over the counter trading such as NASDAQ Many high tech firms like apple trade through them Listed means they are on a certain market For ex GE is listed on NY Stock Exchange and Apple is listed as NASDAQ Primary market is where things are sold for the first time First stock sold is known as initial public offering IPO Second market is where investors buy and sell already existing securities Federal Reserve Other Financial Regulators Includes o Securities and Exchange Commission SEC in charge of financial o Federal Deposit Insurance Corporation FDIC insures deposits in o Office of the Comptroller of the Currency regulates federally chartered o Federal Reserve System central bank of US Fed acts as a lender of last resort for banks who have depositors withdraw more money than they have Responsible for monetary policy which manages money supply and interest rates to pursue macroeconomic objectives including high employment low inflation high growth and stability Fed is run by board of Governors which has 7 members appointed by the president Divided into 12 districts each district has it s own bank Federal open market committee is policy making body of bank FOMC and includes Board of Governors president of Fed Res Bank of New York and four other presidents from district banks They meet 8 times a year in Wash D C FOMC works to get target for federal funds rate which is interest rate banks charge each other on short term loans markets banks banks What does the Financial System do o Risk sharing liquidity information Risk Sharing o Ex I have bonds shares of stock and shares in mutual fund o Allows for diversification so our assets balance out more Liquidity o Ease with which an asset can be exchanged for money o Ex Selling a car is illiquid o By holding claims like stock individual investors have more liquid savings than they would if they owned machines in a factory o Ex Lend 100 000 to a small business investment is illiquid But if we deposit 100 000 into the bank and they then loan the money to the small business then our asset is much more liquid Information o Banks do much research on borrowers to forecast likelihood or payment o Information also revealed through prices of stocks bonds other securities o Ex When price of Apple share rises you know other investors think Apple profits will be higher Financial Crisis of 2007 2009 o Price can also tell Apple how well their investors think they are doing o Origins lay in the housing bubble a bubble is an unsustainable increase in the price of a
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