Chapter 1 I The Financial System a The purpose of the financial system is to move money excess funds between lenders and investors called sellers and borrowers to those with a use for them b Money is moved through two markets either financial markets or financial intermediaries i Financial markets 1 Trade directly buyers know exactly what they are purchasing and sellers know exactly what they are selling ii Financial intermediaries c 3 major components in the financial system investors 1 Trade indirectly they an outside force like an investor facilitate trade like stocker II Financial assets i Financial assets financial institutions and the Federal Reserve and other financial regulators a An asset is anything of value owned by a person or a firm b A financial asset is a financial claim which means that if you own financial asset you have a claim on someone else to pay you money 1 Ex a bank checking account is a financial asset because it s a claim you have against a bank to pay you an amount of money that securities and those that aren t ii Two types of financial assets either it s a security or its not iii A security is tradable it can be bought and sold in a financial market c Financial markets Ex New York Stock Exchange NASDAQ is places or channels for buying and selling stocks bonds and other securities 1 Stocks bonds sold in a particular market are said to be listed on hat market Ex Apple is listed on NASDAQ 2 Primary markets is a financial market in which stocks bonds and other securities are sold for the first time via an IPO initial public offering can be physical and virtual 3 Secondary market is a financial market in which investors buy sell existing securities Can be physical and virtual 4 Disclaimer if you own stock in apple you own a security because you can sell it If you have a checking account through Wells Fargo you have an asset and not a security because you cant sell it d 5 key categories of financial assets i Money 1 Anything people are willing to accept in payment for goods and services or to pay off 2 Money supply total amount of money in the economy debts ii Stocks 1 Equity securities stocks 2 Stocks are also called equities and are forms of financial securities that represent partial ownership of corporation 3 Ex when you buy stock in a company like Microsoft you become a Microsoft shareholder and you own a small part of Microsoft When a company sells stock it is doing the same thing a small firm does when taking a partner who is increasing the funds available to the firm its financial capital in exchange for increasing the number of the firms owners 4 As a stockholder you have a legal claim to share of corporations assets and profits Firms keep their profits as retained earning and pay the remainder to shareholders in a form of dividends which are made every quarter 1 Debt securities bonds 2 Buying a bond a security means you are lending a corporation government a fixed 3 The interest rate payment of lending funds usually expressed as a percentage of the amount of money amount borrowed iii Bonds a Ex you borrow 1 000 from a friend pay him 1 100 a year later The interest rate on the loan is 100 1000 10 or 10 b Bonds typically pay interest in fixed dollar amounts called coupons c Bond matures seller of bonds repays principal i Ex buys 1000 bond issued by IBM that has a coupon of 65 a year and a maturity of 30 years IBM will pay you 65 for the next 30 years and at the end they will pay you 1000 principal ii Bond matures in less than a year short term bond iii Bond matures after a year long term bond iv Foreign exchange 1 Foreign exchange units of foreign currency 2 Most goods services purchased in a country produced outside that country 3 Many investors buy financial assets issued by foreign governments and firms Large Banks are the biggest buyers and sellers of foreign exchange because investors want to buy foreign exchange firms want to import export goods services or invest in physical assets 4 To buy foreign goods services or assets one must exchange domestic currency for foreign currency a Best buy exchanges US dollars for Japanese yen when importing Sony TVs v Securitized loans 1 Securitized loans mortgage backed securities 2 Loans that banks can sell on financial markets became securities and the process of converting loans into securities is called securitization i Ex bank might grant a mortgage and sell it to government sponsored enterprises financial firms who will bundle the mortgage with similar mortgages granted by other banks This bundle is now a security and is called a mortgage backed security and will function like a bond Now any investor can buy a mortgage backed security from the government agency financial firm The bank that grants the original loan will still collect interest paid by borrows and sends those payments to government agency financial firms to distribute to investors who bought the mortgage backed security The bank will receive fees for the original loan and for collecting loan payments and distributing them to lenders ii Saver views a financial asset iii Borrower views as a financial liability iv Savers and buyers can be households firms or governments both domestic and foreign firm 1 Financial liability is a financial claim owed by a person or a III Financial institutions 2 Ex you take out a loan to buy a car The loan is an asset from the viewer point of the bank because it promise that you will make payments but the loan to you borrower is a liability because you owe payments a Financial system matches saver and borrowers through two channels 1 banks and other financial intermediaries and 2 financial markets i These 2 channels are distinguished by how funds flow from savers or lender to borrowers and by financial institution involved ii Funds flow from lenders to borrowers indirectly through financial intermediaries such as banks or directly through financial markets such as the NY stock exchange 1 2 If you get a loan to buy a car the loan is refer to this flow of funds as indirect finance It is indirect because the funds come from people who have invested money in the bank via checking or saving deposits a If you buy stock the flow of funds is direct finance because funds are flowing direction from you to the firm b Financial intermediaries a financial firm such as a bank insurance company that borrows funds from savers and lends them to borrowers i Commercial banks the most important financial intermediaries 1 Banks
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