Chapter 1 Introducing Money and the Financial System Reading Notes Pages 1 17 Key Components of the Financial System 1 Financial Assets 2 Financial Institutions 3 The Federal Reserve and other nancial regulators Financial Assets An asset anything of value owned by a person or a rm Financial asset a nancial claim which means that if you own a nancial asset you have a claim on someone else to pay you money a bank checking account is a nancial asset because it represents a claim you have against a bank to pay you an amount of money equal to the dollar value of your account economists divide nancial assets into those that are securities and those that aren t A security is a tradable which means that it can be bought and sold in a nancial market Financial markets are places or channels for buying and selling stocks bonds and other securities such as the New York Stock Exchange if you own a share of stock in Apple or Google you own a security because you can sell that share ion the stock market If you have a checking account at Citibank you can t sell it Your checking account is an asset but not a security Five Key Categories of Assets 1 Money anything that people are willing to accept in payment for goods and services or to pay o debts Money supply is the total quantity of money in the economy 2 Stocks equities nancial securities that represent partial ownership of corporation When you buy a share of Microsoft you become a Microsoft shareholder and you own part of Microsoft a really tiny piece because they issue millions of shares of stock By selling an additional stock Microsoft is doing the same thing that the owner of a small rm does when she takes on a partner increasing the funds available to the rm its nancial capital in exchange for increasing the number of the rm s owners As an owner of a share of stock in a corporation you have a legal claim to a share of the corporation s assets and to a share of its pro ts if there are any Firms keep some of their pro ts as retained earnings and pay the remainder to shareholders in the form of dividends which are payments corporations typically make every quarter 3 Bonds a nancial security issued by a corporation or a government that represents a promise to repay a xed amount of money Interest rate is the cost of borrowing funds or the payment for lending funds usually expressed as a percentage of the amount borrowed Bonds typically pay interest in xed dollar amounts called coupons When a bond matures the seller of the bond repays the principal A bond that matures in a one year or less is a short term bond A bond that matures in more than one year is a long term bond Bonds can be bought and sold in nancial markets so like stocks bonds are securities For Example if you buy a 1 000 bond issued by IBM that has a coupon of 65 per year and a maturity of 30 years IBM will pay you 65 pr year for the next 30 years at the end of which IBM will pay you the 1 000 principal 4 Foreign Exchange units of foreign currency Most important buyers sellers of foreign exchange are large banks Banks engage in foreign currency transactions on behalf of investors who want to buy foreign nancial assets and rms that want to import export goods and services or to invest in physical assets such as factories in foreign countries 5 Securitized Loans the process of converting loans and other nancial assets that are not tradable into securities For Example a bank might grant a mortgage which is a loan a borrower uses to buy a home and sell it to a government sponsored enterprise or a nancial rm that will bundle the mortgage together with similar mortgages granted by other banks This bundle of mortgages will form the basis of a new security called a mortgage backed security that will function like a bond The banks that grants or originates the original mortgages will still collect the interest paid by borrowers and send those interest payments on to the government agency or nancial rm to distribute to the investor who have bought the mortgage backed security The bank will receive fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders What a saver views as a nancial asset a borrower views as a nancial liability which is a nancial claim owed by a person or rm For Example if you take out a car loan from the bank the loan is an asset from the viewpoint of the bank because it represents a promise by you to make a certain payment to the bank every month until the loan is paid o But the loan is a liability to you the borrower because you owe the bank the payments speci ed in the loan The nancial system matches savers and borrowers through two channels 1 Banks and other nancial intermediaries and 2 nancial markets They are distinguished by how funds ow from savers or lenders to borrowers and by the nancial institutions involved Funds ow from lenders to borrowers indirectly through nancial intermediaries such as banks or directly through nancial markets such as the New York Stock Exchange If you get a loan from the bank to buy a car economist refer to this ow of funds as indirect nance because the funds the bank lends you come from people who have put money in checking or savings deposits in the bank in that sense the bank is not lending its own funds directly to you If you buy a stock that a rm has just issued the ow of funds is direct nance because the funds are owing directly from you to the rm Financial Intermediaries Commercial banks are the most important nancial intermediaries Commercial banks play a key role in the nancial system by taking in deposits from households and rms and investing most of those deposits either by making loans to households and rms or by buying securities such as the government bonds or securitized loans Many rms rely on bank loans to meet their short term needs for credit such as funds to pay for inventories or to meet their payrolls Many rms use bank loans to bridge the gap of time between inventories or meeting payroll to when they receive revenues from the sales of goods and services Some rms rely on bank loans to meet their long term credit needs such as funds they require to physically expand their rm Nonbank Financial Intermediaries Insurance companies specialize in writing contracts to protect their policyholders from the risk of nancial Financial Institutions losses associated with particular events such as automobile accidents or re They collect premiums from policyholders which
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