Chapter 1 Introducing Money and the Financial System Vocab Asset Anything of value owned by a person or a firm Financial Asset An asset that represents a claim on someone else for a payment Security A financial asset that can be bought and sold in a financial market Money Anything that is generally accepted in payment for goods and services or to pay off debts Money supply The total quantity of money in the economy Stock Financial securities that represent partial ownership of a firm also called equities Dividend A payment that a corporation makes to its shareholders Bond A financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money Interest rates The cost of borrowing funds or the payment for lending funds usually expressed as a percentage of the amount borrowed Foreign exchange Units of foreign currency Securitization The process of converting loans and other financial assets that are not tradable into securities Financial liability A financial claim owed by a person or a firm Financial intermediary A financial firm such as a bank that borrows funds from savers and lends to borrowers Commercial bank A financial firm that serves as a financial intermediary by taking in deposits and using them to make loans Portfolio A collection of assets such as stocks and bonds Primary Market A financial market in which stocks bonds and other securities are sold for the first time Secondary Market A financial market in which investors buy and sell existing securities Federal Reserve The central bank of the United States usually referred to as the Fed Monetary Policy The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives Federal funds rate The interest rates that banks charge each other on short term loans Diversification Splitting wealth among many different assets to reduce risk Risk sharing A service the financial system provides that allows savers to spread and transfer risk Liquidity The ease with which each asset can be exchanged for money Information Facts about borrowers and about expectations of returns on financial assets Bubble An unsustainable increase in the price of a class of assets Learning Objectives 1 1 identify the key components of the financial system pgs 2 14 The three major components of the financial system are Financial Assets Financial institutions The federal Reserve and other financial regulators Financial assets can be broken into five key categories Money Stocks Bonds Foreign exchange Securitized loans The financial system matches savers and borrowers through two channels Banks and other financial intermediaries Nonbank financial intermediaries include Financial markets Insurance companies Specialize in writing contracts to protect their policyholders from the risk of financial losses associated with particular events May reinvest premiums you pay to other businesses that need funds to expand Pension funds Important source of demand for financial securities Pension funds invest contributions from workers and firms in stocks bonds and mortgages to earn money to pay retirement payments Mutual funds Obtains money by selling shares to investors Then invests money in a portfolio of financial assets such as stocks and bonds Hedge funds Similar to mutual funds but typically has no more than 99 investors all of whom are wealthy individuals or firms such as pension funds Typically make riskier investments Investment banks Do not take in deposits like commercial banks and rarely lend directly to households Instead they concentrate on providing advice to firms issuing stocks and bonds or considering mergers with other firms Also hope to profit on proprietary trading or buying and selling of securities Financial Markets are places or channels for buying and selling stocks bonds and other securities I e New York Stock Exchange or over the counter trading such as the NASDAQ Primary Markets first sell stocks officially known as an initial public offering IPO Secondary markets can be in the same physical or virtual place as where an IPO first takes place Secondary markets include the NYSE or NASDAQ The financial system transfers funds from savers to borrowers Borrowers transfer returns back to savers through the financial system Savers and borrowers include domestic and foreign households businesses and governments A lender of last resort make short term loans that provide banks with funds to pay out to their depositors Established the Federal Deposit Insurance Corporation FDIC in 1934 which insures deposits in banks up to a limit of 250 000 per account Fed is responsible for monetary policy The financial system provides risk sharing by allowing savers to hold many assets which is known as diversification Risk Sharing Liquidity Moving funds through the financial system The Federal Reserve The three key services the financial system provides to savers and borrowers Chapter 2 Interest Rates and Returns In general we can say that assets created by the financial system stocks bonds are more liquid than are physical assets houses cars Information 1 2 Provide an overview of the financial crisis of 2007 2009 Origins of the financial crisis Begins with the housing bubble of 2000 2005 To promote home ownership congress used two government sponsored enterprises GSEs the Federal National Mortgage association Fannie Mae and the Federal Home Loan Mortgage Corporation Freddie Mac Both sell bonds to investors and use the funds to purchase mortgages from banks READ PGS 14 17 Vocab Future Value The value at some future time of an investment made today Compounding The process of earning interest on interest as savings accumulate over time Present Value The value today of funds that will be received in the future Time value of money The way that the value of a payment changes depending on when the payment is received Discounting The process of finding the present value of funds that will be received in the future Capital Gains Stocks selling price purchase price Learning Objective 2 1 Explain how the interest rates links present value with future value pgs 22 29 Why do lenders charge interest on loans Compensation for inflation Compensation for default risk the chance the borrower will not pay back the loan Compensation for the opportunity cost of waiting to spend your money Compounding and Discounting Compounding for one period If i the interest rate principal the
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