Chapter 1 Introducing Money and the Financial System Can the fed restore the flow of money the financial system is like an irrigation system economic crisis of 2007 disrupted the system like it hadn t been since the 1930 s o when disrupted portions of the U S economy were cut off from the flow of funds they needed to thrive recession of 2007 2008 o 8 million jobs lost o bankruptcy of GM and Chrysler o unemployment above 10 Key Components of the Financial System Financial Assets o asset is anything with value owned by a person or firm o financial asset is a financial claim which means if you own a financial asset you have a claim on someone else to pay you money ex a bank checking account that represents a claim you have against the bank to pay you an amount of money equal to the dollar value of your account financial assets are divided into securities and non securities o o a security is trade able it can be bought and sold in a financial market ex of security a share of a stock you can sell back into the stock market ex of non security checking account which you cannon sell financial market is a place or channel for selling and buying stocks bonds and other securities ex New York Stock Exchange o Five Key Categories of Assets Money Stocks Bonds money is anything that is generally accepted in payment for goods and services or to pay off debts money supply is the total quantity of money in the economy money plays a crucial role in the economy there are many debates concerning the best ways to measure it also known as equities stock equity are financial securities that represent partial ownership of a corporation when you buy stock you become a shareholder owning a small part of the corporation if corporation decides to sell additional stock it is equivalent to a small business taking on a partner this increases the funds available to them or their financial capital this also increases the number of the corporations owners dividends are payments that a corporation makes to its shareholders typically made every quarter bonds are a financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money when you buy a bond you are lending the corporation or government a fixed amount of money interest rate is the cost of borrowing funds or the payment for lending funds which is usually expressed as a percentage of the amount borrowed coupons are the fixed dollar amounts that bonds usually pay interest in when a bond matures the seller of the bond repays the principal short term bond matures in a year or less long term bond matures in more than one year bonds are securities because they can be bought and sold in financial markets Foreign Exchange foreign exchange refers to the units of foreign currency many investors buy financial assets issued by foreign governments and firms to buy foreign assets a domestic business or domestic investor must first exchange domestic currency for foreign currency most important buyers and sellers of foreign exchange are large banks Securitized Loans banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets banks engage in foreign currency transactions that want to import or export good and services or to invest in physical assets in foreign countries securitization is the process of converting loans and other financial assets that are not tradable into securities the federal government and financial firms created markets for many types of loans so that they could be securities ex bank grants a mortgage which is a loan a borrower uses to buy a home then sells it to a government sponsored enterprise or a financial firm 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 mortgage backed security that will function as a bond just like an investor can buy a bond an investor can buy a mortgage backed security from the government agency or financial firm the original bank that granted the original mortgages will collect the interest paid by the borrowers and send those interest payments on to the government agency to distribute them to investors who bought the security the bank receives fees for originating the loan and for collecting the loan payments from borrowers and distributing them to lenders what a saver views as a financial asses a borrower views as a financial liability financial liability is a financial claim owed by a person or firm ex if you take our a car loan from the bank it represents a promise that you will make a payment to the bank every month until if is paid off the loan is a liability to you the borrower because you owe the bank the payments 3 Financial Institutions o o o o financial system matches savers and borrowers through two channels banks and other financial intermediaries financial markets they are distinguished by how funds flow from savers or lenders to borrowers any by the financial institutions involved if you get a loan from a bank to buy a car this is an indirect finance because the funds the bank lends you come from people who have put money in a checking or savings deposits in the bank i e the bank isn t lending you its own funds directly to you if you buy a stock that firm has just issues this is a direct finance because the funds are flowing directly from you to the firms o Financial Intermediaries financial intermediaries are financial firms such as banks that borrow funds from savers and legs them to borrows the most important financial intermediaries are commercial banks a financial firm that serves as a financial intermediary by taking in deposits and investing them either by making loans or buying securities most household rely on borrowing money from banks when they purchase big ticket items many firms rely on bank to bridge the gap between the time they must pay for inventories or meet their payrolls and when they receive revenues from the sales of goods services or for long term credit needs such as funds needed to expand a firm read the making a connection on p g 5 for examples Nonbank Financial Intermediaries some nonbank financial intermediaries operate in similar ways to banks by taking in deposits and making loans ex savings and loans savings banks credit unions etc others don t seem at first glance to be similar to banks but they fulfill a similar function in the financial system by channeling funds from savers to
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