FIN3244 Spring 2016 Peterson Exam 1 Chapters 1 3 CHAPTER 1 INTRODUCING MONEY AND THE FINANCIAL SYSTEM Key Components of the Financial System 1 Financial Assets 2 Financial Institutions 3 The Federal Reserve and other Financial Regulators 1 FINANCIAL ASSETS Financial Asset Financial claim you claim on someone else to pay you money Security Tradable it can be bought and sold in a financial market Economists divide financial assets into those that are securities and those that aren t Financial Market Places or channels for buying and selling stocks bonds and other securities o EX NYSE Assets Anything of value owned by a person or firm 5 key categories of assets are 1 Money Anything that people are willing to accept in payment of goods and services or to pay off debts Money Supply Total quantity of money in the economy 2 Stocks Also called equities financial securities that represent partial ownership of a corporation Shareholder When you own part of a company Dividends When a firm keeps some of their profits as retained earnings and pay remainder to shareholders called dividends payments corporations typically make every quarter 3 Bonds A financial security issued by a corporation or government that represents a promise to repay a fixed amount of money Interest Rate Cost of borrowing funds repayment of lending funds Coupons Fixed dollar amount that bonds typically pay interest on Short term Bond A bond matures in one year or less Long term Bond A bond that matures in more than one year Bonds can be bought and sold in financial markets so like stocks bonds are securities 4 Foreign Exchange Units of foreign currency Most important buyers and sellers in foreign exchange are large banks Banks engage in foreign currency transactions on behalf of investors who want to buy foreign financial assets 5 Securitized Loans Loans that banks could sell on financial markets became securities so the process of converting loans into securities is known as securitization Financial Liability Financial claim owed by a person or a firm Ex Loan from bank Loan is asset to bank lender Loan is a liability to you borrower 2 FINANCIAL INSTITUTIONS The financial system matches savers and borrowers through two channels o 1 Banks and other financial intermediaries Financial Intermediaries Funds flow from lenders to borrowers indirectly FIN3244 Spring 2016 Peterson Exam 1 Chapters 1 3 Ex Banks NYSE Commercial banks play key role in financial system by taking in deposits from households and firms and investing most of those deposits by either making loans to households and firms or by buying securities such as government bonds or securitized loans Nonfinancial Intermediaries Savings and loans savings banks credit unions Insurance companies Collect premiums from policyholders invest to obtain funds necessary to pay claims to policy holders and to cover other costs Pension Funds Invest contributions from works and firms in stocks bonds and mortgages to earn the money necessary to pay pension benefit payment during workers retirements Mutual Funds Obtains money by selling shares to investors Invests money in a portfolio of financial assets such as stocks and bonds typically charging a small management fee for its services Hedge Funds Has no more than 99 investors all of whom are wealthy individuals or institutions such as pension funds Make riskier investments than mutual funds and charge investors much higher fees o 2 Financial Markets Places or channels for buying and selling stocks bonds and other securities Financial markets are typically physical places NYSE London Stock Exchange Stocks and bonds sold in a particular market are said to be listed on that market Primary Market A financial market in which stocks bonds and other securities are sold for the first time Initial Public Offering IPO When a company first sells stock Secondary Market A financial market in which investors buy and sell existing securities 3 THE FEDERAL RESERVE AND OTHER FINANCIAL REGULATORS The federal government of the United States has several agencies that are devoted to regulating the financial system including o The Securities and Exchange Commission SEC Regulates financial markets o The Federal Deposit Insurance Corporation FDIC Insures deposits in banks o The Office of the Comptroller of the Currency Regulates federally chartered banks o The Federal Reserve System Central bank of the United States Federal Reserve The Fed main business of banking is to take in deposits and to make loans Lender of last resort make short term loans that provide banks with funds to pay out their depositors Monetary Policy The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives FIN3244 Spring 2016 Peterson Exam 1 Chapters 1 3 Federal Fund Rates The interest rate that banks charge each other on short term loans Three Key Services the Financial System Provides To Savers 1 Risk Sharing A service the financial system provides that allows savers to spread and transfer risk assets a Diversification splitting wealth into many assets 2 Liquidity The ease with which an asset can be exchanged for money a Financial markets and intermediaries help make financial assets more liquid 3 Information Facts about borrowers and about expectations of returns on financial a The profits the bank earns on its loans are partially compensation to it for investing in information gathering FIN3244 Spring 2016 Peterson Exam 1 Chapters 1 3 CHAPTER 2 INTEREST RATES AND RATES OF RETURN Todays economics consider the interest rate to be the cost of credit Interest you charge on the loan as being the result of o Compensation for inflation o Compensation for default risk the chance that the borrower will not pay back the loan o Compensation for the opportunity cost of waiting to spend your money Most financial transactions involve payment sin the future Compounding and Discounting o Future Value The value at some future time of an investment made today o Principal the amount invested or borrowed o Compounding The process of earning interest on interest as savings accumulates over time o Principal x 1 i FV1 i interest rate Principal the total amount of your investment FV The future value Compounding for more than a period o Principal x 1 i n FVn Present Value The value today of funds to be received in the future o Funds in the future are worth less than funds in the present so funds in the future have to be reduced or
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