>>>>>>>> Chapter 17

The Financial System

1 Outline the structure and 5 Discuss the organization and
importance of the financial functioning of financial institutions.
system.

6 Explain the functions of the Federal

List the various types of Reserve System and the tools it
2
securities. uses to control the supply of money
and credit.
Define financial market, and
3
distinguish between primary and Evaluate the major features of
7
secondary financial markets. regulations and laws affecting the
financial system.

4 Describe the characteristics of the

major stock exchanges. Describe the global financial
8
system.
The financial system is the
process by which money
flows from savers to users.
• Financial System
– Savers
– Users
– Financial Institutions
– Financial Markets

• Savings is a function of many variables.

• Funds can be transferred between users and
savers directly or indirectly.
• Securities
– Financial instruments
– Obligations on the part of the issuer
• Businesses and Governments
– Provide rate of return to purchasers
• Money Market Instruments
• Bonds
• Stock
• Short-term Debt Securities
– Issued by governments, financial institutions
and corporations
• Investors are paid interest for the use of
their funds.
• Generally low-risk
• U.S. Treasury bills, commercial paper, and
bank certificates of deposit
• Government Bonds
– Bonds sold by the U.S. Department of the
Treasury.
• Municipal Bonds
– Bonds issued by state or local governments
• Revenue bonds are used toward a project that will
produce revenue, General Obligation Bonds are
not.
• Price is determined by risk and interest
rate.
• Several firms rate bonds
– Standard & Poor’s (S&P)
– Moody’s
• Investment-grade
• Speculative/Junk
• Common stock – ownership claims in
corporations.
– Vote on major company decisions
– Cash dividends
– Price appreciation

• Preferred stock – stockholders with

preference in the payment of dividends.
 Stockholder has the
right to exchange the
bond or preferred
stock for a fixed
number of shares of
common stock.
• Primary Market – firms and governments
issue securities and sell them initially to
the public.
– When a firm offers a stock for sale to the
general public for the first time.

• Secondary Market – collection of financial

markets in which previously issued
securities are traded among investors.
Stock market (exchange) –
market in which common
stocks are traded, such as the
New York Stock Exchange.
• The New York Stock Exchange – the Big Board is the
most famous and one of the oldest stock markets in the
world. More than 3,000 stocks are listed on NYSE.

• The Nasdaq Stock Market – the second largest stock

market. Over 5,000 companies have their stocks listed
on Nasdaq but many are smaller firms.

• Other U.S. Stock Markets

– The American Stock Exchange/AMEX
– Regional Stock Exchanges
– Foreign Markets
• ECNs – electronic communication
networks
– The 4th Market
– Buyers and sellers meet in a virtual market
and exchange with one another
– Take place on INET or Archipelago

• INET and Archipelago have been

purchased by Nasdaq and NYSE
• Investors use brokerage firms, they:
1) Establish an account
2) Enter orders
3) Trade stock

• The brokerage firm executes the trade

on behalf of the investor, charging a fee
for the order
– Market Order
– Limit Order
Commercial Banks
Savings Banks and Credit Unions
Non-depository Institutions
 An increasing amount of funds move through electronic
funds transfer (EFTs).
 Millions of businesses and consumers now pay bills and
receive payments electronically.
 Most employees directly deposit employee paychecks.
 Social security and other federal payments are made
each year electronically.
 Automated Teller Machines (ATMs) continue to grow in
popularity.
 More than 1/3 of American households use some online
banking.
• Enacted by the Banking Act of 1933

• Restore public confidence in the banking system

• Before deposit insurance, runs were common as

people rushed to withdraw their money from the
bank

• Deposit insurance shifts the risk of bank failures

from individuals to the FDIC
• Offer a variety of consumer services

• 85% of their loans are real estate loans

• Credit unions are cooperative financial

institutions that are owned by
depositors/members.

• Credit unions are created to serve consumers.

– Insured by National Credit Union Administration
(NCUA) which functions the same as the FDIC
Insurance Companies

Pension Funds

Finance Companies
• Created In 1913
• Central bank of the United States
• Regulate commercial banks
• Perform banking-related activities for the
U.S. Department of Treasury
• Providing services for banks
• Setting monetary policy
• 12 Federal reserve districts
– Own federal reserve bank
• District banks are run by a nine-member board
of directors.
• The board of governors is the governing body.
• Politically independent
• Federal Open Markets Committee (FOMC)
sets most policies concerning monetary policy
and interest rates.
• Americans still write billions of paper checks.
• The process by which funds are transferred from
the check writer to receiver
• The multiple-step process is managed and
cleared by the FED.
• The Check Clearing for the 21st Century Act is
making this process more electronic.
• Supply of money and credit
• Measures of the money supply: M1 & M2
• The FED requires banks to maintain
reserves.
• Set the discount rate
• Open Market Operations
• Bank Regulation
• Government Regulation of the Financial
Markets
• Industry Self-Regulation
– Rules of conduct by professional
organizations like National Association of
Securities Dealers
– Market Surveillance
• The financial system is
more connected.
• Financial institutions are
more global.
• Only 3 of the 30 largest
banks in the world are US
institutions.
• Most nations have a
central bank.