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Chapter 17

The Financial System

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Learnin
1 Outline the structure and

importance of the financial

system.

2 List the various types of

5 Discuss the organization and

functioning of financial institutions.

6 Explain the functions of the Federal

Reserve System and the tools it

uses to control the supply of money
and credit.

securities.

3 Define financial market, and

distinguish between primary and

secondary financial markets.

4 Describe the characteristics of the

major stock exchanges.

Evaluate the major features of

regulations and laws affecting the
financial system.

8 Describe the global financial system.

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The financial system is the

process by which money
flows from savers to users.

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Financi
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.

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Type
Securities
Financial instruments
Obligations on the part of the issuer
Businesses and Governments

Provide rate of return to purchasers

Money Market Instruments

Bonds
Stock

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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

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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.

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Price is determined by risk and interest
rate.
Several firms rate bonds
Standard & Poors (S&P)
Moodys

Investment-grade
Speculative/Junk

Stocks
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.

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Convertible
Stockholder has the
right to exchange the
bond or preferred
stock for a fixed
number of shares of
common stock.

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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.

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Understan
Markets

Stock market (exchange)

market in which common
stocks are traded, such as the
New York Stock Exchange.

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Stock Ex
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

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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

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Investor Pa
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in the Sto

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

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Commercial Banks
Savings Banks and Credit Unions
Non-depository Institutions

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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.

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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

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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

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Non De
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Financial I

Insurance
Insurance Companies
Companies

Pension
Pension Funds
Funds

Finance
Finance Companies
Companies

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Th e R
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Federa
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

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Organizat
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Federa
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.

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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.

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Moneta
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

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M1 & M2

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Financ
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

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The Financ
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A Global
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.