Finance

3 key components of the Financial System 1.financial assets2.financial institutions3.the federal reserve and other financial regulators
Financial assets an asset that represents a claim on someone else for a paymentincludes securities
asset anything value owned by a person or a firm
security a financial asset that can be bought and sold in a financial market
financial markets places or channels for buying or selling stocks, bonds, and other securitiestraditionally, financial markets have been physical places (new york stock exchange located on wall street in new york)today, most securities trading takes place electronically linked by computers and is called over the counter trading
Five keys categories of financial assets 1.money2.stocks3.bonds4.foreign exchange5.securitized loans
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 (equities)
dividends payments that a corporation makes to its shareholders after keeping some of its profits
bond financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money
interest rate the cost of borrowing funds (or payment for lending funds) usually expressed as a percentage of the amount borrowed
foreign exchange refers to the units of currencyto buy foreign goods and services or foreign assets, a domestic investor must first exchange domestic currency for foreign currencybanks are the largest buyers and sellers of foreign exchangebank engage in foreign currency transactions on behalf of investors and business firms
securitized loans historically banks made loans with the intention to collect interest paymentsbanks have begun to sell loans on financial markets through a process called securitizationa loan is a financial liability for the borrower
securitization the process of converting loans and other financial assets that are not tradable into tradable securities
financial liability a financial claim owed by a person or a firm
the financial system matches savers and borrowers though two channels 1.banks and other financial intermediaries2.financial markets
financial intermediary a financial firm that borrows funds from savers and lends them to borrowers
financial markets facilitate two types of flow of funds 1.indirect finance 2.direct finance
indirect finance funds flow from lenders to borrowers indirectly through financial intermediaries, such as banks
direct finance funds flow directly from savers to borrowers
financial intermediaries the most financial intermediaries are commercial bankshouseholds rely on borrowing money from banks to purchase big ticket itemsfirms rely on banks to meet their short and long term needs for credit
commercial banks take in deposits and use them to make loans
nonbank financial intermediaries savings nad loans, savings banks, and credit unions are nonbank financial intermediaries that also take in deposits and make loans, but they are legally distanct from banksinvestment banksinsurance companiespension fundsmutual fundshedge funds
investment banks assist firms in underwriting stocks and bonds
insurance companies collect premiums from customers and then invest the premiums to obtain the funds necessary to pay claims and other costs
pension funds collect contributions from workers and firms and make benefit payments during workers retirements
mutual funds obtains money by selling shares to investors and invests the money in a portfolio of financial assets
portfolio a collection of assets, such as stocks and bonds
hedge funds similar to mutual funds but typically have very few weekly investors and make riskier investments
primary markets financial markets in which stocks, bonds, and other securities are sold for the first time
secondary markets financial markets in which investors buy and sell existing securities
federal agencies that regulate the financial system 1.securities and exchange commission2.the federal deposit insurance corporation3.office of the comptroller of the currency4.the federal reserve system
SEC regulates financial markets
FDIC insures deposits in banks
office of the comptroller of the currency regulates federally chartered banks
the federal reserve system the central bank of the US (aka the fed)established by congress in 1913 to deal with banking problemsoriginal role: lender of last resortresponsible for monetary policydivided into 12 districtsthe main policymaking body is federal open market committeeben bernanke has been the chair of the board of governors since 2006FOMC meets 8 times a year to make decisions on a target for th efederal funds rate
monetary policy refers to the actions to manage the money supply and interest rates to pursue macroeconomic policy objectives
federal funds rate the interest rate that banks charge each other on short term loans
the financial systyem provides three services to savers and borrowers 1.risk sharing2.liquidity3.information
risk sharing the chance that the value of financial assets will change relative to what you expectallows savers to spread and transfer risk by holding different assets along with other savers
two ways to reduce a savers risk 1.diversification2.risk sharing
diversification the splitting wealth among many different assets to reduce risk
liquidity the ease with which an asset can be exchanged for moneyfinancial markets and intermediaries help make financial assets more liquid
information in financial markets convey information contains facts about borrowers and expectation of returns on financial assetsfinancial markets convey information to both savers and borrowers by determining the prices of stocks, bonds, and other securities

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