Ch. 2 Notes (BUS G-345; Money, Banking; and Capital Markets; Self)

Ch. 2 Notes (BUS G-345; Money, Banking; and Capital Markets; Self)

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Unformatted text preview: Chapter 2: An overview of the Financial System After this chapter you should be able to do the following. 1. Recognize that financial markets and financial intermediaries are crucial to a well-functioning economy because they channel funds from those who do not have a productive use for them to those who do. f ' 4,. (’If‘ffl-Jill. ’.‘. . ,(rrfljl-IfA-r; .7 M, ‘_ <71 2.1dentify types of markets 3.1dentify money market and capital market instruments. 4.1dentify and understand the functions of financial intermediaries. 5.1ndentify types of financial intermediaries. Function of Financial Markets PM o Promotes mama» eF-Fm - .--»by producing an _ efficient allocation of capital, which increases production J? M «- Directly improve the Mil—Mag; of consumers by allowing them to time purchases better 17/1/10 Perform the essential function of channeling funds from economic players that have 3:2.st surplus funds to those that have a jimwa of funds ' WW 0 12mm: borrowers borrow funds directly from lenders in financial markets by selling them securities. _% »WWMMWJWMW5 Figure 1, Flows of Funds through the Financial System wfhfW/Mokavws 0;;- chl" fiLIfiL-HOLCHI 95“”?!qu C({ilj Structure of Financial Markets Debt and Equity Markets 0 Debt instruments (maturity) # a; L , o Equities (dividends) PM r Prlmary and Secondary Market V. q”.- ,3- _. ‘ a: (3.4%??? ,F£TC‘°’1“- _‘S -—_ ..r.' ‘ ' "’5. ’ " ' 0 Investment Banks W_ secur1t1es 1n Primary markets ‘ 1’7"“ 5' o Brokers and dealers work in secondary markets ‘.-_ If 1 ’ f. Exchanges and Over-the-Counter (OTC) Markets 0 Exchanges: NYSE, Chicago Board of Trade «- OTC Markets: Foreign exchange, Federal funds. Money and Capital Markets 0 fl oney markets deal in short-term debt instruments emf? 0’” 0 (W5 deal in longer-term debt and equity instruments. * r g £4 r n. m: ref—i ,J» r J fa , - . 2. m J Table 1: Princi a1 Mone- Margk :t Instruments IOVcfiCILCrfiC {/5 Mt"? Internationalization of Financial Markets (Glossary) EgrejgnBonds: sold in a foreign country and denominated in that country’s currency W bond denominated in a other than that of the CC... :. : in which it is sold Eurocurrengies: .. = ; deposited in banks "outside—thehome country 0 Euerollars: US. dollars deposited in foreign banks outside the US. or in foreign branches of US. banks World Stock Markets 0 Help finance federal government also Function of Financial MW: Indfifififinance _'_#___._ Lower transaction costs (time and money spent in carrying out financial transactions). 0 Economies of scale 0 Liquidity services Reduce the exposure of investors to risk 0 Risk Sharing (Asset Transformation) I 0 Diversification (to 11112496. H64, firm-“ii m dfliné‘f (ill-“crime Deal with asymmetric information problems (WW? 1.? 0 (Before the transaction) Adverse Selection: Egg/$365??? try to av01d selectmg the rlsky borrower. — Gather information about potential borrower. o (fifty the transaction) Moral Hazard: ensure borrower will not engage in activities that will prevent him/her to repay the loan. — Sign a contract with restrictive covenants. Information we '14{Cty}g£j.f§ £01,639 bein-mv 6/6, 0‘; ooh/ewe Teft-rém-b; Table 3: Primary Assets and Liabilities of Financial Intermediaries Type of Intermediary Depository institutions (banks) Commercial banks Savings and loan associations Mutual savings banks Credit unions Contractual savings institutions Life insurance companies Fire and casualty insurance companies Pension funds, gtn-‘tzt‘nment retirement funds Investment intermediaries Finance companies Mutuai funds Money market mutual funds Primary Liabilities {Sources of Funds) Deposits Deposits Deposits Deposits Premiums from policies Premiums from policies Employer and etnl'fioyee COI‘lLl‘ll)Llll0l1$ Commercial paper‘ stocks‘ bonds Shares Shares (Uses of Funds) Primary Assets Business and consumer loans, mortgages. US. government securities and municipal bonds Mortgages lt-lortgagcs Consumer loans Corporate bonds and mortgages Ivlunicipnl bonds, ct‘ut'porale bonds and Stock, U.S. government securities Corporate hoods and stock Consumer and business loans Stocks. bonds Money market instruments Table 4: Principal Financial Intermediaries and Value of Their Assets for select years , 5 m5 ,kciL rein/‘5 fit him Value ofAssets k m LU 66% j“ (5 billions, end of year) Type of Intermediary 1980 1990 2000 2008 Depository institutions (banks) Commercial banks 1,481 3,3 34 6,469 12 ,272 Savings and loan associations 792 1,365 '1 218 1,518 and mutual savings banks Credit unions 67 215 441 801 Contractual savings institutions Life insurance companies 1,367 3,136 4,798 Fire. and casualty insurance companies 533 862 1,337 Pension funds (private) 1,629 4,355 5,193 State and local government retirement funds 737 2,293 2,730 Investment intermediaries Finance companies . 610 1,140 1,910 Mutual funds 654 4,435 6,588 Moneyr market mutual funds 498 1,812 3,376 Source: Federal Reserve Flow of Funds Accounts: :,:.E:';::~:;".-_. 1' Regulation of the Financial System Reasons to regulate have included the following. To increase the information available to investors: 0 Reduce adverse selection and moral hazard problems 0 Reduce insider trading (SEC). To ensure the spypdness of financial intermediaries: 1» Restrictions on entry (chartering process). 0 Disclosure of information. 0 Restrictions on Assets and Activities (control holding of risky assets). 0 Deposit Insurance (avoid bank runs). 0 Limits on Competition (mostly in the past): fl Branching — Restrictions on Interest Rates Table 5: Principal Regulatory; Agencies of the US. Financial System ,kmn, Fa agémw mun—,9! 4% J0 cp-Lcm/ mom}? ...
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This note was uploaded on 12/21/2011 for the course BUS 100 taught by Professor Intro during the Fall '11 term at UCSB.

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Ch. 2 Notes (BUS G-345; Money, Banking; and Capital Markets; Self)

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