PK02 - Chapter 2 The Financial Environment and the Level of...

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Chapter 2 The Financial Environment and the Level of Interest Rates Learning Objectives 1. Discuss the primary role of the financial system in the economy, and describe the two basic ways in which fund transfers take place. 2. Discuss direct financing and the important role that investment banks play in this process. 3. Describe the primary and secondary markets, and explain why secondary markets are so important to businesses. 4. Explain why money markets are important financial markets for large corporations. 5. Discuss the most important stock market exchanges and indexes. 6. Explain how financial institutions serve consumers and small businesses that are unable to participate in the direct financial markets and describe how corporations use the financial system. 7. Explain how the real rate of interest is determined in the economy, differentiate between the real rate and the nominal rate of interest, and be able to compute the nominal rate of interest. I. Chapter Outline 2.1 The Financial System A. The Financial System at Work It is competitive. 1
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Money is aggregated in small amounts and loaned in large amounts. The people with investment opportunities are rarely the ones who have the money to lend. Financial markets benefit consumers. B. Moving Funds from Lenders to Borrowers Budget positions Balanced budget: income and expenditures are equal Surplus budget: income exceeds expenditures Deficit budget: expenditures exceed income The primary concern of the financial system is funneling money from surplus spending units (SSUs) to deficit spending units (DSUs). Direct funds flow, or Indirect funds flow (intermediation) 2.2 Direct Financing Financial markets perform the important function of channeling funds from people who have surplus funds (SSUs) to businesses (DSUs) that need money for capital projects. A . Direct Financial Markets wholesale markets in which the minimum transaction size is $1 million or more. Investment Banks—firms that specialize in helping companies sell new debt or equity issues in the public or private security markets. 2
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Money Center Banks—large commercial banks located in major U.S. financial centers that transact in both the national and international money markets. Underwriting—a basic investment banking service is to assist firms in the sale of debt or equity in the primary market. To underwrite a new security issue, the investment banker buys the entire issue at a guaranteed price from the issuing firm and resells the securities to institutional investors and the public.
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PK02 - Chapter 2 The Financial Environment and the Level of...

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