Finance EXAM 1
Four policy maker groups
(1) Federal reserve system: sets monetary policy (2) the president: held set fiscal policy (3) congres: helps set fiscal policy (4) US treasury: conducts debt management policy *3 types of policies or decisions (monetary policy, fiscal policy, and debt management) *four economic objectives (economic growth, high employment, price stability, and balance in international transactions)
Why study finance?
(1)to make informed economic decisions (2)to make informed personal and business investment decisions (3)to make informed career decisions based on a basic understanding of business finance
Member banks
-All national banks must be members of the Fed -State-chartered banks are permitted to join the Fed system -About one-third of commercial banks are members of the Fed -Member banks hold about 3/4 of the deposits of all commercial banks
Fed Board of Governors BOG
-Sets reserve requirements and approves discount rates as part of monetary policy -Supervises and regulates member banks and bank holding companies -Establishes & administers protective regulations and consumer finance Oversees Federal Reserve Banks
Federal Reserve District Banks
-The Federal Reserve Act of 1913 provided for establishment of twelve Federal Reserve districts with each district served by a -Federal Reserve Bank In addition to the twelve Reserve Banks, twenty-five branch banks have been established -The geographically large western Federal Reserve districts have most of the Reserve Branch Banks District banks: -Hold reserve balances for depository institutions -Lend to depository institutions located in their districts at the prevailing discount (interest) rate -Issue new currency and withdraw damaged currency from circulation -Collect and clear checks and transfer funds for depository institutions
4. efficient financial markets
-a financial market is "information efficient" if at any point in time the price of securities reflect all information available to the public -when new information becomes available, prices quickly change to reflect that information -information efficient markets provide liquidity and fair prices
3. diversification of investments
-all investment risk is not the same -some risk can be removed or diversified by investing in several different assets or securities
Components of the M1 definition of the Money Supply
-currency -traveler's checks -demand deposits at banks -other checkable deposits at depository institutions
5. management vs. owner objectives
-management objectives may differ from owner objectives -owners or equity investors want to maximize the returns on their investments -managers may seek to emphasize the size of firm sales, assets, or other perks -solution: tie manager compensation to performance measures beneficial to owners
1. time value of money
-money in hand today is worth more than the promise of receiving the same amount of money in the future -time value of money exists because a sum of money today could be invested and grow over time
2. risk-return tradeoff
-risk is the uncertainty about the outcome or payoff of an investment in the future -rational investors would choose a riskier investment only if they feel the expected return is high enough to justify the greater risk
CH 2 Discussion Questions
1. How do surplus economic units and deficit economic units differ? A surplus economic unit generates more money than it spends resulting in excess money to save or spend. A deficit economic unit spends more money than it brings in resulting in a need for additional money. 2. Describe the three basic ways whereby money is transferred from savers to investors. There can be a direct transfer of money between savers and investors. For example, savers can directly purchase the stocks or debt instruments of a business firm by exchanging money for the firm's securities. Money also can be transferred from savers to investors via indirect transfers. For example, if the investor is a business firm, savers can transfer money to the business firm either through the use of an investment banking firm or through a financial intermediary. 3. Identify economic units in addition to business firms who might need funds from savers. Government entities (US Gov) spending more than their tax revenues may need funds from savers to balance their budgets. Some individuals and other units might seek funds from savers to finance from savers to finance home ownership or other real estate investments 4. Identify the major participants in the U.S. monetary system. A central bank (i.e., the Federal Reserve System in the U.S.) is needed to define and regulate money supply and to facilitate the transferring of money through check processing and clearing. An efficient banking system also is needed to create money, transfer money, provide financial intermediation, and to process and clear checks. 5. Indicate how real assets and financial assets differ. Real assets include the direct ownership of land, buildings, homes, equipment, inventories, durable goods and precious metals. Financial assets include money, debt instruments, equity securities, and other financial contracts backed by real assets and the earning abilities of issuers. 7. Describe how an individual's net worth is determined? Individual net worth is the sum of an individual's money, real assets, and financial assets or claims against others less the individuals debt obligations. 8. Briefly describe the development of money, from barter to the use of precious metals. Barter, or the exchange of goods for goods, developed as specialization of production and exchange of goods developed. Some items were generally desired and other goods were traded for them since they could always be used for further trading. The goods that were frequently traded also served as a yardstick for measuring the value of goods traded less frequently. However, barter was clumsy because items of food, clothing, and ornamentation were difficult to carry around; items were of different quality, so arguments could arise over their value. Exchange was also clumsy since it had to take place in whole units, such as one or two furs, and the like. The use of gold and silver did not present these difficulties, and so they became more widely used. As time went on, these metals were made into coins with definite weights in metals of a certain purity, and they served even more effectively as a medium of exchange. 10. Describe how representative full-bodied money and fiat money differ. Representative full-bodied money is paper money that is backed by an amount of precious metal equal in value to the face amount of the paper money. Fiat money is paper money without metal backing but where the government decrees the money to be "legal tender" for purposes of making payments and discharging public and private debts. 11. What is deposit money and how is it backed? Credit money is money backed by the "creditworthiness" of the issuer. Deposit money is backed by the creditworthiness of the depository institution that issued the deposit. 16. How does M2 differ from M1? What are money market mutual funds? M2 is a broader measure of the money supply than M1 because it emphasizes money as a store of value in addition to its function as a medium of exchange. M2 includes all of M1 plus savings deposits, money market deposit accounts (MMDAs), and small-denomination time deposits (under $100,000) at depository institutions plus balance in retail money market mutual funds (MMMFs) where initial investments are less than $50,000. Money market mutual funds (MMMFs) issue "shares" to customers and invest the proceeds in highly liquid, very short maturity, interest-bearing debt instruments called "money market investments." Thus, MMMFs get their name from the type of investments they make. 6. Define money and indicate the basic functions of money. Money acts as: (a) a medium of exchange; (b) a store of value; and (c) a standard of value. Unless the value of money is relatively stable, it will not be held long enough to serve as a medium of exchange or as a store of value or purchasing power. It can serve as a standard of value only if its value is relatively stable, since it is all but impossible to use a varying standard for measuring values. 9.What is the difference between full-bodied money and token coins? Full-bodied money is defined as coins that have metal content equal to their face values. Toke coins are coins with face values higher than the values of their metal content. 15. Describe the M1 definition of the money supply and indicate the relative significance of the M1 components. M1 includes: currency (coin and federal reserve notes), demand deposits at commercial banks and other checkable deposits at depository institutions (commercial banks, savings and loan associations, savings banks, and credit unions), and travelers checks. Currency and demand deposits are the two largest components of M1 and together account for over three-fourths of M1. Traveler's checks represent less than one percent of M1. M1 measures transaction balances which are sums of money that can be spent without first converting them to some other asset, and which are held for anticipated or unanticipated purchases or payments in the immediate future. Essentially, only those amounts that represent the purchasing power of units in our economy other than the federal government are counted.
CH 1 Discussion Questions
1. What is finance? Finance is the study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial resources 5. Identify and briefly describe several reasons for studying finance. There are several reasons to study finance. a. As a citizen (of the U.S.A. or another country), you should want to make informed economic decisions. Whatever your financial and economic goals may be, you need to be an informed participant if you wish to "make a difference." b. Having some knowledge about finance, particularly the financial markets or investments component, should be important to you. An understanding of various aspects of personal finance should help you better manage your existing financial resources, as well as provide the basis for making sound decisions for accumulating wealth over time. c. To be successful in the business world, it is important to have a basic understanding of business finance in addition to an understanding of institutions, markets, and investments. 6. What are the six principles of finance? (1) money has time value (2) higher returns are expected for taking on more risk (3) diversification of investments can reduce risk (4) financial markets are efficient in pricing securities (5) manager and stockholder objectives may differ (6) reputation matters 8. What are the basic requirements of an effective financial system? (a) Policy makers: comprised of the president, congress, the US treasury, and the federal reserve board (b) an effective monetary system: this requires a unit of account such as the dollar and a convenient means of paying for everything from a pack of chewing gum to a business worth millions (c) a system for channeling savings into investment: this requires proper legal instruments and financial institutions so that savers are willing and able to transfer savings to those having a demand for them (d) financial markets and procedures for transferring claims to wealth: this facilitates the investment process since the owner of funds will invest more readily if claims can be converted into cash when there is a need or desire to do so 9. Identify and briefly describe the financial functions in the U.S. financial system. The three components of the financial system are: a monetary system, financial institutions, and financial markets. a. Monetary system financial functions are: creating money and transferring money. b. Financial institutions carry out the savings-investment process via the financial functions of accumulating savings and lending/investing savings. c. Financial markets perform the financial functions of marketing and transferring financial assets. 10. Briefly describe the differences between money and capital markets. Money markets are the markets where debt instruments of one year or less are traded. In contrast, capital markets are markets for debt securities with maturities in excess of one year and corporate stocks 11. What are the differences between primary and secondary securities markets? Primary securities markets are markets in which the initial offering of debt and equity securities to the public occurs. Secondary securities markets are markets where the transfer of existing debt and equity securities between investors occurs. 12. Identify the four types of major financial markets. (1) debt securities markets (2) equity securities markets (3) derivative securities markets (4) foreign exchange markets
Six principles of finance
1. time value of money 2. risk-return tradeoff 3. diversification of investments 4. efficient financial markets 5. management vs. owner objectives 6. reputation matters
CH 3 Discussion Questions
1.Describe the major financial institutions engaged in getting the savings of individuals into business firms that want to make investments to maintain and grow their firms. There are four major types of financial institutions—depository institutions, contractual savings organizations, securities firms, and finance firms. 2. Compare commercial banking with investment banking. What is universal banking? Commercial and investment "banks" are involved in the indirect transfer of money from savers to an investor (e.g., a business firm). The commercial bank accepts the deposits of savers in exchange for the bank's securities (e.g., CDs). The bank then loans money to the business firm in exchange for the firm's promise to repay the loan. In contrast, the investment bank markets the business firm's securities to savers either by first purchasing the securities from the firm and then reselling the securities or by just marketing the securities directly to savers. A universal bank is a bank that engages in both commercial banking and investment banking activities. 3. Describe the functions of banks and the banking system. Banks and the banking system perform five functions: (1) accepting deposits, (2) granting loans, (3) issuing checkable deposit accounts, (4) clearing checks, and (5) creating deposit money. If, or when, U.S. banking moves to universal banking, the sixth function will be: (6) raising financial capital for businesses which we call investment banking. In accepting deposits, banks provide a safe place for the public to keep money for future use. The banking system puts the accumulated deposits to use through loans to persons and individuals having immediate use for them. This is the financial intermediation activity of depository institutions in the savings-investment process. 4. Describe 3 basic ways for processing or collecting a check in the United States. There are three basic ways for processing or clearing a check. First, the Last Bank can present your check directly to the First Bank for collection. The First Bank "pays" the check and deducts the amount of the check from your checking account. Second, the Last Bank can "clear" your check by presenting it through a Bank Clearinghouse. Third, the Last Bank could process your check through its Federal Reserve Bank. 12. How are depositors' funds protected today in the United States? The Federal Deposit Insurance Corporation (FDIC), the Federal Savings and Loan Insurance Corporation (FSLIC), and the National Credit Union Share Insurance Fund (NCUSIF) were established under federal legislation to protect deposits in banks, S&Ls, and credit unions—in that order. However, as a result of the S&L crisis and the associated bankruptcy of the FSLIC, the functions of the FSLIC were transferred to the FDIC in 1989. 14.What are the major asset categories for banks and identify the most important category. What are a bank's major liabilities and which category is the largest in size? The major asset categories for banks are: (1) Cash and Balances Due from Depository Institutions, (2) Securities, (3) Loans, and (4) Other Business Assets. Loans account for approximately 60 percent of bank assets which makes this the most important asset account category. The major liabilities categories for banks are: (1) Deposits, (2) Other Liabilities, and (3) Owners' Capital. Deposits account for approximately 70 percent of commercial bank liabilities and owners' capital. Of course, it is important to note that the financial crisis of 2007-09 caused the balance sheets of many banks to differ from these historical percentage relationships.
CH 5 Discussion Questions
1.List and describe briefly the economic policy objectives of the nation. The nation's economic policy objectives are four-fold, as follows: a. Economic growth: This encompasses not only growth of total output but also growth on a per capita basis. b. High and stable levels of employment: It is a stated objective of the government to promote stability of employment and production at levels close to the nation's total potential. c. Price stability: Inflation causes inequities and discourages investment. Consistently stable prices help create an environment in which the other economic objectives are achieved more easily. d. International financial equilibrium: The increasing importance of international trade and of the flow of funds in the international capital markets imposes a strong incentive for maintaining international financial equilibrium. 2.Describe the relationship between policy makers, types of policies, and policy objectives. As indicated in Figure 5.1 of the textbook, there are multiple policy makers, types of policies, and policy objectives. The sequence, of course, is for policy makers to make decisions to achieve objectives. More specifically, certain policy makers have special responsibility for certain types of decisions. For example, the Federal Reserve System has primary responsibility for monetary policy. Yet policy makers are subject to influence by other policy makers in the exercise of their duties. For example, it is well known that the President, the Congress, and the Treasury all impose considerable pressure on the Federal Reserve authorities. 3. Describe the effects of tax policy on monetary and credit conditions. Tax policy of the federal government has a direct effect on monetary and credit conditions through its influence on the volume of savings and funds available for investment. Further, tax policy, as it relates to corporate activity, has a direct relationship to the demands for funds in the capital markets and in turn the supply of funds for short-term investment in government bonds. 4. Federal government deficit financing may have a very great influence on monetary and credit conditions. Explain. Budgetary deficits result in government competition for private funds. At times when credit demands are great, private borrowers may be crowded out. At times when credit demands are slack, deficits may simply result in putting idle bank reserves to work. When deficits are so large that the private sector cannot absorb them, the Fed may create credit by purchasing government obligations, leading to the possibility of rising inflation. 5. Discuss the various objectives of debt management. Although it has been argued that the Treasury should conduct its debt management activities in such a way as to provide a dynamic influence on the economy, it has, in fact, been largely content to play as neutral a role as possible and to limit its influence to encouraging orderly growth and stability. Other objectives include holding down interest costs, maintaining stable government securities markets, and accommodating individuals' investment needs by tailoring securities to meet them. 6. Explain how Federal Reserve notes are supported or backed in our financial system. Federal Reserve notes are backed or supported by: (a) gold certificates; (b) Special Drawing Rights (SDRs), which represent a form of reserve asset or "paper gold" created by the International Monetary Fund; (c) eligible paper (business notes and drafts); and (d) United States government and agency securities. Today, U.S. government securities represent the primary source of backing for Federal Reserve notes. Gold certificates, which reflect the stock of U.S. gold holdings, represent a much smaller secondary support or backing.
federal government receipts and expenditures
1970-1997: annual deficit budgets 1998-2001: annual surplus budget 2002-Present: annual deficits with fiscal 2009 and 2010 deficits each exceeding $1.0 trillion
CH 7 Discussion Questions
2.Describe the major components of gross domestic product. Gross domestic product (GDP) is comprised of: (a) personal consumption expenditures (PCE) which are expenditures by individuals for durable goods, nondurable goods, and services; (b) government purchases (GP) which are expenditures for goods and services by both the federal and the state and local governments; (c) gross private domestic investment (GPDI) which measures fixed investment in residential and nonresidential structures, producers' durable equipment, and changes in business inventories; and (d) net exports (NE) of goods and services (i.e., exports minus imports). In equation form, we have: GDP = PCE + GP + GPDI + NE. Also see Table 7.1. 4. Identify the various sources of revenues of the federal government. As shown in Figure 7.1 for fiscal year 2008, the principal sources of federal revenues are: personal income taxes (39%), social security and other retirement taxes (30%) borrowing to cover deficit (15%), corporate income taxes (10%), and excise, estate, and other taxes (6%). 5. Identify the major expense categories in the federal budget. As shown in Figure 7.1 for fiscal 2008, the major expense items in the federal budget are: social security, medicare, and other retirement (37%), national defense, veterans, and foreign affairs (24%), social programs (including Medicaid) (20%), physical, human and community development (9%), net interest on debt (8%), and law enforcement and general government (2%). 11. Describe the recent levels of savings rates in the United States. The savings rate is defined as personal savings divided by disposable personal income. In 2000, the personal savings rate in the U.S. was only 1.0 percent. The savings rate in 2005 was 1.4 percent. In contrast, the savings rate was 8.1 percent in 1970 and 9.2 percent in 1975. The savings rate for 2006 had increased to 2.4 percent and reached 4.6 percent in 2009 as indicated in Table 7.3. 13.Describe the principal factors that influence the level of savings by individuals. The principal factors that influence the levels of savings by individuals are: (a) levels of income; (b) economic expectations; (c) economic cycles; and (d) the life stage of the individual saver. A discussion of each of these is provided in the chapter. 15.What are the life cycle stages of individuals? The life cycle stages of individuals are: (a) formative/education developing, (b) career starting/family creating, (c) wealth building, and (d) retirement enjoyment.
CH 4 Discussion Questions
2.What functions and activities do central banks usually perform? A central bank is a government-established organization responsible for supervising and regulating the banking system and for creating and regulating the money supply. Central banks typically play an important role in a country's payments system. It is also common for a central bank to lend money to its member banks, hold its own reserves, and be responsible for creating money. 3. Describe the organizational structure of the Federal Reserve System in terms of its five major components. The Fed system consists of five components: (1) member banks, (2) Federal Reserve District Banks, (3) Board of Governors, (4) Federal Open Market Committee, and (5) advisory committees. The Federal Reserve System is composed of 12 federal reserve districts, each district being served by a Federal Reserve Bank. Member banks own the stock issued by the Federal Reserve Banks. The Board of Governors in Washington, D.C. directs and coordinates the activities of the Federal Reserve Banks. The Federal Open Market Committee (FMOC) conducts open-market operations by buying and selling U.S. government securities. The Fed's three major advisory committees are: Federal Advisory Council, Consumer Advisory Council, and the Thrift Institutions Advisory Council. 4. Explain how the banking interests and large, medium, and small businesses are represented on the board of directors of each Reserve Bank. To assure representation of various economic elements in the district, the nine directors must be residents of the district in which they serve. The directors are divided into three groups, Class A, Class B, and Class C directors. Class A directors represent member banks of the district, while Class B directors represent nonbanking interests. These nonbanking interests are commerce, agriculture, and industry. The Class C directors are appointed by the Board of Governors. They may not be stockholders, directors, or employees of existing banks. 5. What is a Reserve Branch Bank? How many such branches exist, and where are most of them located? The 25 Federal Reserve Branch Banks are located in areas not conveniently served geographically by a Federal Reserve Bank. The majority are located in the large Federal Reserve districts in the West and South: Atlanta has five; San Francisco has four; and Dallas, Kansas City, and St. Louis each have three. A map of the location of all branches is given in Figure 4.2 in the text. 6. How are members of the Board of Governors of the Federal Reserve System appointed? To what extent are they subject to political pressures? The seven members of the Board of Governors are appointed by the President with the advice and consent of the Senate. One member is designated as chairperson and another as vice-chairperson. The members are appointed for 14-year terms. One person is appointed every two years, thus staggering the terms which reduces, but does not eliminate, the possibility of partisan political pressure. The Board need not be bipartisan in nature, nor is there any specific provision with respect to the qualifications that a member must have. 8.Identify the six individuals who served as chairs of the Fed Board of Governors since the early 1950s. Indicate each individual's approximate time and length of service as chair. The five Fed chairs, along with the period served are: William McChesney Martin, Jr. (1951-1970) Arthur Burns (1970-78) G. William Miller (1978-1979) Paul Volcker (1979-1987) Alan Greenspan (1987-2006) Ben Bernanke (2006-present) 10. Identify and briefly describe the three instruments that may be used by the Fed to set monetary policy. The three instruments are: (1) changing reserve requirements, (2) changing the discount rate, and (3) conducting open-market operations. Banks are required by the Fed to hold reserves equal to a specified percentage of their deposits. By setting reserve requirements, the Fed establishes the maximum amount of deposits the banking system can support with a given level of reserves. The Fed discount rate is the interest rate that a bank must pay to borrow from its regional Federal Reserve Bank. Higher interest rates will discourage banks from borrowing, and vice versa. Open-market operations is the buying and selling of securities by the Fed to alter the supply of money. 12. Describe the two "targets" that the Fed can use when establishing monetary policy. Which target has the Fed focused on in recent years? Monetary policy can focus either on: (1) trying to control the rate of change or growth in the money supply, or (2) targeting a level for a specific type of interest rate such as the federal funds rate which the rate on overnight loans from banks with excess reserves to banks with a reserves deficiency. In recent years, the Fed has focused on the level of the federal funds rate to carryout monetary policy. 13. Explain the usual procedures for examining national banks. How does this process differ from the examination of member banks of the Federal Reserve System holding state charters? National banks are subject to examination by the Comptroller of the Currency, the Federal Reserve System, and the Federal Deposit Insurance Corporation. In practice, national banks are seldom examined by the staff of the Federal Reserve System, but a copy of the report by the Comptroller of the Currency is generally forwarded to the district Reserve Bank. Federal Reserve Banks direct their major attention to examining state-chartered member banks of the districts. State-chartered banks are not subject to the supervision of the Comptroller of the Currency, but they are subject to the laws of the states in which they are chartered, as well as the Federal Reserve System and FDIC.
FISCAL POLICY: Stabilizing Factors
AUTOMATIC STABILIZERS: continuing federal programs that help stabilize economic activity EXAMPLES: unemployment insurance, welfare payments, pay-as-you-go progressive TRANSFER PAYMENTS: government payments for which no current services are given in return EXAMPLES: unemployment benefits, welfare benefits
Securities Firms
Accept and invest individual savings and also facilitate the sale and transfer of securities between investors Three types (1) investment companies (mutual funds) (2) investment banking firms (3) brokerage firms
Depository Institutions
Accept deposits from individuals and then lend pooled deposits to businesses, governments, and individuals Four Types: (1) commercial banks (2) savings and loan associations (3) savings banks (4) credit unions
EXAM ONE
CH 1 DQ: 1,6,8,10,11,12 CH 2 DQ: 2,3,5,7,8,10,11,16 CH 3 DQ: 2,3,4,14 CH 4 DQ: 4,5,8,12,13 CH 5 DQ: 1,2,4,6 CH 7 DQ: 2,4,5,11,13,15
Overview of the Banking System
COMMERCIAL BANK: accepts deposits, makes loans, and issues check-writing accounts INVESTMENT BANK: helps businesses sell their securities to raise financial capital UNIVERSAL BANK: bank that engages in both commercial banking and investment banking activities Glass-Steagall Act of 1933: provided for separation of commercial banking and investment banking activities in the US Gramm-Leach-Bliley Act of 1999: repealed the separation of commercial banking and investment banking activities provided for in the Glass-Steagall Act
Federal Open Market Committee
Comprised of the Fed Board of Governors and Five Reserve Bank Presidents Directs open market operations (buying and selling of U.S. government securities), which are the primary instruments of monetary policy
Monetary Policy Functions and Instruments: Overview
Dynamic Actions: Fed actions that stimulate or repress the level of prices or economic activity Defensive Activities: Fed activities that offset unexpected monetary developments & contribute to the smooth functioning of the economy Accommodative Function: Fed efforts to meet credit needs of individuals & institutions, clearing checks, & supporting depository institutions
Two themes within finance topic
ENTREPRENEURIAL FINANCE: study of how growth-driven, performance-focused, early-stage firms raise funds and manage operations and assets PERSONAL FINANCE: study how individuals prepare for financial emergencies, protect against premature death and the loss of property, and accumulate wealth
2007-2009 Financial Crisis
Early Factors: 2000 -- Internet or "tech" bubble burst and stock prices began declining rapidly 2001 -- Economic recession resulted (exacerbated by the 9/11/2001 terrorist attacks) 2001-2002 - Monetary policy focused on providing liquidity and fiscal policy became stimulative resulting in low interest rates and economic growth Borrowing-Related Cultural Shift: U.S. consumers moved from "save now, buy later" to "spend now, pay later" with the result being increased mortgage loans and credit card borrowings U.S. government officials encouraged wider home ownership and mortgage lenders offered adjustable-rate mortgages (ARMs) and even subprime mortgages to poorly qualified borrowers The "housing price bubble" burst in mid-2006 and home owners began defaulting
Structure of the Federal Reserve System
FED SYSTEM CONSISTS OF FIVE COMPONENTS: (1)member bands (2)federal reserve district banks (3)board of governors (4)federal open market committee (5)advisory committees
CH 1. Financial Environment What is finance?
FINANCE: study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial assets FINANCIAL ENVIRONEMNT: encompasses the financial system, institutions, markets, and individuals that make the economy operate efficiently
Financial Definitions
FINANCIAL INSTITUTIONS: help the financial system operate efficiently and transfer funds from savers to investors FINANCIAL MARKETS: physical locations or electronic forums that facilitate the flow of funds INVESTMENTS: area involves sale or marketing of securities, analysis of securities, and management of investment risk FINANCIAL MANAGEMENT: involves financial landing, asset management and fund raising decisions to enhance firm value
CH. 3 Banks and Other Financial Institutions Types/Roles of Financial Institutions
FINANCIAL INTERMEDIATION: process by which cavings are accumulated in depository institutions and then lent or investigated FINANCIAL INSTITUTIONS CATEGORIES: -depository institutions -contractual savings organizations -securities firms -finacne firms
Government Influence on economy
FISCAL POLICY --the government influences economic activity through taxation and expenditure plans --the government raises funds to pay for its activities in 3 ways (1)levies taxes (2)borrows (3)prints money for its own use
GDP equations
GDP = PCE +GE + GPDI +NE (KNOW and basic definitions) PCE: personal consumption expenditures GE: government expenditures GPDI: gross private domestic invest. NE: net exports
GDP components
GDP is composed of: -personal consumptions expenditures -gov. expend. including gross invest. -gross private dom. investment -net exports of goods and services
Example of Joint Monetary and Fiscal Policy Efforts
GOVERNMENT DEFICITS: when the government spends more than it's tax income, it must compete with other borrowers in the financial system MONETIZING THE DEBT: to maintain economic stability during economic deficits, the Fed may increase the money supply to offset the demand for increased funds to finance the deficit
Development of money in the US
Historical types of US Coins: FULL-BODIED MONEY: coins that contain the same value in metal as their face value TOKEN COINS: coins containing metal of less value than their stated value Historical types of paper currency: REPRESENTATIVE FULL-BODIED MONEY: paper money fully backed by a precious metal FIAT MONEY: legal tender proclaimed to be money by law; not backed by precious metal
Measures of the US Money Supply
M1 Money Supply M2 Money Supply M2 Money Supply
Functions of money
MEDIUM OF EXCHANGE: the basic function of money STORE OF VALUE: money can be held for some period of time, without losing it value before it is spent STANDARD OF VALUE: exists when prices and debts are stated in terms of the monetary unit
Basic definitions
MONEY: anything generally accepted as payment for goods, services, and debts BARTER: exchange of goods or services without using money LIQUIDITY: ease and low cost of exchanging an asset for money
Implementation of Monetary Policy
Monetary policy can focus either on: (1) Trying to control the rate of change or growth in the money supply (e.g., M1), or (2) Targeting a level for a specific type of interest rate (e.g., federal funds rate) FEDERAL FUNDS RATE: Rate on overnight loans from banks with excess reserves to banks who have deficit reserves
Monetary Policy and Instruments
Monetary policy is formulated by the Fed to regulate money supply growth (as well as the cost and availability of money) Reserve Requirements: Fed sets reserve requirements for depository institutions Discount Rate Policy: Fed sets interest rate at which it will lend to depository institutions Open-Market Operations: Fed buys/sells government securities to change bank reserves
US Banking System Prior to the Fed
NATIONAL BANKING SYSTEM: established when the National Banking Acts were passed in 1863 and 1864 WEAKNESS OF THE SYSTEM: -inefficient payments system -money supply "inelastic" or inflexible to demand changes -liquidity problems due to inefficient lending.borrowing mechanism
Contractual Savings Organizations
Organizations collect premiums and contributions from participants and provide insurance against major financial losses and retirement Two types (1) insurance companies (2) pension funds
Overview of the Financial System
POLICY MAKERS: president, congress, and US Treasury Federal Reserve Board Role: pass laws and set fiscal and monetary policies MONETARY POLICY: federal reserve central bank commercial banking system Role: create and transfer money FINANCIAL INSTITUTIONS: depository institutions, contractual savings organizations, securities firms, and finance firms Role: accumulate and lend/invest savings FINANCIAL MARKETS: securities markets, mortgage markets, derivatives markets, and currency exchange markets Role: market and facilitate transfer of financial assets
Finance Firms
Provide loans directly to consumers and businesses and help borrowers obtain mortgage loans on real property Two Types (1) finance companies (2) mortgage banking firms
Importance and Functions of Money
REAL ASSETS: direct ownership of land, buildings, or homes, equipment, inventories, durable goods, and precious metals FINANCIAL ASSETS: money, debt securities and contracts, and equity securities backed by real assets and earning power of issuers
CH. 2 Money and the Monetary System Process of Moving Savings into Investments
SURPLUS ECONOMIC UNIT: generates more money than it spends resulting in excess money DEFICIT ECONOMIC UNIT: generates less money than it spends resulting in a need for additional money
Major capital market securities
Securities: - - - Issuers: Mortgages -Fin. intermediaries Treasury bonds -U.S. government Municipal bonds -State/local gov'ts. Corporate bonds -Corporations Corporate stocks -Corporations
Effects of tax policy
TAX POLICY: setting the level and structure of taxes to affect the economy DEFICIT FINANCING: how a government finances its needs when spending is greater than revenues CROWDING OUT: lack of funds for private borrowing caused by the sale of government obligations to cover large federal deficits
Two views of GDP combined
TWO BASIC EQUATIONS: MS x VM = GDP RO x PL = GDP THE EQUATIONS COMBINED: MS x VM = RO x PL NOMINAL GDP INCREASES WITH: >An increase in money supply and/or velocity of money >An increase in real output and/or price level
Protection of depositors' funds
The Federal Deposit Insurance Corporation (FDIC) was created in 1933 to protect deposits in banks The Federal Savings and Loan Insurance Corporation (FSLIC) was created to protect deposits in S&Ls [replaced by SAIF in 1989] The National Credit Union Share Insurance Fund (NCUSIF) was created to protect deposits in credit unions Deposit account insurance has been increased over time--it reached $100,000 in 1980 and currently is $250,000 Bank Insurance Fund: Collects annual insurance premiums from commercial banks to create the pool of funds available to FDIC for covering insured depositors Federal Deposit Insurance Corporation Improvement Act of 1991: Provides for differences in deposit premiums based on the relative riskiness of banks
Federal Reserve System
US central bank that sets monetary policy and regulates banking system
debt financing
budgetary deficit: occurs when expenditures are greater than revenues federal statutory debt limits: limits on the federal debt set by congress
capital market securities
capital markets: markets where debt securities with maturities longer than one year and corporate stocks are issued or traded capital market securities: debt securities with maturities longer than one year and corporate stocks
life stages of the corporation
corporation: start up stage survival stage rapid growth stage maturity stage
CH. 5 national economic policy important terms
economic growth high employment price stability balance in international transactions gross domestic product: GDP is the output of goods and services in an economy inflation: increase in price of goods/services not offset by increase in quality real GDP: when GDP exceeds rate of inflation, the result is higher living standards
6. reputation matters
ethical behavior: how an individual or organization treats others legally, fairly, and honestly -high reputation value reflects high quality ethical behavior, so employing high ethical standards is the right thing to do
CH. 4 Federal Reserve System Central Bank
federal government agency that facilitates operation of the financial system and regulates money supply growth
CH 7. Savings and Investment Process GDP
gross domestic product: measures the output of goods and services in an economy over a specified time period
life stages of the individual saver
individual saver: formative/education developing career starting/family creating wealth building retirement enjoying
factors affecting savings
level of income economic expectations cyclical influences life stage of the individual saver or corporation
Major sources of saving
personal saving: savings of individuals equal to personal income less personal current taxes less personal outlays voluntary savings: savings held or set aside by choice for future use contractual savings: savings accumulated on a regular schedule by prior agreement
Personal savings in the US
personal savings definition: personal income less: taxes and other payments equals: disposable personal income less: personal outlays equals: personal savings savings rate definition: savings rate = personal savings/disposable personal income **decline in historical personal savings rates
capital formation
process of constructing real property, manufacturing producers durable equipment, and increasing business inventories
federal government dollar: fiscal year 2008
where it comes from (income) personal income taxes (39%) social security and retirement taxes (30) borrowing to cover deficit (15) corporate income taxes (10) excise, estate and other taxes (6)
federal government dollar: fiscal year 2008q
where it goes (outlays) -social security, medicare (37) national defense, veterans, foreign affairs (24) social programs (20) physical, human, and community development (9) net interest on the debt (8) law enforcement and general gov (2)
