BADM chapter 15

The investment banker

underwrites new issues of securities for corporations, states, and municipalities needed to raise money in the capital markets. The new issue market is called a primary market because the sale of the securities is for the first time. After the first sale, the securities trade in the secondary markets by brokers. The investment banker advises on the price of the new securities and generally guarantees the sale while overseeing the distribution of the securities through the selling brokerage houses.

automated teller machine (ATM)

which dispenses cash, accepts deposits, and allows balance inquiries and cash transfers from one account to another. ATMs provide 24-hour banking services—both at home (through a local bank) and far away (via worldwide ATM networks such as Cirrus and Plus). Rapid growth, driven by both strong consumer acceptance and lower transaction costs for banks (about half the cost of teller transactions), has led to the installation of hundreds of thousands of ATMs worldwide.

The Federal Deposit Insurance Corporation (FDIC)

which insures individual bank accounts, was established in 1933 to help stop bank failures throughout the country during the Great Depression. Today, the FDIC insures personal accounts up to a maximum of $250,000 at nearly 8,000 FDIC member institutions.11 While most major banks are insured by the FDIC, small institutions in some states may be insured by state insurance funds or private insurance companies.

monetary policy

Without this intervention, the supply of and demand for money might not balance. This could result in either rapid price increases (inflation) because of too little money or economic recession and a slowdown of price increases (disinflation) because of too little growth in the money supply.

Credit cards

allow you to promise to pay at a later date by using preapproved lines of credit granted by a bank or finance company. They are a popular substitute for cash payments because of their convenience, easy access to credit, and acceptance by merchants around the world. The institution that issues the credit card guarantees payment of a credit charge to merchants and assumes responsibility for collecting the money from the cardholders.

Finance companies

are businesses that offer short-term loans at substantially higher rates of interest than banks. Commercial finance companies make loans to businesses, requiring their borrowers to pledge assets such as equipment, inventories, or unpaid accounts as collateral for the loans. Consumer finance companies make loans to individuals. Like commercial finance companies, these firms require some sort of personal collateral as security against the borrower's possible inability to repay their loans.

Insurance companies

are businesses that protect their clients against financial losses from certain specified risks (death, injury, disability, accident, fire, theft, and natural disasters, for example) in exchange for a fee, called a premium. Because insurance premiums flow into the companies regularly, but major insurance losses cannot be timed with great accuracy (though expected risks can be assessed with considerable precision), insurance companies generally have large amounts of excess funds. They typically invest these or make long-term loans, particularly to businesses in the form of commercial real estate loans.

Pension funds

are managed investment pools set aside by individuals, corporations, unions, and some nonprofit organizations to provide retirement income for members. One type of pension fund is the individual retirement account (IRA), which is established by individuals to provide for their personal retirement needs. IRAs can be invested in a variety of financial assets, from risky commodities such as oil or cocoa to low-risk financial "staples" such as U.S. Treasury securities. The choice is up to each person and is dictated solely by individual objectives and tolerance for risk. The interest earned by all of these investments may be deferred tax-free until retirement.

Certificates of deposit (CDs)

are savings accounts that guarantee a depositor a set interest rate over a specified interval of time as long as the funds are not withdrawn before the end of the interval—six months, one year, or seven years, for example. Page 474Money may be withdrawn from these accounts prematurely only after paying a substantial penalty. In general, the longer the term of the CD, the higher is the interest rate it earns. As with all interest rates, the rate offered and fixed at the time the account is opened fluctuates according to economic conditions.

Money market accounts

are similar to interest-bearing checking accounts, but with more restrictions. Generally, in exchange for slightly higher interest rates, the owner of a money market account can write only a limited number of checks each month, and there may be a restriction on the minimum amount of each check.

Mutual savings banks

are similar to savings and loan associations, but, like credit unions, they are owned by their depositors. Among the oldest financial institutions in the United States, they were originally established to provide a safe place for savings of particular groups of people, such as fishermen. Found mostly in New England, they are becoming more popular in the rest of the country as some S&Ls have converted to mutual savings banks to escape the stigma created by the widespread S&L failures in the 1980s.

Brokerage firms

buy and sell stocks, bonds, and other securities for their customers and provide other financial services. Larger brokerage firms like Merrill Lynch, Charles Schwab, and Edward Jones offer financial services unavailable at their smaller competitors. Merrill Lynch, for example, offers the Merrill Lynch Cash Management Account (CMA), which pays interest on deposits and allows clients to write checks, borrow money, and withdraw cash much like a commercial bank.

checking account

(also called a demand deposit), money stored in an account at a bank or other financial institution that can be withdrawn without advance notice.

Savings accounts

(also known as time deposits) are accounts with funds that usually cannot be withdrawn without advance notice and/or have limits on the number of withdrawals per period. While seldom enforced, the "fine print" governing most savings accounts prohibits withdrawals without two or three days' notice. Savings accounts are not generally used for transactions or as a medium of exchange, but their funds can be moved to a checking account or turned into cash.

credit union

is a financial institution owned and controlled by its depositors, who usually have a common employer, profession, trade group, or religion. The Aggieland Credit Union in College Station, Texas, for example, provides banking services for faculty, employees, and current and former students of Texas A&M University. A savings account at a credit union is commonly referred to as a share account, while a checking account is termed a share draft account. Because the credit union is tied to a common organization, the members (depositors) are allowed to vote for directors and share in the credit union's profits in the form of higher interest rates on accounts and/or lower loan rates.

Electronic funds transfer (EFT)

is any movement of funds by means of an electronic terminal, telephone, computer, or magnetic tape. Such transactions order a particular financial institution to subtract money from one account and add it to another. The most commonly used forms of EFT are automated teller machines, automated clearinghouses, and home banking systems.

debit card

looks like a credit card but works like a check. The use of a debit card results in a direct, immediate, electronic payment from the cardholder's checking account to a merchant or other party. While they are convenient to carry and profitable for banks, they lack credit features, offer no purchase "grace period," and provide no hard "paper trail." Debit cards are gaining more acceptance with merchants, and consumers like debit cards because of the ease of getting cash from an increasing number of ATM machines.

Nonbank financial institutions

offer some financial services, such as short-term loans or investment products, but do not accept deposits. These include insurance companies, pension funds, mutual funds, brokerage firms, nonfinancial firms, and finance companies.

Savings and loan associations (S&Ls)

often called "thrifts," are financial institutions that primarily offer savings accounts and make long-term loans for residential mortgages. A mortgage is a loan made so that a business or individual can purchase real estate, typically a home; the real estate itself is pledged as a guarantee (called collateral) that the buyer will repay the loan. If the loan is not repaid, the savings and loan has the right to repossess the property. Prior to the 1970s, S&Ls focused almost exclusively on real estate lending and accepted only savings accounts. Today, following years of regulatory changes, S&Ls compete directly with commercial banks by offering many types of services.

Automated clearinghouses (ACHs)

permit payments such as deposits or withdrawals to be made to and from a bank account by magnetic computer tape. Most large U.S. employers, and many others worldwide, use Page 486ACHs to deposit their employees' paychecks directly to the employees' bank accounts.

mutual fund

pools individual investor dollars and invests them in large numbers of well-diversified securities. Individual investors buy shares in a mutual fund in the hope of earning a high rate of return and in much the same way as people buy shares of stock. Because of the large numbers of people investing in any one mutual fund, the funds can afford to invest in hundreds (if not thousands) of securities at any one time, minimizing the risks of any single security that does not do well. Mutual funds provide professional financial management for people who lack the time and/or expertise to invest in particular securities, such as government bonds. While there are no hard-and-fast rules, investments in one or more mutual funds are one way for people to plan for financial independence at the time of retirement.

The National Credit Union Administration (NCUA)

regulates and charters credit unions and insures their deposits through its National Credit Union Insurance Fund.