AC 509 Chapter 2 The Role of Financial Markets and Financial Intermediaries
Note
A transfer of funds from one intermediary (savings and loan association) to another (money market mutual fund) can have an important impact on the supply of credit available to a particular sector of the economy.
Note
All commercial banks that are members of the Federal Reserve System must purchase insurance from FDIC.
1. when you start your own business and invest your savings in the operation 2. when securities are initially sold to investors in the "primary" market.
Direct Investment
1. Commercial Banks 2. Thrift Institution 3. Life Insurance Companies
Examples of financial intermediary
Saving accounts Money market accounts Certificate of deposists
Examples of interest bearing accounts
Time deposit - no requirement Checking account - 10%
Examples of reserves
1. saving and loans association 2. mutual saving banks 3. credit union
Examples of thrift institution
1. Safety of principal 2. Liquidity 3, Interest rates that exceed the rates paid by the bank
Three factors that explain the popularity of money market mutual fund
1. Positive relationship 2. Negative relationship (inverted yield curve) 3. Neutral relationship (relatively flat)
Three relationships found in the yield curve
1. Insurance 2. Saving plan (accumulated cash value)
Two elements contain by life insurance policy
1. to facilitate the transfer of funds from savers to firms, government, and individuals who use the funds. 2. to facilitate the transfer of existing securities from sellers to buyers
Two functions of financial markets
1. M-1 2. M-2
Two measures of money
1. cash in the vault 2. deposit with another bank
Two ways to hold reserves
shells, stones, metals, coins, and paper money
What do the words "anything" and "generally accepted" in money mean?
1. Intermediary's diversified portfolio 2. the insurance of deposits
What made financial intermediaries a haven for investors?
M-2
Which is preferable by economists and financial analysts?
Mortality tables
a life insurance company can predict with accuracy the volume of death benefits that the company will have to pay and can construct a portfolio of long-term assets that meets the forecast benefits.
Money
a medium of exchange; its value is related to what it will purchase
Repurchase agreement (repos)
a sale of security in which the seller agrees to buy back (repurchase) the security at a specified price at a specified date; repurchase price > initial sale price
Saving and loans association
a source of mortgage loans; self-liquidating
Pension plans
accumulate assets for workers so that they will have funds for retirement.
Deposit Institution Deregulation and Monetary Control Act of 1980 (Monetary Control Act of 1980)
all depository institutions became subject to the regulation of the Federal Reserve.
Commercial paper
an unsecured short-term note issued by a corporation as an alternative to borrowing funds from commercial banks; only those creditworthy can sell this type of security.
Money
anything that is generally accepted as a means of payment (for goods and services; retirement of debt)
Financial Intermediaries
borrow funds from one group and lend to another; a process that channels resources into productive investment
Federal Reserve System
central bank; has the power to control the supply of money and to oversee the commercial banking system; created by Congress.
Checking and savings account Time deposit
constitute almost 50% of the bank's source of finance.
Rate of interest
cost of credit is often expressed as a percentage.
Interest
cost of credit; the price paid for the use of someone else's money
Intermediate term
debt that matures in one to ten years.
Minimum amount of reserve
determined by the Federal Reserve
Mutual saving banks
developed in 1800s; owned by its depositors; but managed by a board of trustees; owners may readily withdraw their funds
Liquidity
ease of converting an asset into cash without a loss; depth of the financial market
Federal Deposit Insurance Corporation (FDIC)
established because of the large losses sustained by commercial banks; increases the general public's confidence in the banking system.
Investment bankers
facilitate initial sale
Broker and secondary markets
facilitate subsequent sales
Required reserves
funds that banks must hold against deposit liabilities
Power to create money
given by the Constitution to the FEDERAL GOVERNMENT.
Use of Interest
helps allocate scarce credit among competing uses for the fund.
Secondary reserves
high-quality, short-term marketable securities, such as U.S. government securities (Treasury bills) that may be readily sold.
Fully loaned up
if there is no excess reserves
Yield curve
illustrates the term structure of interest rates; graph relating interest rates and the term to maturity.
Schwab U.S. Treasury Money Fund
invest solely in U.S. government securities or securities that are collateralized by obligations of the federal government.
Money market mutual fund
investment company that invest SOLELY in short-term money market instruments (newly issued)
Mutual funds
invests on behalf of individuals; not financial intermediary
Time deposit (certificate of deposit or CDs)
issued by a bank with a specified interest rate and maturity
Tax anticipation notes
issued by states or municipalities to finance current operations before tax revenues are received; tax exempt
Eurodollar certificate of deposits (Eurodollar CDs)
issued either by branches of domestic banks located abroad or by foreign banks; denominated in U.S. Dollars; a secondary market exist
Negotiable CDs
issued in amounts of $100,000 or more whose terms are individually negotiated between the bank and the saver and for which there exists a secondary market
Main reason of having reserves
it's one of the tools of monetary control.
Correspondent bank
major bank which a smaller bank has a relationship to facilitate check clearing and to serve as depository for reserves.
Banks with national charter
must join the Federal Reserve and are subjected to its regulation as well as to examination by the Comptroller of the Currency
Money market mutual funds
offer individuals an alternative to the checking accounts, savings accounts, and saving certificates issued by banks and thrift institutions.
Federal government deposit insurance
one of the positive results of the Great Depressions of the 1930s
Usual time period for a debt
one year
Life insurance companies
perform the role of a financial intermediary because they receive the funds of savers, create claims on themselves, and lend the funds to borrowers.
Thrift insitution
place for savers to deposit funds
Teachers Insurance and Annuity Association (TIAA)
purchases an entirely different type of portfolio that stresses debt, especially mortgages; savers to borrowers; acts as a financial intermediary (pension plan)
College Retirement Equity Fund (CREF)
purchases existing corporate stock
Government regulations
purpose is to protect the bank's creditors, especially their depositors.
Banks with state charter
regulated by the individual banking state commission and are subject to regulation by the Federal Reserve.
Savings
represent a command over resources that are not in used.
Excess reserves
reserves held by a bank in excess of those it must hold to meet its reserve requirement
U.S. Treasury Bill (T-Bill)
safest short-term securities issued by the federal government
Short term and Long term
short term: refers to a year or less long term : refers to greater than a year
Banker's acceptances
short-term promissory notes guaranteed by a bank; supported by two parties: the firm on which the draft is drawn and the bank that accepts the draft.
depth of the financial market
the ability to sell an asset without affecting its price
Note
the amount of the reserve requirement varies with the type of account.
Second function of financial markets
the creation of markets in existing securities; transfer of ownership of securities among various investors
Comptroller of the Currency
the federal agency that grants national bank charters
Financial intermediary
the funds are initially lent to the intermediary and the intermediary subsequently lends the funds to the ultimate user
Note
the longer the term of the debt and the riskier (or less creditworthy) the debt instrument, the higher will be the rate of interest.
Money market
the market for low-risk, large-denomination debt instrument that matures within a year.
Capital market
the market for securities with a longer horizon
Financial markets
the mechanism to transfer these savings to productive uses
Commercial banks
the most important depository institution (in terms of size); prime source of funds to consumers; tends to stress loans that must be paid off (mature) quickly.
Commercial banks
the most important financial intermediary in terms of the amount of loan
Primary function of financial system
the process of transferring savings to investment
Term structure of interest rates
the relationship between interest rates(cost of credit) and the length of time to maturity(the term) for debt in a given risk class
M-1
the sum of coins and currency plus demand deposits (interest-bearing checking account and traveler's check)
M-2
the sum of coins and currency plus demand deposits, regular saving accounts and small certificate of deposit (less than $100,000)
Money supply
the total amount of money in circulation.
Role of financial intermediary
the transfer of purchasing power from saver to borrower by an intermediary that creates claims on itself
Crucial component of financial system
the transfer of savings through financial intermediaries -from individuals with funds to firms, government, and other individuals who need the funds.
Primary liability of commercial banks
their deposits: checking accounts(demand deposit), savings and time deposits
Competition for Funds
through yield and services offered.
Note
to obtain the funds, the financial intermediary create CLAIMS ON THEMSELVES.
Used of Money
to transfer purchasing power to the future; acts as a STORE OF VALUE from one time period to another.
Indirect investment
transfer through financial intermediaries.
Commercial banks and Life insurance companies
Commercial banks: short-term liquid loans Life insurance companies: mortality tables
1. inflation 2. action of the Federal Reserve to curb rising prices
Reasons of having negative relationship in yield curve
$250,000
Amount insured by FDIC; legal limit
Note
For a pension plan to serve as a financial intermediary, it must pass the funds directly to a borrower or invest them directly in a firm
Note
No financial market can exist without its sources of funds.
Investment bankers Brokers Secondary market
Not financial intermediary but acts as a middleman (facilitate the buying and selling of new and existing securities)
Stocks, bonds, saving accounts, saving bonds, real estate, gold and collectibles
Other store of value (nonmonetary assets)