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Structure of Financial Systems

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pension fund
A nonbanking institution that manages investment pools set aside by individuals, corporations, unions, and some nonprofit organizations to provide retirement income for memebers.
The Federal Reserve System is responsible for
regulating banks and financial institutions, creating a stable economic enviroment, managing regional and national check clearing, and monetary policy.
Which of the following is probably the most familiar form of electronic banking?
Commercial bank
The financial institution that relies mainly on checking and savings accounts as their major source of funds is the
Federal Reserve System
The independent government agency that regulates the nation's banking and financial industry is called the
checking accounts
Demand deposits are more commonly known as
near money
Assets that are easily turned into cash but cannot be used directly as a medium of exchange are called
measure of value
Because money acts as a common denominator that allows people to compare the different goods and services that can be consumed on a particular income level, it functions as a(n)
What is the purpose of the financial system?
To facilitate the design, sale and exchange of a broad set of contracts with very specific set of characteristics
Direct Financing & Indirect Financing
How does the financial system allocate resources?
Direct Financing:
The asset holder has a direct claim on the borrower
Indirect Financing:
The asset holder owns a claim on a financial institution that in turn owns a claim on the borrower
Who owns the underlying asset?
Distinction between direct and indirect finance is:
Financial intermediation:
Improves the flow of funds from DSUs to SSUs, and provide information
A well functioning financial system:
Facilitates production, employment and consumption
What is a financial instrument?
A written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under specified conditions
Example of means of payment:
Employees take stock options as payment for working
Example of a store of value:
Securities store value better than money because they generate increases in wealth that are bigger than those we can obtain from holding money in most of its forms
Very homogenous
Financial instruments that we encounter on a day-to-day bases tend to be:
Classes of Financial Instruments:
Underlying instruments & Derivative instruments
Underlying Instruments are:
Used by savers/lender to transfer resources directly to investors/borrowers (Stocks and Bonds)
Derivative Instruments are:
Those where their value and payoffs are "derived" from the behavior of the underlying instrument (Options, Futures, & Swaps)
Primary Market:
One in which a borrower obtains funds from a lender by selling newly issued securities (Investment banks underwriting IPOs)
Secondary Market:
Are those where people can buy and sell existing securities
Centralized Exchanges:
Buyers and sellers meet in a central, physical location (NYSE)
Over-the-Counter Markets:
(OTCs) Are decentralized markets where dealers stand ready to buy and sell securities electronically (NASDAQ)
Electronic Communication Networks:
(ECNs) enable traders (or their brokers) to find counter-parties who wish trade in specific stock, including those listed on an exchange.
Debt Markets:
Are the markets for loans, mortgages, and bonds. (Money and Bond market instrument)
Equity Markets:
Markets for stocks
Derivatives Markets:
Are the markets where investors trade instruments like futures, options, and swaps, which are primarily to transfer risk
Debt Instruments allow for the:
Transfer of resources from lenders to borrowers and at the same time give investors a store of value for their wealth
Financial Institutions/Intermediaries provide:
Access to the financial markets, both to savers who wish to purchase financial instruments directly and to borrowers who want to issue them
What would the world be like if we did not have financial institutions?
All finance would be direct, with borrowers attempting to obtain funding directly from lenders
Depository Institutions & Non-Depository Institutions
We can divide financial intermediaries into two broad categories:
Depository Institutions:
Take deposits and make loans: commercial banks, savings banks, and credit unions
Non-Depository Institutions:
Provide multiple functions:
US Treasury Bills
5 Money Market Instruments
7 Capital Market Instruments
Stocks, mortgages and mortgage-backed securities, corporate bonds, US Gov securities, us gov agency securities, municipal bonds, consumer and bank commercial loans
Two Types of Financial Market Instruments and difference
Money Market (short term) and Capital Market (long term)
3 main types of Financial intermediaries
depository institution, contractual savings institutions, investment intermediaries
3 Depository Institutions
commercial banks, S&L and Mutual Savings Banks, credit unions
3 Contractual Savings Institutions
life insurance companies, fire and casualty insurance companies, pension funds and government retirement funds
4 investment intermediaries
financial companies, mutual funds, money market mutual funds, investment banks