1、1Overview of the Financial SystemChapter Two:2Chapter PreviewnWe examine the role of the financial system in an advanced economy.We study the effects of financial markets and institutions on the economy,and look at their general structure and operations.Topics include:qFunction of Financial Marketsq
2、Structure of Financial MarketsqInternationalization of Financial MarketsqFunction of Financial IntermediariesqFinancial IntermediariesqRegulation of the Financial System32.1 Function of Financial Markets nAllows transfers of funds from person or business without investment opportunities(i.e.,“Lender
3、-Savers”)to one who has them(i.e.,“Borrower-Spenders”)nImproves economic efficiency4Figure 2.1 Flow of Funds Through the Financial System2.1.1 Function of Financial Markets 52.1.2Financial Markets Funds TransfereesnLender-SaversnHouseholdsnBusiness firmsnGovernmentnForeignersnBorrower-SpendersnBusin
4、ess firmsnGovernmentnHouseholdsnForeigners62.1.3 Segments of Financial MarketsDirect FinanceBorrowers borrow directly from lenders in financial markets by selling financial instruments which are claims on the borrowers future income or assetsIndirect FinanceBorrowers borrow indirectly from lenders v
5、ia financial intermediaries(established to source both loanable funds and loan opportunities)by issuing financial instruments which are claims on the borrowers future income or assets72.1.4 Importance of Financial MarketsnFinancial markets are critical for producing an efficient allocation of capita
6、l,which contributes to higher production and efficiency for the overall economy,as well as economic security for the citizenry as a wholenFinancial markets also improve the lot(命运)of individual participants by providing investment returns to lender-savers,facilities to borrowers-spenders.82.2.1 Clas
7、sifications of Financial MarketsDebt MarketsqShort-Term(maturity 1 year)Capital MarketEquity MarketsqCommon Stock92.2.2 Characteristics of Debt Markets InstrumentsnDebt instruments qBuyers of debt instruments are suppliers(of capital)to the firm,not owners of the firmqDebt instruments have a finite
8、life or maturity dateqAdvantage is that the debt instrument is a contractual promise to pay with legal rights to enforce repaymentqDisadvantage is that return/profit is fixed or limited102.2.3 Characteristics of Equity Markets InstrumentsnEquity instruments(common stock is most prevalent equity inst
9、rument)qBuyers of common stock are owners of the firmqCommon stock has no finite life or maturity dateqAdvantage of common stock is potential high income since return is not fixed or limitedqDisadvantage is that debt payments must be made before equity payments can be made11npreferred stock122.2.4 C
10、haracteristics of Financial MarketsDebt MarketsqAlthough less well-known by the average person,debt markets in U.S.are much larger in total dollars than equity markets,due to greater number of participant classes(households,businesses,government,and foreigners)and size of individual participants(bus
11、inesses,and government)132.2.5 Characteristics of Financial MarketsEquity MarketsqAlthough U.S.markets are highly efficient,the worlds largest,and more familiar to the average person,they are far smaller than the U.S.debt markets largely due to the fact that the only applicable participants are busi
12、nesses142.2.6 Classifications of Financial MarketsPrimary MarketqNew security issues sold to initial buyersqInitial Public Offerings 首次公开募股Secondary MarketqSecurities previously issued are bought and sold152.2.7 Classifications of Financial MarketsExchangesqTrades conducted in central locations(e.g.
13、,New York Stock Exchange)Over-the-Counter MarketsqDealers at different locations buy and sellNYSE home pagenyse162.3 Internationalization of Financial MarketsnInternational Bond MarketqForeign bondsqEurobonds(now larger than U.S.corporate bond market)nWorld Stock MarketsqU.S.stock markets are no lon
14、ger always the largestat one point,Japans was larger172.4 Function of Financial Intermediaries(FIs)nFinancial IntermediariesEngage in process of indirect financeMore important source of finance than securities markets1.Needed because of transactions costs and asymmetric information 182.4.1 Function
15、of Financial IntermediariesnTransactions Costs Financial intermediaries make profits by reducing transactions costs 1.Reduce transactions costs by developing expertise and taking advantage of economies of scale192.4.2 Function of Financial IntermediariesA financial intermediarys low transaction cost
16、s mean that it can provide its customers with liquidity services,services that make it easier for customers to conduct transactions Banks provide depositors with checking accounts(current account 往来帐户)that enable them to pay their bills easilyDepositors can earn interest on checking and savings acco
17、unts and yet still convert them into goods and services whenever necessary202.4.3 Function of Financial IntermediariesnAnother benefit made possible by the low transaction costs of financial institutions they can help reduce the exposure of investors to risk;Financial intermediaries do this through
18、the process known as risk sharing:they create and sell assets with risk characteristics that people are comfortable with,and the intermediaries then use the funds they acquire by selling these assets to purchase other assets that may have far more risk.qThis process is referred to as asset transform
19、ation,because in a sense risky assets are turned into safer assets for investors21nFinancial intermediaries also promote risk sharing by helping individuals to diversify and thereby lower the amount of risk to which they are exposed.Diversification(多样化多样化)entails investing in a collection(portfolio,
20、资资产组合产组合)of assets whose returns do not always move together,with the result that overall risk is lower than for individual assets.222.4.4 Asymmetric Information:Adverse Selection and Moral HazardnAdverse SelectionBefore the transaction occursqAdverse selection in financial markets occurs when the p
21、otential borrowers who are the most likely to produce an undesirable(adverse)outcomethe bad credit risksare the ones who most actively seek out a loan and are thus most likely to be selected.1.Because adverse selection makes it more likely that loans might be made to bad credit risks,lenders may dec
22、ide not to make any loans even though there are good credit risks in the marketplace.232.4.5 Asymmetric Information:Adverse Selection and Moral HazardnMoral HazardAfter transaction occurs1.Hazard that borrower has incentives to engage in undesirable(immoral)activities making it more likely that wont
23、 pay loan back242.4.7 Financial Intermediaries252.4.8 Size of Financial Intermediaries262.4.9 Types of Financial IntermediariesnDepository Institutions(Banks)qCommercial banksqSavings&Loan Associations(S&Ls)qMutual Savings BanksnContractual Savings InstitutionsqLife insurance companiesqFire&casualty
24、 insurance companiesqPension funds,government retirement funds272.4.10 Types of Financial IntermediariesnInvestment IntermediariesqFinance companiesqMutual fundsqMoney market mutual funds282.4.11Depository Institutions(Banks)nCommercial banksqRaise funds primarily by issuing checkable,savings,and ti
25、me deposits which are used to make commercial,consumer and mortgage loansqCollectively,these banks comprise the largest financial intermediary and have the most diversified asset portfolios292.4.12Depository Institutions(Banks)nS&Ls,Mutual Savings Banks and Credit UnionsqRaise funds primarily by iss
26、uing savings,time,and checkable deposits which are most often used to make mortgage and consumer loans,with commercial loans also becoming more prevalent at S&Ls and Mutual Savings BanksqMutual savings banks and credit unions issue deposits as shares and are owned collectively by their depositors,mo
27、st of which at credit unions belong to a particular group,e.g.,a companys workers302.4.13 Contractual Savings Institutions(CSIs)nAll CSIs acquire funds from clients at periodic intervals on a contractual basis and have fairly predictable future payout requirements.qLife Insurance Companies receive f
28、unds from policy premiums,can invest in less liquid corporate securities and mortgages,Fire and Casualty Insurance Companies receive funds from policy premiums,must invest most in liquid government and corporate securities,312.4.14 Contractual Savings Institutions(CSIs)nAll CSIs acquire funds from c
29、lients at periodic intervals on a contractual basis and have fairly predictable future payout requirements.qPension and Government Retirement Funds hosted by corporations and state and local governments acquire funds through employee and employer payroll contributions,invest in corporate securities,
30、and provide retirement income via annuities322.4.15 Investment IntermediariesnFinance Companies sell commercial paper(a short-term debt instrument)and issue bonds and stocks to raise funds to lend to consumers to buy durable goods,and to small businesses for operationsnMutual Funds acquire funds by
31、selling shares to individual investors(many of whose shares are held in retirement accounts)and use the proceeds to purchase large,diversified portfolios of stocks and bonds332.4.16 Investment IntermediariesnMoney Market Mutual Funds acquire funds by selling checkable deposit-like shares to individu
32、al investors and use the proceeds to purchase highly liquid and safe short-term money market instruments342.5 Regulatory Agencies35362.5.1 Regulation of Financial MarketsnMain Reasons for RegulationIncrease Information to Investors1.Ensure the Soundness of Financial Intermediaries37SEC home pagesec.
33、gov2.5.2 Regulation Reason:Increase Investor InformationnAsymmetric information in financial markets means that investors may be subject to adverse selection and moral hazard problems that may hinder the efficient operation of financial markets and may also keep investors away from financial markets
34、nThe Securities and Exchange Commission(SEC)requires corporations issuing securities to disclose certain information about their sales,assets,and earnings to the public and restricts trading by the largest stockholders(known as insiders)in the corporation382.5.4 Regulation Reason:Ensure Soundness of
35、 Financial IntermediariesnBecause providers of funds to financial intermediaries may not be able to assess whether the institutions holding their funds are sound or not,if they have doubts about the overall health of financial intermediaries,they may want to pull their funds out of both sound and un
36、sound institutions,with the possible outcome of a financial panic that produces large losses for the public and causes serious damage to the economy392.5.5 Regulation Reason:Ensure Soundness of Financial Intermediaries(cont.)nTo protect the public and the economy from financial panics(金融恐慌),the gove
37、rnment has implemented six types of regulations:qRestrictions on EntryqDisclosureqRestrictions on Assets and ActivitiesqDeposit InsuranceqLimits on CompetitionqRestrictions on Interest Rates402.5.6 Regulation:Restriction on EntrynRestrictions on EntryqRegulators have created very tight regulations a
38、s to who is allowed to set up a financial intermediaryqIndividuals or groups that want to establish a financial intermediary,such as a bank or an insurance company,must obtain a charter from the state or the federal governmentqOnly if they are upstanding(正直的)citizens with impeccable credentials(无犯罪记
39、录证书)and a large amount of initial funds will they be given a charter.41n祖国我对你意见太多请不要怪我因为你的丑陋代表着我 n祖国我对你意见太多请不要怪我因为我是你忠实的儿子你可以任意折磨我 n祖国我对你意见太多请不要怪我因为我理解你你可以不理解我 n祖国我对你意见太多请不要怪我我愿意你十全十美因为你就是我 n祖国我对你意见太多请不要怪我因为我不能改变我就是我 422.5.7 Regulation:DisclosurenDisclosure RequirementsnThere are stringent reporting
40、 requirements for financial intermediariesqTheir bookkeeping must follow certain strict principles,qTheir books are subject to periodic inspection,qThey must make certain information available to the public.432.5.8 Regulation:Restriction on Assets and ActivitiesnThere are restrictions on what financ
41、ial intermediaries are allowed to do and what assets they can holdnBefore you put your funds into a bank or some other such institution,you would want to know that your funds are safe and that the bank or other financial intermediary will be able to meet its obligations to you442.5.9 Regulation:Rest
42、riction on Assets and ActivitiesqOne way of doing this is to restrict the financial intermediary from engaging in certain risky activitiesqAnother way is to restrict financial intermediaries from holding certain risky assets,or at least from holding a greater quantity of these risky assets than is p
43、rudent452.5.10 Regulation:Deposit InsurancenThe government can insure people providing funds to a financial intermediary from any financial loss if the financial intermediary should failnThe Federal Deposit Insurance Corporation(FDIC),insures each depositor at a commercial bank or mutual savings ban
44、k up to a loss of$100,000 per account462.5.11 Regulation:Deposit InsurancenSimilar government agencies exist for other depository institutions:qThe Savings Association Insurance Fund(part of the FDIC)provides deposit insurance for savings and loan associations,and the National Credit Union Share Ins
45、urance Fund(NCUSIF)does the same for credit unions472.5.12 Regulation:Past Limits on CompetitionnAlthough the evidence that unbridled(无约束的)competition among financial intermediaries promotes failures that will harm the public is extremely weak,it has not stopped the state and federal governments fro
46、m imposing many restrictive regulations;nIn the past,banks were not allowed to open up branches in other states,and in some states banks were restricted from opening additional locations.482.5.13 Regulation:Past Restrictions on Interest RatesnCompetition has also been inhibited(被禁止)by regulations th
47、at impose restrictions on interest rates that can be paid on depositsnThese regulations were instituted because of the widespread belief that unrestricted interest-rate competition helped encourage bank failures during the Great DepressionnLater evidence does not seem to support this view,and restri
48、ctions on interest rates have been abolished492.5.15 Financial Regulation Abroad nThose countries with similar economic systems also implement financial regulation consistent with the U.S.model:Japan,Canada,and Western EuropeqFinancial reporting for corporations is requiredqFinancial intermediaries
49、are heavily regulatednHowever,U.S.banks are more regulated along dimensions of branching and services than their foreign counterparts.50Chapter SummarynThe basic function of financial markets is to channel funds from savers who have an excess of funds to spenders who have a shortage of funds.nFinanc
50、ial markets can be classified as debt and equity markets,primary and secondary markets,exchanges and over-the-counter markets,and money and capital markets.51Chapter Summary(cont.)nAn important trend in recent years is the growing internationalization of financial markets.Eurobonds,which are denomin
