The Financial System consists of financial markets and financial institutions.
Financial markets: where people buy and sell different types of goods and haggle over prices.
Financial institutions: firms such as commercial banks, credit unions, insurance companies, pension funds, mutual funds, and finance companies that provide financial services to consumers, businesses, and government units.
A Preview of the Financial System * If the financial system is competitive, the interest rate the bank pays on CDs will be at or near the highest rat that you can earn on CDs of similar maturity and risk * Banks and other depository institutions, such as insurance companies, gather money from consumers in small dollar amounts, aggregate it, and then make loans in much larger dollar amounts. * An important function of the financial system is to allocate money to the most productive investment projects in the economy. * Finally, banks are profit-making organizations.
A balanced budget
A surplus budget: surplus spending units
A deficit budget: deficit spending units
In real world, IOUs are called financial claims (securities/ financial instruments). Financial claims are liabilities for borrowers and are simultaneously assets for lenders.
How Funds Flow Through the Financial System 1) Direct financing : where funds flow directly through financial markets 2) Indirect financing: where funds flow indirectly through financial institutions in the financial intermediation marke
1.2 Financial Markets and Direct Finance
Typical financial instruments bought and sold in the direct financial markets are stocks and bonds.
Overview of Investment Banking
Two important player that deliver critical services in the direct credit markets are investment banking firms and large money center banks.
Investment banks are firms that specialize in helping businesses sell new debt or equity in the financial markets.
Money center banks are large commercial banks usually located in major financial centers who are major participants in the money markets.
Congress passed the Glass-Steagall Act of 1933, which separated commercial banking from investment banking.
Beginning in 1999, bank regulators gradually allowed money center banks to engage in investment banking activities, because 1) the 1990s were a period of time marked by a significant amount of deregulation in the economy and 2) recent research exonerated the banking system from being the primary culprit causing the Great Depression.
Investment Banking Today
The trigger point came in 2007, when banks and other mortgage lenders experienced a large number of defaults in th subprime mortgage market, which was a market for high-risk mortgage loans.
The remaining Wall Street investment banks were forced by regulators to merge with large money center banks.
Investment Banking Services
Bring New Securities to Market: to help firms bring their new debt or equity securities to market. There are three distinct tasks involved. 1) Origination (all the work necessary to prepare a security issue for sale 2) underwriting (an investment banker helps a firm sell its new security issue in the direct financial markets (firm commitment) 3) distribution occurs immediately after the securities are bought from the issuer and is the marketing and sales of securities to institutional and individual investors.
Trading and Brokerage Services: Brokers help bring buyers and sellers together, acting as matchmakers and, if a sale takes place, they receive a commission for their services. Dealers “make markets” for securities by carrying an inventory of securities for which they stand ready either buy or sell at quoted prices.
How consumers Access Financial Markets
Direct market participants are seasoned professionals who make their living