Académique Documents
Professionnel Documents
Culture Documents
McGraw-Hill/Irwin Copyright 2008 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Learning Objectives
2-3
Learning Objectives
2-4
The Role of Financial Assets
The financial system is the mechanism
through which loanable funds reach
borrowers
Operation of the financial market
Money exchanged for financial claims
Stocks
Bonds
Other securities
Transforms savings into investment
Permits the economy to grow
2-5
The Nature and Characteristics of
Financial Assets
A financial asset
A claim against the income or wealth of a
business firm, household, or unit of
government
Represented usually by a certificate
receipt, computer record file, or other legal
document
Usually related to the lending of money
Examples include stocks, bonds,
deposits, and others
2-6
Characteristics of Financial Assets
2-7
Characteristics of Financial Assets
Equities
Ownership shares in a business firm
Claims against the firms profits
Claims against proceeds from the sale of its assets
Examples are common stock and preferred stock
2-9
Types of Financial Assets
Debt Securities
Priority claim over the holders of equities to the
assets and income of an economic unit
Can be negotiable or nonnegotiable
Examples include bonds, notes, accounts payable,
and savings deposits
Derivatives
Market value tied to or influenced by the value or
return on a financial asset
Examples include futures contracts, options, and
swaps
2-10
How Financial Assets Are Created
Internal financing to acquire assets
Use current income
Use accumulated savings
2-12
Unit Balance Sheets Following the
Equipment Purchase and Debt Issuance
2-13
Unit Balance Sheets Following Equipment
Purchase and Stock Issuance
2-14
Financial Assets and the Financial System
2-15
Financial Assets and the Financial System
2-17
Financial System Matters
Strong financial system helps society
Reducing barriers to external financing
Lowering cost of capital
Accelerating economic growth
2-18
Lending and Borrowing in the
Financial System
Economists John Gurley and Edward Shaw pointed
out that each business firm, household, or unit of
government active in the financial system must
conform to:
R - E = FA - D
Where
R = Current income receipts
E = Expenditures out of current income
FA = Change in holdings of financial assets
D = Change in debt and equity outstanding
2-19
Lending and Borrowing in the
Financial System
So, for any given time period, each
economic unit must fall into one of three
groups:
Deficit-budget unit (DBU):
E > R, so D > FA (net borrower of funds)
2-22
What is Money?
2-23
Alternative Definitions of Money
M1 (Narrow Money)
Physical Currency (notes/bills and coins) plus
demand deposits, which are checking
accounts.
This is used as a measurement for
economists trying to quantify the amount of
money in circulation.
The M1 is a very liquid measure of the money
supply, as it contains cash and assets that
can quickly be converted to currency.
Alternative Definitions of Money
M2 (Broad Money)
M1 + small time deposits (less than $100,000),
savings deposits, and non-institutional
money-market funds.
Economists use M2 when looking to quantify
the amount of money in circulation and trying
to explain different economic monetary
conditions.
M2 is a key economic indicator used to
forecast inflation.
Alternative Definitions of Money
M3
M2 + all large time deposits, institutional
money-market funds, short-term repurchase
agreements, along with other larger liquid
assets.
7000
6000
5000
4000
3000
2000
1000
0
2000 2001 2002 2003 2004 2005 2006 2007
M1 M2
Source: http://www.federalreserve.org/releases/H6/hist/h6hist1.txt
2-29
The Functions of Money
In the past, money was generally considered to have
the following four main functions, which are summed
up in a rhyme found in older economics textbooks:
"Money is a matter of functions four, a medium, a
measure, a standard, a store.
The Functions of Money
Money serves as a unit of account.
2-31
The Value of Money and Other Financial
Assets and Inflation
Inflation
Rise in the average price level of all goods
and services
Lowers purchasing power of money
Can damage value of financial contracts
Deflation
The opposite of inflation
Fall in the average price level of all goods
and services
2-32
The Value of Money and Other Financial
Assets and Inflation
2-33
The Value of Money and Other Financial
Assets and Inflation
2-35
The Evolution of Financial
Transactions
The transfer of funds from savers to
borrowers can be accomplished in at
least three different ways
Direct Finance
Semidirect Finance
Indirect Finance
2-36
The Evolution of Financial
Transactions
2-39
The Evolution of Financial
Transactions
Indirect Finance Financial intermediation of
funds
Secondary Securities
Primary Securities (indirect claims against ultimate
(direct claims against ultimate borrowers issued by financial
borrowers in the form of loan intermediaries in the form of
contracts, stocks, bonds, notes, deposits, insurance policies,
etc.) retirement savings accounts, etc.)
Financial intermediaries
Ultimate (banks, savings and loan associations, Ultimate
borrowers insurance companies, credit unions, lenders
(DBUs) mutual funds, finance companies, (SBUs)
pension funds)
Flow of funds and other Flow of funds and other
financial services financial services
(loans of spending power) (loans of spending power)
Low risk & affordable 2-40
Classifying Financial Institutions
Depository institutions
Bulk of their loanable funds from deposit
accounts sold to the public
Commercial banks, savings and loan
associations, savings banks, credit unions
Contractual institutions
Funds from offering legal contracts to
protect the saver against risk
Insurance companies, pension funds
2-41
Classifying Financial Institutions
Investment institutions
Sell shares to the public
Invest the proceeds in stocks, bonds, and
other assets
Mutual funds, money market funds, real
estate investment trusts
2-42
The Disintermediation of Funds
Disintemediation process
Withdrawal of funds from a financial
intermediary by the ultimate lenders
(SBUs)
Lending of those funds to ultimate
borrowers (DBUs)
Disintermediation shifts funds
Away from indirect finance
To direct finance
2-43
The Disintermediation of Funds
Financial Disintermediation
Primary Securities
Loanable funds
2-44
The Disintermediation of Funds
Disintermediation is not a foregone
conclusion
Reintermediation
Reversal of flow of funds
Back to a safe haven of financial
intermediaries
Interest rates are low or declining
Or riskiness of financial instruments appear
to be rising
2-45
New Forms of Disintermediation
Initiation by financial intermediaries
Banks sell off loans
Difficulty in raising capital
Initiation by borrowing customers
Customer learn alternate financing
conduits
Nonfinancial retail and industrial firms
attempting to draw financial services
customers
Raise funds in the open market
2-46
Bank-Dominated Versus Security-
Dominated Financial Systems
2-47
Bank-Dominated Versus Security-
Dominated Financial Systems
2-48
Markets on the Net
Answers.com at
http://www.answers.com/topic/disinter
mediation
Bondsonline at www.bondsonline.com
Encarta at encarta.msn.com
Encyclopedia.com at encyclopedia.com
Federal Reserve Bank of Atlanta at
www.frbatlanta.org
Federal Reserve Bank of New York at
www.ny.frb.org
2-49
Markets on the Net
2-53
Chapter Review
2-54
Chapter Review
Disintermediation of funds
New types of disintermediation
Bank-dominated versus security-
dominated financial systems
2-55