Introduction and Overview of the Financial System

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to purchase goods and services globally. (6) Risk Function-providing a means to protect against risks to people, property, and income, by producing and selling risk protection services. (7) Policy Function- a channel for government policy to achieve society’s goals of full employment, low inflation, and sustainable economic growth. Government attempts to stabilize the economy and avoid inflation by manipulating interest rates, credit availability. MOST important function is to facilitate the transformation of savings into real investment for growth, new jobs, living standard.

Structures and types of financial markets within the global financial system Channels where loanable funds continually being drawn and replenished by suppliers.

Money and capital markets Money Market- designed for the making of short term loans, temporary surpluses meet temporary shortages. Only short term debt instruments, less than one year are traded, finance the working capital need of corporations. Instruments=T-Bills, small time savings, federal funds, short term securities have smaller fluctuation prices etc. Capital Market- designed for long term investment, channel that provides lending and borrowing long term over a year. Instruments differ from small loans to multimillion dollar credits mortgages, common stocks, bonds. (construction of schools, homes, highways, etc.)

Debt and equity markets Debt markets- firms can obtain funds with debt instruments-a contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when the final payment is made. The maturity is the time to that instruments expiration date. Equity markets-issue equities or common stocks, claims to share in the net income and assets of a business.

Open and negotiated markets- Open markets often useful for global financial systems- mechanisms created to make loans and trade securities where anyone or any institution can participate. Negotiated markets- mechanisms set up to make loans and trade securities in which the terms are bargained between a lender and a borrower.

Primary and secondary markets-Primary markets are for the trading of new securities (stocks, bonds, etc) never issued before, its primary function is raising capital to support new investments in buildings, equipment, and inventories. Secondary markets- deal in securities previously issued, its main function is to provide liquidity to security investors=converting financial instruments into ready cash, larger volume, does not support new investment.

Exchanges and over-the counter markets- where sellers and buyers meet to conduct trade. OTC-where dealers at different locations have inventory of securities ready to buy and sell to anyone who comes in the computer, very competitive.

Spots, futures, forwards, and option market- Spot market one where securities or financial services are traded for immediate delivery. Futures or forward markets designed to trade contracts calling for the future delivery of financial instruments. Option markets-offer investors in the money and capital markets an opportunity to reduce risk, agreements on selected stocks gives investors the right to buy or sell designated securities.

The foreign exchange markets- the market in which exchange rates are determined. The exchange rate is the price of one currency in terms of another.

Financial assets and the financial system- Different kinds of financial assets: money, equities, debt securities, derivatives. They arise in the process of borrowing and lending money, Total assets=Total liabilities+Net worth.Role of the financial system in channeling savings into investment spending to accelerate economic growth.

Lending and borrowing in the financial system (1)Deficit- budget units net borrowers of funds (2)Surplus- budget units net lenders of funds (3)Balanced Budget units. Makes possible continual shifting of units and sectors between net borrowers and net lenders of funds.

Financial intermediation- the process performed by banks taking money from lenders and giving it to borrowers, they thrive on it by lending at high interest