Financial Environment Overview

• The financial environment comprises the financial system, financial markets, and individuals involved in fund production, intermediation, and usage.

Financial Institutions

• Entities providing access to financial markets for savers and borrowers.

Financial Markets

• Forums where suppliers and demanders of funds conduct business directly.

Three Areas of the Financial Environment

• Financial Institutions and Markets
• Investments
• Financial Management

Financial Institutions and Markets

• Financial Institutions: Intermediaries facilitating the transfer of funds between savers/investors and those seeking funds.
• Financial Markets: Locations or electronic forums enabling the flow of funds among investors, businesses, and governments.

Investments

• Encompasses securities sales/marketing, securities analysis, and investment risk management through portfolio diversification.

Financial Management

• Involves financial planning, asset management, and fund-raising decisions to enhance business value.

Types of Financial Institutions

• Depository Institutions: Primary source of funds is individual savings.
  • Banks: Accept deposits from the public and lend these pooled funds for profit.
  • Credit Unions: Cooperative non-profit organizations providing consumer credit to members.
• Contractual Savings Organizations: Primary source of funds are premiums paid on policies.
  • Insurance Companies: Provide financial protection for life, property, liability, and health uncertainties.
  • Pension Fund Companies: Receive contributions from employees and/or employers and invest the proceeds on behalf of the employees.
• Securities Firms: Primary source of funds is individual savings/investments.
  • Investment Companies (Mutual Funds): Sell shares to individuals and invest the pooled proceeds in corporate and government securities.
  • Brokerage Firms: Assist individuals in purchasing or selling securities.
• **Finance Firms: Primary source of funds are other financial institutions.
  • Finance Companies: Provide loans directly to consumers and businesses or aid individuals in obtaining financing.

Types of Financial Markets

• Securities Markets: Locations or electronic forums where debt and equity securities are sold and traded.
• Primary Markets: Initial offering of debt and equity securities to the public, directly benefiting the security issuer.
• Secondary Markets: Transfer of existing debt and equity securities between investors.

Kinds of Securities

• Debt Securities: Obligations to repay borrowed funds.
• Equity Securities: Ownership rights in businesses and institutions.

Types of Debt and Equity Securities

• Money Markets:
  • Treasury Bills: Issued by the government.
  • Negotiable Certificates of Deposit (CDs): Issued by commercial banks.
  • Commercial Paper: Issued by corporations.
• Capital Markets:
  • Treasury Bonds: Issued by the government.
  • Municipal Bonds: Issued by local governments.
  • Corporate Bonds: Issued by corporations.
  • Corporate Stocks: Issued by corporations.

Kinds of Market for Debt Securities

• Money Market: Trades debt instruments of one year or less.
  • Treasury Bills: Short-term obligations issued by the government.
  • Negotiable Certificates of Deposit: Short-term instruments issued by depository institutions, tradable in secondary money markets.
  • Commercial Paper: Short-term unsecured promissory notes issued by high credit quality corporations.
• Capital Markets: Markets for debt securities with maturities longer than one year.
  • Treasury Bonds: Long-term debt security issued by the government, with maturities typically ranging from 5-20 years.
  • Municipal Bonds: Debt security issued by a local government.
  • Corporate Bonds: Long-term debt security issued by corporations.
  • Corporate Stocks: Equity securities issued by corporations.
• Mortgage Markets: Where mortgage loans, backed by real property, are originated and sometimes traded.
  • Mortgage Loans: Long-term loans backed by real property, repaid through installments of interest and partial repayment of the loan amount.
• Derivatives Markets: Facilitate the purchase and sale of derivative securities.
  • Derivative Securities: Financial contracts that derive their values from underlying securities or other related financial assets
• Currency Exchange Markets: Electronic markets where banks and institutional traders buy and sell currencies.

Currency Exchange

• Each country has its own currency.
• Exchange Rate: The price of one nation’s currency when converted to another nation’s currency.
• Currency Exchange System: Allows the currency of one country to be exchanged for the currency of another.
  • Exchange rates change daily, causing currency appreciation or depreciation.
  • Appreciation: When a currency buys more of another currency.
  • Depreciation: When a currency buys less of another currency.

Financial Systems

• Networks of financial institutions, financial markets, financial instruments, and financial services facilitating the transfer of funds.
• Financial Intermediation: The process by which savings are accumulated in depository institutions and then lent or invested.

Financial Functions in the Financial System

• Monetary System:
  • Creating money
  • Transferring money
• Financial Institutions:
  • Accumulating savings
  • Lending/investing savings
• Financial Markets:
  • Marketing financial assets
  • Transferring financial assets

The Monetary System

• Money: Anything used as a medium of exchange and widely acceptable for payments.

Functions of Money

• Medium of Exchange: Used for buying goods and services.
• Unit of Account: Standard for measuring the value of commodities.
• Store of Value: Retains value over time.
• Standard of Deferred Payments: Basis for determining the value of future payments or credits.

Monetary Standard

• A set of institutions and rules governing the supply of money in an economy.

Types of Monetary Standards

• Metallic Standard: Monetary unit is determined in terms of metals like gold or silver.
  • Standard coins are made from the metal, with their value equal to their intrinsic metallic worth.
• Fiat Standard: Use of inconvertible paper money, irredeemable and not issued against any reserve.
  • Currency is not convertible, and the quantity of money is controlled by a government agency to maintain its value.