Financial System Introduction PDF

# Introduction - Every financial transaction has a story. - There is a complex web of interdependent institutions and markets making up the foundation of daily financial transactions: 1. The Six Parts of the Financial System 2. The Five Core Principles of Money and Banking ## Six Parts of...

# Introduction - Every financial transaction has a story. - There is a complex web of interdependent institutions and markets making up the foundation of daily financial transactions: 1. The Six Parts of the Financial System 2. The Five Core Principles of Money and Banking ## Six Parts of the Financial System 1. **Money** - To pay for purchases and store wealth - Things people use to buy goods and services. 2. **Financial Instruments** - To transfer resources from savers to investors and to transfer risk to those best equipped to bear it. - Stocks: Buying a piece of a company, if the company does well, the value of your stock may go up. - Bonds: Lending money to a company, they agree to pay you back with interest. - Derivatives: More complex, get tools that help people manage risks (e.g., stocks, bonds, commodities, foreign exchange). 3. **Financial Markets** - To buy and sell financial instruments. - A marketplace where money and investments are exchanged. - **Stock market**: People buy and sell shares of companies. - **Bond market**: People buy and sell loans from companies or governments. - **Foreign exchange market**: People trade different currencies (FOREX). - **Commodities markets**: Oil and gold. 4. **Financial Institutions** - To provide access to financial markets, collect information, and provide services. - Banks began as vaults, developed into institutions that accepted deposits and gave loans, and evolved to today’s financial supermarket. - **Banks**: - Accept deposits - Give loans 5. **Government Regulatory Agencies** - Make sure the elements of the financial system operate safely and reliably. - Were introduced by the federal government after the Great Depression. - Provide wide-ranging financial regulation, rules, and supervision; and examine the systems a bank uses to manage its risk. - The 2007-2009 financial crises has led governments to greater regulation, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act 6. **Central Banks** - They monitor and stabilize the financial system. - Began as large private banks to finance wars. - Control the availability of money and credit to promote low inflation, high growth, and stability of the financial system. - Today’s policymakers strive for transparency in their operations. - The financial crisis of 2007-2009 has lead the U.S. central bank to try many new policy tools. ## Six Parts of the Financial System 1. **Financial Instruments** - Transfers resources from savers to investors. - Buying and selling individual stocks used to be only for the wealthy. - Today, we have mutual funds and other stocks available through banks or online. - Putting together a portfolio is open to everyone. ## Six Parts of the Financial System 1. **Financial Markets** - Allow the buying and selling of financial instruments easily. - Went from being in coffee houses and taverns to well-organized markets like the New York Stock Exchange. - Now transactions are mostly handled by electronic markets. - This has reduced the cost of processing financial transactions, making the way for a much broader array of financial instruments available. ## Five Core Principles of Money and Banking 1. Time has value. 2. Risk requires compensation. 3. Information is the basis for decisions. 4. Markets determine prices and allocation resources. 5. Stability improves welfare. ## Five Core Principles of Money and Banking 1. Time has value. 2. Risk requires compensation. 3. Information is the basis for decisions. 4. Markets determine prices and allocation resources. 5. Stability improves welfare. ## Five Core Principles of Money and Banking **Core Principle 3**: Information is the basis for decisions. - The more important the decision, the more information we gather. - Collection and processing of information is the foundation of the financial system. ## Five Core Principles of Money and Banking **Core Principle 4**: Markets determine prices and allocate resources. - Markets are the core of the economic system. - Markets channel resources and minimize the cost of gathering information and making transactions. - In general, the better developed the financial markets, the faster the country will grow. ## Five Core Principles of Money and Banking **Core Principle 5**: Stability improves welfare. - A stable economy reduces risk and improves everyone’s welfare. - Financial instability in the autumn of 2008 triggered the worst global downturn since the Great Depression. - A stable economy grows faster than an unstable one. - One of the main roles of central banks is stabilizing the economy.