FHF McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

part CHAPTER 15 Money and the Financial System 6 FHF 15-2 CHAPTER 14 Accounting and Financial Statements CHAPTER 16 Financial Management and Securities Markets

FHF FinanceFinance  The study of money—how it’s made, how it’s lost and how it’s managed Money  Anything generally accepted in exchange for goods and services  Many materials have been used as money 15-3

FHF Functions of Money  Medium of exchange Accepted as payment for products and resources Bartering: Trading one good or service for another of similar value  Inefficient because not always divisible and can be complicated in multiple-party transactions  Measure of value Single standard for assigning and comparing values of products and resources  Store of value Means of retaining and accumulating wealth 15-4

FHF Characteristics of Money  Acceptability  Divisibility  Portability  Stability  Durability  Difficulty to counterfeit 15-5

FHF Types of Money  Paper Money and Coins  Checking Account (Demand Deposit): Money stored in an account at a bank that can be withdrawn without advance notice Checks serve as a more secure substitute for cash  Savings Account (Time Deposit) : Accounts with funds that usually cannot be withdrawn without advance notice 15-6 …continued on next page

FHF Types of Money Money Market Account  Higher interest rates than standard bank rates with greater restrictions Certificates of Deposit (CDs)  Savings accounts that guarantee a set interest rate over a period of time providing funds are not withdrawn before maturity 15-7 …continued on next page

FHF Types of Money Credit Cards  Means of access to preapproved lines of credit granted by a bank or a finance company  Credit card companies have been the subject of criticism and scrutiny  Credit CARD (Card Accountability Responsibility and Disclosure) Act was passed into law in 2009 Credit CARD (Card Accountability Responsibility and Disclosure) Act Important for all card holders 15-8 …continued on next page

FHF Types of Money Debit Card  A card that looks like a credit card but works like a check  A direct electronic payment from the cardholder’s checking account Traveler’s Checks, Money Orders, Cashier’s Checks  Other common forms of “near” money  Guaranteed as cash 15-9

FHF The U.S. Financial System Federal Reserve Board (The Fed)  Guardian of the American financial system  Independent agency of the federal government  Established in 1913 to regulate the nation’s banking and financial industry 15-10

FHF The Federal Reserve System 15-11

FHF The Fed Four major functions : 1. Controls the money supply with monetary policy 2. Regulates financial institutions 3. Manages regional and national check-clearing procedures 4. Supervises the federal deposit insurance of commercial banks in the Federal Reserve system 15-12

FHF Monetary Policies Monetary Policy  The means by which the Fed controls the amount of money available in the economy  Aims to keep supply and demand in balance to avoid inflation/deflation 15-13

FHF Four Main Monetary Policy Tools 1. Open Market Operations : Decisions to buy or sell U.S. Treasury bills in the open market  Buying securities increases money in supply and vice versa 2. Reserve Requirements : Percentage of deposits a bank must hold in reserve  Has a strong effect on the economy and not used often 3. Discount Rate : Rate of interest the Fed charges to loan money to banking institutions  Lowering discount rate encourages borrowing and expands money supply and vice versa 4. Credit Controls : Authority to establish and enforce credit rules 15-14

FHF Other Regulatory Functions of the Fed Regulating member banks  Establishes and enforces banking rules that affect monetary policy and competition  Has authority to approve bank mergers Check clearing  National check processing through check clearinghouses Depository insurance  Supervises the federal insurance funds that protect the deposits in member banking institutions 15-15

FHF Tools for Regulating the Money Supply 15-16

FHF Financial Crisis The Fed used every tool in its arsenal  Reduced discount rate to almost zero  Increased money supply  Bought and sold financial assets in nearly frozen markets  Created liquidity for failing financial institutions that could not sell their assets  Guaranteed loans to improve credit markets  All those moves did not guarantee a quick recovery 15-17

FHF Banking Institutions Commercial Banks  Largest and oldest of all financial institutions, relying mainly on checking and savings accounts  Loan to businesses and individuals Savings and Loan Associations (S&Ls– also called “thrifts”)  Primarily offer savings accounts and make long-term loans for residential mortgages  Most have merged with commercial banks  New hybrid bank institutions perform multiple functions …continued on next page

FHF Banking Institutions Credit Unions  Financial institutions owned and controlled by depositors  Usually having a common employer, profession, trade group, or religion Mutual Savings Banks  Similar to S&Ls, but owned by depositors  Found mostly in New England 15-19

FHF Insurance for Banks Federal Deposit Insurance Corporation (FDIC)  Insures personal accounts up to $250,000 National Credit Union Association (NCUA)  Regulates and charters credit unions  Insures deposits through its National Credit Union Insurance Fund  Similar to the FDIC 15-20

FHF Bank Failures  Nearly 300 banks have failed since 2008; hundreds more are at riskfailed Washington Mutual Ameribank Indymac Bank  Consumers’ money protected by FDIC 15-21

FHF Non-Banking Institutions  Diversified Firms: Traditionally non-financial firms that have expanded into the financial field  Insurance Companies : Businesses that protect their clients against losses from specified risks  Pension Funds : Managed investment pools to provide retirement income for members …continued on next page

FHF Non-Banking Institutions  Mutual Fund : Investment company that pools investor money and invests in large numbers of diversified securities  Brokerage Firm : Buy and sell securities for clients and provide other services  Investment Bank : Underwrites new issues of securities for corporations, states and municipalities needed to raise money in capital markets  Finance Companies : Businesses that offer short-term loans at substantially higher interest rates than banks 15-23

FHF  One of the most important secondary home mortgage lenders in the U.S. Created to relieve lenders of debt so they can lend more money  Provides many banks with capital  Has experienced major accounting scandals  Was placed in a conservatorship of the Federal Housing Finance Authority  Failure would have meant partial collapse of the house mortgage market 15-24

FHF Electronic Banking  ETF : Electronic funds transfer  ATM : Automated teller machines  ACH s: Automated clearinghouses  Online Banking : Bank at home or anywhere/anytime ( Increasing the range of services) 15-25

FHF Future of Banking  Advances in technology are challenging and changing the banking industry  Trend toward larger banks, even in the wake of financial crisis Uncertain whether the crisis will continue  Future of the banking industry will be shaped by federal government action Oversight and regulations to prevent future financial meltdowns 15-26