Chapter 1 The Financial Environment © 2003 John Wiley and Sons

2 Chapter Outcomes n Define what is meant by finance n Explain why finance should be studied n Describe the basic requirements of an effective financial system n Identify the major financial institutions and their roles in the financial system

3 Chapter Outcomes (Continued) n Describe the four types of financial markets n Identify major types of securities traded in the securities markets n Describe the financial functions performed in the U.S. financial system n Identify and discuss some career opportunities in finance

4 What is Finance? n FINANCIAL ENVIRONMENT: Encompasses the financial system, institutions, markets, and individuals that make the economy operate efficiently n FINANCE: Study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial assets

5 Three Areas of Finance nInInstitutions and Markets nInInvestments nFnFinancial Management [Note: These areas do not operate in isolation but rather interact or intersect with each other. ]

6 Finance Area Definitions nFnFINANCIAL INSTITUTIONS: Help the financial system operate efficiently and transfer funds from savers to investors nFnFINANCIAL MARKETS: Physical locations or electronic forums that facilitate the flow of funds

7 Finance Area Definitions (Continued) nInINVESTMENTS: Area involves sale or marketing of securities, analysis of securities, and management of investment risk nFnFINANCIAL MANAGEMENT: Involves financial planning, asset management, and fund raising decisions to enhance firm value

8 Two Themes within the Finance Topic nEnENTREPRENEURIAL FINANCE: Study of how growth-driven, performance- focused, early-stage firms raise funds and manage operations and assets nPnPERSONAL FINANCE: Study of how individuals prepare for financial emergencies, protect against premature death and the loss of property, and accumulate wealth

9 Why Study Finance? n You should want to make informed economic decisions n You should want to acquire a basic knowledge of investments for business and personal reasons n You should want a basic under- standing of financial management for career or professional enhancement reasons

10 Overview of the Financial System n POLICY MAKERS President, Congress, & U.S. Treasury plus Federal Reserve Board n MONETARY SYSTEM Federal Reserve Central Bank plus Commercial Banking System n FINANCIAL INSTITUTIONS n FINANCIAL MARKETS

11 Roles within the Financial System n POLICY MAKERS: Pass laws & set fiscal & monetary policies n MONETARY SYSTEM: Create & transfer money n FINANCIAL INSTITUTIONS: Accumulate & lend/invest savings n FINANCIAL MARKETS: Market & facilitate transfer of financial assets

12 Types of Financial Institutions n DEPOSITORY INSTITUTIONS n CONTRACTUAL SAVINGS ORGANIZATIONS n SECURITIES FIRMS n FINANCE FIRMS [Note: “financial intermediation” is the process by which individual savings are accumulated in financial institutions and, in turn, lent or invested.]

13 Specific Examples of Financial Institutions n DEPOSITORY INSTITUTIONS Commercial Banks Savings and Loan Associations Savings Banks Credit Unions n CONTRACTUAL SAVINGS FIRMS Insurance Companies Pension Funds

14 Additional Institutions n SECURITIES FIRMS Investment Companies (Mutual Funds) Investment Banking Firms Brokerage Firms n FINANCE FIRMS Finance Companies Mortgage Banking Firms

15 Primary Sources of Funds for Institutions nDnDepository Institutions & Mutual Funds Primary source: individual savings nInInsurance Companies Primary source: policy premiums nPnPension Funds Primary source: employee/employer contributions nInInvestment Banking, Brokerage, Mortgage Banking, & Finance Firms receive their funds from other institutions

16 Types of Financial Markets n SECURITIES MARKETS n MORTGAGE MARKETS n DERIVATIVES MARKETS n CURRENCY MARKETS

17 Basic Securities Markets Definitions n SECURITIES MARKETS: Physical locations or electronic forums where debt and equity securities are sold and traded n PRIMARY SECURITIES MARKETS: Where the initial offering of debt and equity securities to the public occurs n SECONDARY SECURITIES MARKETS: Where the transfer of existing debt and equity securities between investors occurs

18 Other Financial Markets n MORTGAGE MARKETS: Where mortgage loans, backed by buildings and houses, are originated and sometimes trade n DERIVATIVES MARKETS: Facilitate purchase and sale of derivative securities that derive their values from underlying securities n CURRENCY EXCHANGE MARKETS: Electronic markets where banks & institutional traders buy & sell various currencies

19 Types of Assets n REAL ASSETS: include direct ownership of land, buildings or homes, equipment, inventories, and precious metals n FINANCIAL ASSETS or CLAIMS: debt instruments, equity securities, and other financial contracts that are backed by real assets

20 Types Of Secondary Securities Markets n MONEY MARKETS: where debt instruments of one year or less are traded n CAPITAL MARKETS: markets for debt securities with maturities longer than one year and corporate stocks

21 Types Of Money Market Securities Security: Issuer: n Treasury bills U.S. government n Negotiable certifi- Commercial banks cates of deposit (CDs) n Commercial paper Corporations

22 Types of Capital Market Securities Security: Issuer: n Treasury bondsU.S. government n Municipal bondsState/local governments n Corporate bondsCorporations n Corporate stocksCorporations

23 International Securities nEnEUROBOND bond denominated in U.S. dollars that is sold to investors located outside the United States nFnFOREIGN BOND bond issued by a corporation or government that is denominated in the currency of a foreign country where it is sold

24 Financial Functions in the U.S. Financial System n Creating money n Transferring money n Accumulating savings n Lending/investing savings n Marketing financial assets n Transferring financial assets

25 Career Opportunity Areas in Finance n Financial management n Depository financial institutions n Contractual savings and real property organizations n Securities markets and investment firms

26 Entry-Level Finance Positions Financial Management n Cash management analyst n Capital expenditures analyst n Credit analyst n Financial analyst n Cost analyst n Tax analyst

27 Entry-Level Finance Positions Depository Financial Institutions n Loan analyst n Bank teller n Investments research analyst

28 Entry-Level Finance Positions Contractual Savings and Real Property Organizations n Insurance agent (broker) n Research analyst n Real estate agent (broker) n Mortgage analyst

29 Entry-Level Finance Positions Securities Markets and Investment Firms n Stock broker (account executive) n Security analyst n Investment banking analyst n Financial planner assistant

30 Plan Of Study nPnPART 1: INSTITUTIONS AND MARKETS focuses on the financial institutions, markets, and other participants that make the U.S. financial system operate effectively nPnPART 2: INVESTMENTS focuses on the characteristics of stocks and bonds, how securities are valued, and the operations of securities markets

31 Plan of Study (Continued) nPnPART 3: FINANCIAL MANAGEMENT focuses on the financial planning, asset management, and fund raising activities that will enhance firm value