1. Chapter 2: The Financial System
Objective
Understanding the workings of
the financial system
Determining rates
of return
Copyright © Prentice Hall Inc Author: Nick Bagley, bdellaSoft, Inc.

2. Chapter 2 Contents 1 What is a Financial System 2 The Flow of Funds
3 The Functional Perspective
4 Financial Innovation & the “Invisible Hand”
5 Financial Markets
6 Financial Market Rates
7 Financial Intermediaries
8 Financial Infrastructure and Regulation
9 Governmental & Quasi- Governmental Organizations

3. The Flow of Funds Diagram
Markets
Surplus Units
Deficit Units
Intermediaries

4. Fund Flows via Market Markets Surplus Units Deficit Units
Intermediaries

5. Fund Flows via Intermediary
Markets
Surplus Units
Deficit Units
Intermediaries

6. Fund Flows via Intermediary and Market
Markets
Surplus Units
Deficit Units
Intermediaries

7. Funds Flow via Markets and Intermediaries
Surplus Units
Deficit Units
Intermediaries

8. Funds Flow: Disintermediation
Markets
Markets
Surplus Units
Surplus Units
Deficit Units
Deficit Units
Intermediaries
Intermediaries

9. Funds Flow: Secured Credit
Markets
Poor Credit Risk
Surplus Units
Deficit Units
Intermediaries

10. Six Key Financial Functions:
Transferring Resources Across Time & Space
Managing Risk
Clearing and Settling Payments
Pooling Resources and Subdividing Shares
Providing Information
Dealing with Incentive Problems

11. Exchange Rate Example Japan U.K. Time 150 ¥/£ 9%£/£ 140 ¥/£ 15000 ¥
£100
3% ¥/¥ (direct)
1.73% ¥/£/£/¥
9%£/£
140 ¥/£
£109
15260 ¥
15450 ¥

12. Exchange Rate Example Japan U.K. Time 150 ¥/£ 9%£/£ 149 ¥/£ 15000 ¥
£100
3% ¥/¥ (direct)
8.27% ¥/£/£/¥
9%£/£
149 ¥/£
£109
16241 ¥
15450 ¥

13. Exchange Rate Example Japan U.K. Time 150 ¥/£ 9%£/£ Forward ¥/£
15000 ¥
(borrowed)
£100
Invested
3% ¥/¥ (direct)
3% ¥/£/£/¥
9%£/£
Forward ¥/£
£109
Matures
15450 ¥
Repaid

15. Yield Comparisons

16. Computation of Return

20. Nominal to Real