1. US and Global Financial Institutions
Financial Systems Overview 101

2. Lesson Overview Economic System System Basics Banking Security Markets
Banking System Basics
Impacts on Money Creation
Impacts on Capital Flows in the Intl. Economy
Security Markets
Security Mkt Basics
Impacts on the Intl. Economy
Currency Exchanges
Currency Exchange Basics
Impact on the Intl. Economy

3. Economics
Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets.
Prices and selection of products
Macroeconomics is the study of the economy as a whole. Its goal is to explain the economic changes that affect many households, firms, and markets at once.
Inflation
Unemployment
Economic Growth

4. The Circular-Flow Diagram
The Circular-Flow Diagram: a visual model of the economy, shows how dollars flow through markets among households and firms
Two types of “actors”:
households
firms
Two markets:
the market for goods and services
the market for “factors of production”
THINKING LIKE AN ECONOMIST 4

5. FIGURE 1: The Circular-Flow Diagram
Households:
Own the factors of production, sell/rent them to firms for income
Buy and consume goods & services
Firms
Households
Firms:
Buy/hire factors of production, use them to produce goods and services
Sell goods & services
This and the following slide build the Circular-Flow Diagram piece by piece.
THINKING LIKE AN ECONOMIST 5

6. The Circular-Flow Diagram: Economic System Model
Revenue
Markets for Goods & Services
Spending
G & S sold
G & S bought
Firms
Households
Wages, rent, profit
Factors of production
Income
Labor, land, capital
In this diagram, the green arrows represent flows of income/payments. The red arrows represent flows of goods & services (including services of the factors of production in the lower half of the diagram).
To keep the graph simple, we have omitted the government, financial system, and foreign sector, as discussed on the next slide.
You may wish to change the order in which the elements appear. To do so, look for “Custom Animation” in your version of PowerPoint.
Markets for Factors of Production
THINKING LIKE AN ECONOMIST 6

7. Circular Flow Issues Doesn’t account for… Taxes Intl. Trade
Circular Flow Issues
Doesn’t account for…
Taxes
Intl. Trade
Intl. Monetary Flows
Demand comes from the behavior of buyers.
THE MARKET FORCES OF SUPPLY AND DEMAND 7

8. Financial System
…the group of institutions in the economy that help to match one person’s savings with another person’s investment.
Financial Markets: Direct match between savers and borrowers
ie. Stock and bond markets
Financial Intermediaries: Indirectly match savers and borrowers
ie. banks and mutual funds,
Demand comes from the behavior of buyers.
THE MARKET FORCES OF SUPPLY AND DEMAND 8

9. Banking System How does a bank work? Where does money come from?
Banking System
How does a bank work?
Where does money come from?
Where does it go?
Demand comes from the behavior of buyers.
THE MARKET FORCES OF SUPPLY AND DEMAND 9

11. Banking Money Creation with Fractional-Reserve
This T-Account shows a bank that…
accepts deposits,
keeps a portion as reserves,
and lends out the rest.
It assumes a reserve ratio of 10%.
Assets
Liabilities
First National Bank
Reserves
$10.00
Loans
$90.00
Deposits
$100.00
Total Assets
Total Liabilities

12. Increase in the Money Supply = $190.00!
The Money Multiplier
Increase in the Money Supply = $190.00!
Assets
Liabilities
First National Bank
Reserves
$10.00
Loans
$90.00
Deposits
$100.00
Total Assets
Total Liabilities
Second National Bank
$9.00
$81.00

13. THE MARKET FOR LOANABLE FUNDS
Financial markets coordinate the economy’s saving and investment in the market for loanable funds.
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds.

14. Supply and Demand for Loanable Funds
Loanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.
The supply of loanable funds comes from people who have extra income they want to save and lend out.
The demand for loanable funds comes from households and firms that wish to borrow to make investments.

15. Supply and Demand for Loanable Funds
Interest rate
the price of the loan
the amount that borrowers pay for loans and the amount that lenders receive on their saving
in the market for loanable funds, the real interest rate

16. Supply and Demand for Loanable Funds
Financial markets work much like other markets in the economy.
The equilibrium of the supply and demand for loanable funds determines the real interest rate.

17. Figure 1 The Market for Loanable Funds
Interest
Rate
Supply
Demand 5%
$1,200
Loanable Funds
(in billions of dollars)

18. Intl. Capital Flows

19. Open-Economy Macroeconomics: Basic Concepts
An open economy interacts with other countries in two ways.
It buys and sells goods and services in world product markets.
It buys and sells capital assets in world financial markets.

20. The Flow of Financial Resources: Net Capital Outflow
Net capital outflow refers to the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.
A U.S. resident buys stock in the Toyota corporation and a Mexican buys stock in the Ford Motor corporation.

21. The Flow of Financial Resources: Net Capital Outflow
When a U.S. resident buys stock in Telmex, the Mexican phone company, the purchase raises U.S. net capital outflow.
When a Japanese residents buys a bond issued by the U.S. government, the purchase reduces the U.S. net capital outflow.

22. The Flow of Financial Resources: Net Capital Outflow
Variables that Influence Net Capital Outflow
The real interest rates being paid on foreign assets.
The real interest rates being paid on domestic assets.
The perceived economic and political risks of holding assets abroad.
The government policies that affect foreign ownership of domestic assets.

23. Figure 3 How Net Capital Outflow Depends on the Interest Rate
Real
Interest
Rate
Net capital outflow
is negative.
Net capital outflow
is positive.
Net Capital
Outflow

24. World Financial Centers - Securities

25. Financial Markets The Stock Market
Stock represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes.
The sale of stock to raise money is called equity financing.
Compared to bonds, stocks offer both higher risk and potentially higher returns.
The most important stock exchanges in the United States are the New York Stock Exchange, the American Stock Exchange, and NASDAQ.
What about the primary Korean markets?

26. Financial Markets The Stock Market
Most newspaper stock tables provide the following information:
Price (of a share)
Volume (number of shares sold)
Dividend (profits paid to stockholders)
Price-earnings ratio

27. Financial Markets
Reading the stock page…

28. Financial Markets Columns 1&2 52-Week Hi-Lo Range
Column 3  Company Name and Type of Stock:  If there are no special symbols or letters following the company name, it is common stock (shares without a fixed rate of return of investment.) Other types of stock are “pf“ or preferred, etc.
Column 4  Ticker symbol: This alphabetic symbol is a unique stock identifier.
Column 5  Dividend Payment: This indicates the annual dividend payment per share.
Column 6  Percent Yield:  This figure represents the dividend return an investor can expect on each share of stock.  It is calculated by dividing the annual dividend each share pays by its current market value, and is expressed as a percentage.
Column 7  Price-Earnings Ratio (PE):  This calculation is one way of evaluating a stock's relative performance and value.  It is computed by dividing the stock's price by the company's per-share earnings for the most recent four quarters.  Higher Price-Earnings multiples suggest the investors are more optimistic about a stock's prospects than comparable lower-PE stocks, but the reason for high and low PEs also include the company's growth outlook, the industry the company is engaged in, company accounting policies, and whether the firm is a startup or a more established business.
Column 8  Trading Volume:  This figure shows a total number of shares traded for the day, listed in hundreds. 
Column 9  Hi/Lo:  This indicates the trading price range of the security during the day's trading. 
Column 10  Close and Net Change: 

29. Financial Markets The Bond Market
A bond is a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond.
Characteristics of a Bond
Term: The length of time until the bond matures.
Credit Risk: The probability that the borrower will fail to pay some of the interest or principal.
Tax Treatment: The way in which the tax laws treat the interest on the bond.
Bonds can be from companies (private/public) or the government (local-municipal, regional, provincial or national) levels
Municipal bonds are federal tax exempt.

30. World Trade Flows

31. The Flow of Goods: Exports, Imports, Net Exports
Net exports (NX) are the value of a nation’s exports minus the value of its imports.
Net exports are also called the trade balance.

32. The Flow of Goods: Exports, Imports, Net Exports
Factors That Affect Net Exports
The tastes of consumers for domestic and foreign goods.
The prices of goods at home and abroad.
The exchange rates at which people can use domestic currency to buy foreign currencies.

33. The Flow of Goods: Exports, Imports, Net Exports
Factors That Affect Net Exports
The incomes of consumers at home and abroad.
The costs of transporting goods from country to country.
The policies of the government toward international trade.

34. The Equality of Net Exports and Net Capital Outflow
For an economy as a whole, NX and NCO must balance each other so that:
NCO = NX
Why?
When a nation is running a trade surplus (NX>0), it is selling more goods/services to foreigners than it is buying. What is it doing with the foreign currency received? Must be buying foreign assets. Capital is flowing out of the country (NCO>0).
When a nation is running a trade deficit (NX<0), it is buying more goods and services from foreigners than it is selling. How is it financing the purchase? It must be selling assets abroad. Capital is flowing into the country (NCO<0).

35. International transactions are influenced by international prices.
THE PRICES FOR INTERNATIONAL TRANSACTIONS: REAL AND NOMINAL EXCHANGE RATES
International transactions are influenced by international prices.
The two most important international prices are the nominal exchange rate and the real exchange rate.

36. Nominal Exchange Rates
The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.

37. Real Exchange Rates
The real exchange rate is the rate at which a person can trade the goods and services of one country for the goods and services of another.

38. Figure 1 The Market for Loanable Funds
Real
Interest
Rate
Supply of loanable funds
(from national saving)
Demand for loanable
funds (for domestic
investment and net
capital outflow)
Equilibrium
quantity
real interest
rate
Quantity of
Loanable Funds

39. The Market for Foreign-Currency Exchange
Real
Exchange
Rate
Supply of dollars
(from net capital outflow)
Demand for dollars
(for net exports)
Equilibrium
quantity
real exchange
rate
Why does demand slope downward? Why is the Equil. Qty vertical?
Quantity of Dollars Exchanged
into Foreign Currency

40. The Effects of Government Budget Deficit
1. A budget deficit reduces
the supply of loanable funds . . .
(a) The Market for Loanable Funds
(b) Net Capital Outflow
Real
Real
Interest S S
Interest
Rate
Rate r2 B r2 E1 r A
which
increases
the real
interest
rate . . .
which in
turn reduces
net capital
outflow.
Demand
NCO
Quantity of
Net Capital
Loanable Funds
Outflow
Real
Exchange S S
Rate
4. The decrease
in net capital
outflow reduces
the supply of dollars
to be exchanged
into foreign
currency . . . E2
which
causes the
real exchange
rate to
appreciate.
Demand
Quantity of
Dollars
(c) The Market for Foreign-Currency Exchange