1. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 3 Overview of the Financial System

2. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-2 Purpose of the Financial System Provides channels to transfer funds from savers to borrowers. Savers are suppliers of funds. Borrowers are demanders of funds. Financial markets issue claims on borrowers directly to savers. Financial intermediaries act as go-betweens by holding a portfolio of assets and issuing claims to savers.

3. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-3 Figure 3.1 Moving Funds Through the Financial System

4. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-4 Figure 3.2 Key Services Provided by the Financial System

5. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-5 Key Services Provided by the Financial System Risk sharing by allowing savers to hold many assets Liquidity, which is the ease with which an asset can be exchanged for money Information about borrowers and returns on financial assets

6. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-6 Financial Markets Primary markets are those in which newly issued claims are sold to initial buyers. Secondary markets are those in which previously issued claims are resold. Risk-sharing, liquidity, and information services are provided in secondary markets.

7. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-7 Types of Secondary Financial Markets Maturity: money and capital markets Trading places: auction and over-the-counter markets Settlement: cash or derivative

8. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-8 Financial Intermediaries’ Tasks Match savers and borrowers Provide risk-sharing, liquidity, and information services

9. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-9 Competition and Change Financial innovation results from change. Ease of communicating information has allowed for greater financial integration.

10. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-10 Goals of Financial Regulation Provision of information Maintenance of financial stability Controlling the money supply Encouraging particular activities (like home ownership) Regulation affects the ability of financial markets and institutions to provide risk- sharing, liquidity, and information services, as seen in Table 3.1

11. Copyright © 2008 Pearson Addison-Wesley. All rights reserved. 3-11 Table 3.1 Regulation of Financial Institutions and Markets in the United States