us and global financial institutions financial systems overview 101
TRANSCRIPT
US and Global Financial Institutions
Financial Systems Overview 101
2-2
Lesson OverviewEconomic System
• System Basics
Banking
• 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
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
THINKING LIKE AN ECONOMIST 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 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
Households: Own the factors of production,
sell/rent them to firms for income Buy and consume goods & services
HouseholdsFirms
Firms: Buy/hire factors of production,
use them to produce goods and services
Sell goods & services
Firms: Buy/hire factors of production,
use them to produce goods and services
Sell goods & services
THINKING LIKE AN ECONOMIST 6
The Circular-Flow Diagram: Economic System Model
Markets for Factors of Production
HouseholdsFirms
IncomeWages, rent, profit
Factors of production
Labor, land, capital
Spending
G & S bought
G & S sold
RevenueMarkets for
Goods & Services
THE MARKET FORCES OF SUPPLY AND DEMAND 7
Circular Flow Issues
• Doesn’t account for… Taxes Intl. Trade Intl. Monetary Flows
THE MARKET FORCES OF SUPPLY AND DEMAND 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,
THE MARKET FORCES OF SUPPLY AND DEMAND 9
Banking System
• How does a bank work?
• Where does money come from?
• Where does it go?
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$100.00
Total Liabilities$100.00
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$100.00
Total Liabilities$100.00
Assets Liabilities
Second National Bank
Reserves$9.00
Loans$81.00
Deposits$90.00
Total Assets$90.00
Total Liabilities$90.00
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.
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.
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
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.
Figure 1 The Market for Loanable Funds
Loanable Funds(in billions of dollars)
0
InterestRate Supply
Demand
5%
$1,200
Intl. Capital Flows
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.
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.
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.
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.
Figure 3 How Net Capital Outflow Depends on the Interest Rate
0 Net CapitalOutflow
Net capital outflowis negative.
Net capital outflowis positive.
RealInterest
Rate
World Financial Centers - Securities
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?
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
Financial Markets
• Reading the stock page…
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:
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.
World Trade Flows
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.
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.
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.
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).
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.
• The nominal exchange rate is the rate at which a person can trade the currency of one country for the currency of another.
Nominal Exchange Rates
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.
Figure 1 The Market for Loanable Funds
Quantity ofLoanable Funds
RealInterest
RateSupply of loanable funds
(from national saving)
Demand for loanablefunds (for domesticinvestment and net
capital outflow)
Equilibriumquantity
Equilibriumreal interest
rate
The Market for Foreign-Currency Exchange
Quantity of Dollars Exchangedinto Foreign Currency
RealExchange
RateSupply of dollars
(from net capital outflow)
Demand for dollars(for net exports)
Equilibriumquantity
Equilibriumreal exchange
rate
Why does demand slope downward? Why is the Equil. Qty vertical?
The Effects of Government Budget Deficit
(a) The Market for Loanable Funds (b) Net Capital Outflow
RealInterest
Rate
RealInterest
Rate
(c) The Market for Foreign-Currency Exchange
Quantity ofDollars
Quantity ofLoanable Funds
Net CapitalOutflow
RealExchange
Rate
Demand
Demand
r2
NCO
SS
S S
r2
B
E1
r rA
1. A budget deficit reducesthe supply of loanable funds . . .
2. . . . which increasesthe real interestrate . . .
4. The decreasein net capitaloutflow reducesthe supply of dollarsto be exchangedinto foreigncurrency . . .
5. . . . which causes thereal exchange rate toappreciate.
3. . . . which inturn reducesnet capitaloutflow.
E2