Lecture 1: Overview of the Financial System
Main components of financial system
Financial markets
Financial institutions and banking
Role of central banks and money
Financial institutions and banking: organisms that make financial markets work.
Central banks (Federal Reserve (US)) and monetary policy: ________ and
________ the operations of the financial markets and institutions, and the interest
rates
Financial Markets
Financial markets: venues where funds are transferred from people who have a
_______ of funds to people who have a ________.
Representative financial markets
Bond market and interest rates
•A ________ (financial instrument) is a claim on the issuer’s future
income or assets
•A bond is a ____ security that promises to make payments
____________ for a specified period of time
•An ____________ is the cost of borrowing or the price paid for the
rental of funds
The stock market
•Common stock represents a share of ________ in a corporation
•A share of stock is a claim on the ________ and ______ of the
corporation
Financial institutions and banking
Financial Intermediaries: institutions that borrow funds from people who have
saved and make loans to other people:
–Banks: accept _________ and make _____
–Other Financial Institutions: insurance companies, finance companies,
pension funds, mutual funds and investment banks
Financial Innovation: in particular, the advent of the ___________ age and e-
finance
Financial crises
Financial crises are major disruptions in financial markets that are
characterized by sharp declines in _____ prices and the failures of many
financial and nonfinancial firms.
Recent events: global financial crisis in 2008, Iceland and Ireland crises
in 2009, and Greece, Portugal, and Spain crises in 2010.
Role of money and central banks
Money and business cycles
Evidence suggests that _____ plays an important role in generating
business cycles
Recessions (unemployment) and expansions affect all of us
Monetary Theory ties changes in the ____________ to changes in
aggregate economic activity and the price level
Money and inflation
The aggregate price level is the average price of goods and services in
an economy
A continual rise in the price level (_______) affects all economic
players
Data shows a connection between the ____________ and the price
level
Money and interest rates
Interest rates are the _____ of money
Prior to 1980, the rate of ____________ and the interest rate on long-
term Treasury bonds were closely tied
Since then, the relationship is less clear but the rate of ____________
is still an important determinant of interest rates
Monetary and fiscal policy
Monetary policy is the management of the ____________ and
_____________
–Conducted in the U.S. by the Federal Reserve System (Fed)
Fiscal policy deals with government ________
and _________
–Budget deficit is the excess of ____________ over revenues for a
particular year
–Budget surplus is the excess of ________ over expenditures for a
particular year
–Any deficit must be financed by borrowing
The foreign exchange market
The foreign exchange market is where funds are converted from one
