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FINANCIAL INSTITUTIONS:The structure of the financial industry

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TIME VALUE OF MONEY:Future Value, Present Value >>
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Money & Banking ­ MGT411
VU
Lesson 7
FINANCIAL INSTITUTIONS
Financial Institutions
Structure of Financial Industry
Time Value of Money
Financial Institutions
Financial institutions are the firms that provide access to the financial markets;
They sit between savers and borrowers and so are known as financial intermediaries.
Banks, insurance companies, securities firms and pension funds
A system without financial institutions would not work very well for three reasons
Individual transactions between saver-lenders and borrower-spenders would be extremely
expensive.
Lenders need to evaluate the creditworthiness of borrowers and then monitor them, and
individuals are not equipped to do this.
Most borrowers want to borrow long term, while lenders favor short-term loans
Role of Financial Institutions
Reduce transactions cost by specializing in the issuance of standardized securities
Reduce information costs of screening and monitoring borrowers.
Curb information asymmetries, helping to ensure that resources flow into their most productive
uses
Make long-term loans but allow savers ready access to their funds.
Provide savers with financial instruments (more liquid and less risky than the individual stocks
and bonds) that savers would purchase directly in financial markets
Figure: Flow of funds through Financial Institutions: Access to Financial Markets
Financial Institutions
Bonds & Stocks
Bonds & SStcks s
nds & toock
that act as Brokers
Funds
Funds
s
Borooroers/rS/Spends rs
Br rw we spendere
Lenders/Savers
(Primarily Governments
(Primarily
and Firms)
(Primarily Households)
Governments and
Loans, Bonds,
Stocks and
Real Estate
Financial Institutions
Financial Institutions
that transform assets
Funds
that transform assets
Deposits & Insurance
Funds
Policies
Indirect Finance
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Money & Banking ­ MGT411
VU
The simplified Balance Sheet of a Financial Institution
Assets
Liabilities
Bonds
Deposits
Stocks
Insurance policies
Loans
Real estate
The structure of the financial industry
The structure of the financial industry:
Financial institutions or intermediaries can be divided into two broad categories
Depository institutions - take deposits and make loans.
(Commercial banks, savings banks, and credit unions)
Nondepository institutions
Insurance companies, securities firms, mutual fund companies, finance companies, and pension
funds
Insurance companies
Accept premiums, which they invest in securities and real estate in return for promising
compensation to policyholders should certain events occurs (like death, property losses, etc.)
Pension funds
Invest individual and company contributions into stocks, bonds and real estate in order to
provide payments to retired workers.
Securities firms
They include brokers, investment banks, and mutual fund companies
Brokers and investment banks issue stocks and bonds to corporate customers, trade them, and
advise clients.
Mutual fund companies pool the resources of individuals and companies and invest them in
portfolios of bonds, stocks, and real estate.
Government Sponsored Enterprises:
Federal credit agencies that provide loans directly for farmers and home mortgages, as well as
guarantee programs that insure the loans made by private lenders.
HBFC, ZTBL, Khushhali bank, SME Bank
The government also provides retirement income and medical care to the elderly (and disabled)
through Social Security and Medicare.
Finance Companies:
Raise funds directly in the financial markets in order to make loans to individuals and firms.
The monetary aggregates are made up of liabilities of commercial banks, so clearly the financial
structure is tied to the availability of money and credit.
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Table of Contents:
  1. TEXT AND REFERENCE MATERIAL & FIVE PARTS OF THE FINANCIAL SYSTEM
  2. FIVE CORE PRINCIPLES OF MONEY AND BANKING:Time has Value
  3. MONEY & THE PAYMENT SYSTEM:Distinctions among Money, Wealth, and Income
  4. OTHER FORMS OF PAYMENTS:Electronic Funds Transfer, E-money
  5. FINANCIAL INTERMEDIARIES:Indirect Finance, Financial and Economic Development
  6. FINANCIAL INSTRUMENTS & FINANCIAL MARKETS:Primarily Stores of Value
  7. FINANCIAL INSTITUTIONS:The structure of the financial industry
  8. TIME VALUE OF MONEY:Future Value, Present Value
  9. APPLICATION OF PRESENT VALUE CONCEPTS:Compound Annual Rates
  10. BOND PRICING & RISK:Valuing the Principal Payment, Risk
  11. MEASURING RISK:Variance, Standard Deviation, Value at Risk, Risk Aversion
  12. EVALUATING RISK:Deciding if a risk is worth taking, Sources of Risk
  13. BONDS & BONDS PRICING:Zero-Coupon Bonds, Fixed Payment Loans
  14. YIELD TO MATURIRY:Current Yield, Holding Period Returns
  15. SHIFTS IN EQUILIBRIUM IN THE BOND MARKET & RISK
  16. BONDS & SOURCES OF BOND RISK:Inflation Risk, Bond Ratings
  17. TAX EFFECT & TERM STRUCTURE OF INTEREST RATE:Expectations Hypothesis
  18. THE LIQUIDITY PREMIUM THEORY:Essential Characteristics of Common Stock
  19. VALUING STOCKS:Fundamental Value and the Dividend-Discount Model
  20. RISK AND VALUE OF STOCKS:The Theory of Efficient Markets
  21. ROLE OF FINANCIAL INTERMEDIARIES:Pooling Savings
  22. ROLE OF FINANCIAL INTERMEDIARIES (CONTINUED):Providing Liquidity
  23. BANKING:The Balance Sheet of Commercial Banks, Assets: Uses of Funds
  24. BALANCE SHEET OF COMMERCIAL BANKS:Bank Capital and Profitability
  25. BANK RISK:Liquidity Risk, Credit Risk, Interest-Rate Risk
  26. INTEREST RATE RISK:Trading Risk, Other Risks, The Globalization of Banking
  27. NON- DEPOSITORY INSTITUTIONS:Insurance Companies, Securities Firms
  28. SECURITIES FIRMS (Continued):Finance Companies, Banking Crisis
  29. THE GOVERNMENT SAFETY NET:Supervision and Examination
  30. THE GOVERNMENT'S BANK:The Bankers' Bank, Low, Stable Inflation
  31. LOW, STABLE INFLATION:High, Stable Real Growth
  32. MEETING THE CHALLENGE: CREATING A SUCCESSFUL CENTRAL BANK
  33. THE MONETARY BASE:Changing the Size and Composition of the Balance Sheet
  34. DEPOSIT CREATION IN A SINGLE BANK:Types of Reserves
  35. MONEY MULTIPLIER:The Quantity of Money (M) Depends on
  36. TARGET FEDERAL FUNDS RATE AND OPEN MARKET OPERATION
  37. WHY DO WE CARE ABOUT MONETARY AGGREGATES?The Facts about Velocity
  38. THE FACTS ABOUT VELOCITY:Money Growth + Velocity Growth = Inflation + Real Growth
  39. THE PORTFOLIO DEMAND FOR MONEY:Output and Inflation in the Long Run
  40. MONEY GROWTH, INFLATION, AND AGGREGATE DEMAND
  41. DERIVING THE MONETARY POLICY REACTION CURVE
  42. THE AGGREGATE DEMAND CURVE:Shifting the Aggregate Demand Curve
  43. THE AGGREGATE SUPPLY CURVE:Inflation Shocks
  44. EQUILIBRIUM AND THE DETERMINATION OF OUTPUT AND INFLATION
  45. SHIFTS IN POTENTIAL OUTPUT AND REAL BUSINESS CYCLE THEORY