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1Copyright ©2001 Prentice Hall, Inc.
Overview of FinanceOverview of Finance
What is finance?What is finance?
What are the major fields within finance?What are the major fields within finance?
What are typical jobs and career paths in finance? What are typical jobs and career paths in finance?
2Copyright ©2001 Prentice Hall, Inc.
What is Finance?What is Finance?
It’s the study of how to access and allocate a It’s the study of how to access and allocate a scarce resource, money.scarce resource, money.
Financial decisions are cost-benefit decisions that Financial decisions are cost-benefit decisions that involve RISK and TIMEinvolve RISK and TIME
3Copyright ©2001 Prentice Hall, Inc.
Why study finance? 5 ReasonsWhy study finance? 5 Reasons
1. To manage your personal resources1. To manage your personal resources ““A fool and his money…”A fool and his money…” You have decided to get a car. Lease or buy?You have decided to get a car. Lease or buy? You are choosing between several investment You are choosing between several investment
alternativesalternatives You are discussing mortgage alternatives with a You are discussing mortgage alternatives with a
banker.banker.
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Why study finance? 5 ReasonsWhy study finance? 5 Reasons
2. To deal with the world of business2. To deal with the world of business Few business decisions do not have a financial aspectFew business decisions do not have a financial aspect Need to know terminology, concepts, techniquesNeed to know terminology, concepts, techniques Do the revenue and cost forecasts justify the investment Do the revenue and cost forecasts justify the investment
of scarce resources into a major project?of scarce resources into a major project?
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Why study finance? 5 ReasonsWhy study finance? 5 Reasons
3. To pursue interesting and rewarding career 3. To pursue interesting and rewarding career opportunitiesopportunities
We will return to this one shortlyWe will return to this one shortly
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Why study finance? 5 ReasonsWhy study finance? 5 Reasons
4. To make informed public choices as a citizen4. To make informed public choices as a citizen Should you vote for a candidate who wants toShould you vote for a candidate who wants to
Privatize Social Security?Privatize Social Security? Declare a sales tax holiday in Massachusetts?Declare a sales tax holiday in Massachusetts? Allow businesses to provide less detail on financial Allow businesses to provide less detail on financial
statements?statements? Allow individuals to buy shares of stock with borrowed Allow individuals to buy shares of stock with borrowed
money?money?
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Why study finance? 5 ReasonsWhy study finance? 5 Reasons
5. It’s brain candy!5. It’s brain candy! Major branch of applied economicsMajor branch of applied economics Nobel PrizesNobel Prizes Helps foster understanding of why people, Helps foster understanding of why people,
corporations, and governments act the way they do corporations, and governments act the way they do
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Major Fields in FinanceMajor Fields in Finance
Corporate Financial ManagementCorporate Financial Management BankingBanking InvestmentsInvestments InsuranceInsurance Real EstateReal Estate
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Fields and Careers: Corporate Financial Fields and Careers: Corporate Financial ManagementManagement
Large corporations often have training programs which rotate key Large corporations often have training programs which rotate key employees through a variety of functional areas, including financeemployees through a variety of functional areas, including finance
Typical positions with significant finance content:Typical positions with significant finance content: Budget analystBudget analyst Accounts receivable managerAccounts receivable manager TreasurerTreasurer Investor relationsInvestor relations CFOCFO
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Fields and Careers: BankingFields and Careers: Banking
Banking has numerous subfields:Banking has numerous subfields: Retail bankingRetail banking
Branch manager, loan officerBranch manager, loan officer Commercial lendingCommercial lending
Financial analyst, loan officerFinancial analyst, loan officer Consumer creditConsumer credit
Customer service, credit scoring, financial advisingCustomer service, credit scoring, financial advising Mortgage bankingMortgage banking
Mortgage originator, mortgage brokerMortgage originator, mortgage broker
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Fields and Careers: InvestmentsFields and Careers: Investments
Investment management subfields:Investment management subfields: Securities brokerageSecurities brokerage
stockbrokerstockbroker Securities analysisSecurities analysis
equity analyst, bond analystequity analyst, bond analyst Portfolio managementPortfolio management
fund manager, trust advisor, pension fund managerfund manager, trust advisor, pension fund manager Financial planningFinancial planning
financial advisingfinancial advising Investment bankingInvestment banking
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Fields and Careers: InsuranceFields and Careers: Insurance
Insurance subfields:Insurance subfields:
Property and CasualtyProperty and Casualty LifeLife HealthHealth Risk ManagementRisk Management
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Fields and Careers: Real EstateFields and Careers: Real Estate
Real estate subfields:Real estate subfields: BrokerageBrokerage
Commercial, ResidentialCommercial, Residential
DevelopmentDevelopment Property managementProperty management Real Estate Investment Trust (REIT)Real Estate Investment Trust (REIT)
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OutlineOutline
The U.S. Financial SystemThe U.S. Financial System
The Functions of the Federal Reserve SystemThe Functions of the Federal Reserve System
15Copyright ©2001 Prentice Hall, Inc.
The U.S. Financial SystemThe U.S. Financial System
Technology has changed the U.S. financial Technology has changed the U.S. financial system profoundly.system profoundly.
Ex. In 1914, you did all banking business at Ex. In 1914, you did all banking business at the bank, needed an appointment, and were the bank, needed an appointment, and were expected to be properly attired. In 2001, you expected to be properly attired. In 2001, you can handle transactions over the internet at 3 can handle transactions over the internet at 3 AM wearing pajamas!AM wearing pajamas!
Technology has changed the U.S. financial Technology has changed the U.S. financial system profoundly.system profoundly.
Ex. In 1914, you did all banking business at Ex. In 1914, you did all banking business at the bank, needed an appointment, and were the bank, needed an appointment, and were expected to be properly attired. In 2001, you expected to be properly attired. In 2001, you can handle transactions over the internet at 3 can handle transactions over the internet at 3 AM wearing pajamas!AM wearing pajamas!
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Deposit InstitutionsDeposit Institutions
Accept deposits from customers or members Accept deposits from customers or members and offer checking and savings accounts, and offer checking and savings accounts, loans, and other banking services.loans, and other banking services.
Commercial BanksCommercial Banks
ThriftsThrifts
Credit UnionsCredit Unions
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Nondeposit InstitutionsNondeposit Institutions
Offer specific financial services:Offer specific financial services:
Insurance CompaniesInsurance Companies
Pension FundsPension Funds
Finance CompaniesFinance Companies
Brokerage FirmsBrokerage Firms
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Banking Services: Checking and Banking Services: Checking and Savings, Credit/Debit CardsSavings, Credit/Debit Cards
Checks:Checks:
Written orders that tell the user's bank to pay specific Written orders that tell the user's bank to pay specific amounts to particular individuals or businessesamounts to particular individuals or businesses
Also known as Also known as demand depositsdemand deposits; no interest; no interest
Debit cards function as checksDebit cards function as checks
Savings Accounts:Savings Accounts:
Nondemand deposits; interest bearingNondemand deposits; interest bearing
Credit Cards:Credit Cards:
buy now and repay the loaned amount plus interestbuy now and repay the loaned amount plus interest
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LoansLoans
Banks are a major source of funds for individuals Banks are a major source of funds for individuals and businesses of all sizesand businesses of all sizes
Secured Loans:Secured Loans:
Customer puts up property as collateralCustomer puts up property as collateral
Unsecured Loans or Lines of Credit: Unsecured Loans or Lines of Credit:
Backed by customers reputation and promise to payBacked by customers reputation and promise to pay
Banking Transaction CostsBanking Transaction Costs
$0.00
$0.20
$0.40
$0.60
$0.80
$1.00
$1.20$1.07
$0.29 $0.27
$0.04
Live Teller Debit Card ATM Internet
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Deregulation & CompetitionDeregulation & Competition
1980 Depository Institutions and Monetary Control Act1980 Depository Institutions and Monetary Control Act Blurred lines between banks and other financial institutionsBlurred lines between banks and other financial institutions U.S. banks merged/got taken overU.S. banks merged/got taken over
1999 Financial Services Modernization Act1999 Financial Services Modernization Act Removed barriers between investment activities and banksRemoved barriers between investment activities and banks May impose upon individuals privacyMay impose upon individuals privacy
Community Banks Community Banks
Interstate BankingInterstate Banking
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Bank Safety & RegulationBank Safety & Regulation
Federal Deposit Insurance Corporation (FDIC)Federal Deposit Insurance Corporation (FDIC)
$100,000 limit per account$100,000 limit per account
Established 1933Established 1933
Other deposit institutions have own insurance programsOther deposit institutions have own insurance programs
Insurance funded by premiums that each bank paysInsurance funded by premiums that each bank pays
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The Functions of the Federal The Functions of the Federal Reserve SystemReserve System
Created in 1913/1914—established system of 12 Created in 1913/1914—established system of 12 district banksdistrict banks
Commonly known as “the Fed”Commonly known as “the Fed” Most powerful financial institution in the U.S.Most powerful financial institution in the U.S. Serves as central bankServes as central bank
Three main functions:Three main functions: Influencing the U.S. money supplyInfluencing the U.S. money supply Supplying currencySupplying currency Clearing checksClearing checks
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Influencing the U.S. Money SupplyInfluencing the U.S. Money Supply
Changes in the Money Supply can have a major Changes in the Money Supply can have a major impact on economic conditions. Here are measures:impact on economic conditions. Here are measures:
Currency:Currency:Bills and coins that make up a country's money stockBills and coins that make up a country's money stock
Demand Deposits:Demand Deposits:Money that customers can use at any time, such as Money that customers can use at any time, such as checking accountschecking accounts
Time Deposits:Time Deposits:Bank accounts that pay interest and require some Bank accounts that pay interest and require some advance notice before money can be withdrawnadvance notice before money can be withdrawn
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How the Money Supply Is How the Money Supply Is MeasuredMeasured
M1:M1:Consists of currency, demand deposits, and NOW Consists of currency, demand deposits, and NOW accountsaccounts
M2:M2:A broader measure; consists of M1 plus savings and A broader measure; consists of M1 plus savings and small-time depositssmall-time deposits
M3:M3:The broadest measure of the money supply; consists of The broadest measure of the money supply; consists of M1 and M2 plus large time deposits and other restricted M1 and M2 plus large time deposits and other restricted depositsdeposits
The most commonly used measureThe most commonly used measure
The Total Money SupplyThe Total Money Supply
Oct. ‘01: M1 = $1,157 M2 = $$5,400 M3 = $7,909
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Tools for Influencing the Tools for Influencing the Money SupplyMoney Supply
Reserve Requirement:Reserve Requirement:Percentage of a bank's deposit that must be set aside an on which banks Percentage of a bank's deposit that must be set aside an on which banks may not earn interest (Oct ‘01: 10%)may not earn interest (Oct ‘01: 10%)
Discount Rate:Discount Rate:Interest rate the Federal Reserve charges on loans to commercial banksInterest rate the Federal Reserve charges on loans to commercial banks
Prime Interest Rate (Prime):Prime Interest Rate (Prime):Lowest interest rate banks offer on short‑term loans to preferred Lowest interest rate banks offer on short‑term loans to preferred borrowersborrowers
Open-Market Operations:Open-Market Operations:Federal Reserve’s purchase or sale of government bonds on the open Federal Reserve’s purchase or sale of government bonds on the open marketmarket
Selective Credit Controls:Selective Credit Controls:Federal Reserve's power to set credit terms on various types of loansFederal Reserve's power to set credit terms on various types of loans
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Interest Rates: 1985-2001Interest Rates: 1985-2001
Prime Interest Rate
0.002.004.006.008.0010.0012.0014.00
1985.01
1986.01
1987.01
1988.01
1989.01
1990.01
1991.01
1992.01
1993.01
1994.01
1995.01
1996.01
1997.01
1998.01
1999.01
2000.01
2001.01
Influencing the Money SupplyInfluencing the Money Supply
Reserve RequirementsReserve Requirements
Discount RateDiscount Rate
Open-Market OperationsOpen-Market Operations
Selective Credit ControlsSelective Credit Controls
To To INCREASEINCREASE money supplymoney supply
To To DECREASEDECREASE money supplymoney supply
Decrease
Lower
Buy
Fewer
Increase
Raise
Sell
More
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Supplying Currency & Supplying Currency & Clearing ChecksClearing Checks
Regional Federal Reserve Banks provide member Regional Federal Reserve Banks provide member banks with adequate amounts of currency (Federal banks with adequate amounts of currency (Federal Reserve Notes) throughout the yearReserve Notes) throughout the year
Money on deposit in banks or other financial Money on deposit in banks or other financial institutions is recorded in computerized ledger institutions is recorded in computerized ledger entriesentries
The Fed acts as clearing house for the checksThe Fed acts as clearing house for the checks
How the Fed Clears ChecksHow the Fed Clears Checks
Ms. Richlives in Boston, where she has a checking account. While vacationing in Dallas, she buys some gifts and pays for them by check.
Dallas Storedeposits her check into its account at a Dallas bank.
Store’s Dallas Bankdeposits the check for credit in its account at the Federal Reserve Bank of Dallas.
Federal Reserve Bank of Dallassends the check to the Federal Reserve bank of Boston for collection.
Federal Reserve Bank of Boston
forwards the check to Ms. Rich’s Boston bank.
Ms. Rich’s Boston Bank
deducts the amount of the check from Ms. Rich’s bank account.
Boston Bankauthorizes the Federal Reserve Bank of Boston to deduct the amount of the check from its deposit account with the Reserve Bank.
Federal Reserve Bank of Boston
pays the Federal Reserve Bank of Dallas.
Federal Reserve Bank of Dallas
Credits the deposit account of the Dallas store’s bank.
Store’s Dallas BankCredits the storekeeper’s account