(Textbook) Behavior in Organizations, 8ed (A. B. Shani)

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(No Transcript)
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Chapter 2

• Financial Assets, Money,Financial Transactions,
  and Financial Institutions

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? Learning Objectives ?

• To learn about the channels through which funds
  flow between lenders and borrowers within the
  global system of money and capital markets.
• To discover the nature and characteristics of
  financial assets how they are created and
  destroyed by decision-makers within the financial
  system.

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? Learning Objectives ?

• To explore the critical roles played by money
  within the financial system and the linkages
  between money and inflation in the prices of
  goods and services.
• To examine the important functions carried out by
  financial intermediaries in lending and borrowing
  and in creating and destroying financial assets.

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Introduction The Role of Financial Assets

• The financial system is the mechanism through
  which loanable funds reach borrowers.
• Through the operation of the financial markets,
  money is exchanged for financial claims in the
  form of stocks, bonds, and other securities,
  thereby transforming savings into investment so
  that the economy can grow.

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The Creation of Financial Assets

• A financial asset is
• a claim against the income or wealth of a
  business firm, household, or unit of government,
• represented usually by a certificate, receipt,
  computer record file, or other legal document,
• and usually created by or related to the lending
  of money.

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Characteristics of Financial Assets

• Financial assets are sought after because they
  promise future returns to their owners and serve
  as a store of value (purchasing power).

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Characteristics of Financial Assets

• They do not depreciate like physical goods, and
  their physical condition or form is usually not
  relevant in determining their market value.
• They have little or no value as a commodity and
  their cost of transportation and storage is low.
• Financial assets are fungible they can easily
  be changed in form and substituted for other
  assets.

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Different Kinds of Financial Assets

• Any financial asset that is generally accepted in
  payment for purchases of goods and services is
  money. Currency and checking accounts are forms
  of money.
• Equities represent ownership shares in a business
  firm and are claims against the firms profits
  and against proceeds from the sale of its assets.
  Common stock and preferred stock are equities.

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Different Kinds of Financial Assets

• Debt securities entitle their holders to a
  priority claim over the holders of equities to
  the assets and income of an economic unit. They
  can be negotiable or nonnegotiable. Examples
  include bonds, notes, accounts payable, and
  savings deposits.
• Derivatives have a market value that is tied to
  or influenced by the value or return on a
  financial asset. Examples include futures
  contracts, options, and swaps.

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How Financial Assets Are Born

• To acquire assets, households and business firms
  may use current income and accumulated savings
  internal financing.
• An economic unit may also raise funds by issuing
  financial liabilities (debt) or stock (equities),
  provided that a buyer can be found external
  financing.

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Balance Sheets of Units in a Simple Financial
System
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Unit Balance Sheets Following the Purchase of
Equipment and the Issuance of a Debt Security
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Unit Balance Sheets Following the Purchase of
Equipment and the Issuance of Stock
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Financial Assets and the Financial System

• The act of borrowing or of issuing new stock
  simultaneously gives rise to the creation of an
  equal volume of financial assets.
• All financial assets are recorded as a liability
  or claim on some other economic units balance
  sheet.
• Volume of financial assets created for lenders
• Volume of liabilities issued by borrowers

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Financial Assets and the Financial System

• For the balance sheet of any economic unit,
• Total assets Total liabilities Net worth
• where assets real assets financial assets
• For the whole economy and financial system,
• Total financial assets Total liabilities
• So, for the economy as a whole,
• Total real assets Total net worth

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Financial Assets and the Financial System

• So, society increases its wealth only by saving
  and increasing the quantity of its real assets,
  for these assets enable the economy to produce
  more goods and services in the future.
• However, the financial system provides the
  essential channel necessary for the creation and
  exchange of financial assets between savers and
  borrowers so that real assets can be acquired.

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Lending and Borrowing in the Financial System

• Economists John Gurley and Edward Shaw pointed
  out that each business firm, household, or unit
  of government active in the financial system must
  conform to
• R E ?FA ?D
• where R Current income receipts
• E Expenditures out of current income
• ?FA Change in holdings of financial assets
• ?D Change in debt and equity outstanding

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Lending and Borrowing in the Financial System

• So, for any given time period, each economic unit
  must fall into one of three groups
• Deficit-budget unit (DBU)
• E gt R, so ?D gt ?FA (net borrower of funds)
• Surplus-budget unit (SBU)
• R gt E, so ?FA gt ?D (net lender of funds)
• Balanced-budget unit (BBU)
• R E, so ?D ?FA (neither net lender nor
  borrower)

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Lending and Borrowing in the Financial System
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Lending and Borrowing in the Financial System

• The global financial system permits businesses,
  households, and governments to adjust their
  financial position from that of net borrower
  (DBU) to net lender (SBU) and back again,
  smoothly and efficiently.

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What is Money?

• All financial assets are valued in terms of
  money, and flows of funds between lenders and
  borrowers occur through the medium of money.
• Money itself is a financial asset, because all
  forms of money in use today are claims against
  some public or private institution.

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Alternative Definitions of Money
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Alternative Definitions of Money
Source http//www.ny.frb.org/aboutthefed/fedpoint
/fed49.html
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The Functions of Money

• Money serves as a standard of value (or unit of
  account) for all goods and services.
• Money serves as a medium of exchange, such that
  buyers and sellers no longer need to have an
  exact coincidence of wants in terms of quality,
  quantity, time, and location.
• Money serves as a store of value a reserve of
  future purchasing power. However, the value of
  money can experience marked fluctuations.

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The Functions of Money

• Money functions as the only perfectly liquid
  asset in the financial system. It exhibits price
  stability, ready marketability, and reversibility.

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The Value of Money and Other FinancialAssets and
Inflation

• Inflation refers to a rise in the average price
  level of all goods and services.
• Inflation lowers the value or purchasing power of
  money and is a special problem in the money and
  capital markets because it can damage the value
  of financial contracts.
• The opposite of inflation is deflation, where the
  average level of prices for goods and services
  actually declines.

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The Value of Money and Other FinancialAssets and
Inflation

• Inflation is commonly measured using price
  indices, such as
• the Consumer Price Index (CPI),
• the Producer Price Index (PPI), or
• the Gross Domestic Product (GDP) Deflator Index.

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The Value of Money and Other FinancialAssets and
Inflation

• Suppose the U.S. CPI rises from 100 to 125 over a
  five-year period.
• Over the five-year period, the cost-of-living
  index climbed

and the U.S. dollars relative purchasing power
fell to
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The Evolution of Financial Transactions

• Financial systems change constantly in response
  to shifting demands from the public, the
  development of new technology, and changes in
  laws and regulations.
• Over time, the ways of carrying out financial
  transactions have evolved in complexity.
• In particular, the transfer of funds from savers
  to borrowers can be accomplished in at least
  three different ways.

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The Evolution of Financial Transactions

• Direct Finance Direct lending gives rise to
  direct claims against borrowers.

? Simple ? Difficult to match risky
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The Evolution of Financial Transactions

• Semidirect Finance Direct lending with the aid
  of market makers who assist in the sale of direct
  claims against borrowers.

? Lower search (information) costs ? Risky
matching is still required
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The Evolution of Financial Transactions

• Indirect Finance Financial intermediation of
  funds.

? Low risk affordable
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Relative Size and Importance ofMajor Financial
Institutions
Total Financial Assets Held by U.S. Financial
Institutions
( billions at year-end) 1970 1980 1990 2000
2004Q1 Financial intermediaries Commercial
banks 489 1,248 3,340 6,488 8,044 SL
assoc. and savings banks 252 794 1,358 1,219 1,557
Life insurance companies 201 464 1,357 3,204 3
,849 Private pension funds 110 413 1,629 4,587
4,260 Investment co. (mutual
funds) 47 64 602 4,457 4,890 State local
govt pension funds 60 198 820 2,290 2,303
Finance companies 63 199 611 1,138 1,401
Property-casualty insurance co. 50 174 534 872 1,0
69 Money market funds 74 498 1,812 1,972
Credit unions 18 72 202 441 635 Mortgage
companies 16 49 36 32 Real estate
investment trusts 4 6 13 62 133 Other financial
institutions Security brokers and
dealers 16 36 262 1,221 1,725
Source Board of Governors of the Federal Reserve
System, Flow of Funds Accounts
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Classification of Financial Institutions

• Depository institutions derive the bulk of their
  loanable funds from deposit accounts sold to the
  public.
• Commercial banks, savings and loan associations,
  savings banks, credit unions.
• Contractual institutions attract funds by
  offering legal contracts to protect the saver
  against risk.
• Insurance companies, pension funds.

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Classification of Financial Institutions

• Investment institutions sell shares to the public
  and invest the proceeds in stocks, bonds, and
  other assets.
• Mutual funds, money market funds, real estate
  investment trusts.

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Portfolio (Financial-Asset) Decisions by
Financial Institutions

• Portfolio decisions deciding what financial
  assets to buy or sell are affected by
• The relative rate of return and risk attached to
  different financial assets.
• The cost, volatility, and maturity of incoming
  funds provided by surplus-budget units.
• Hedging principle the approximate matching of
  the maturity of financial assets held with
  liabilities taken on.

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Portfolio (Financial-Asset) Decisions by
Financial Institutions

• The size of the individual financial institution.
• Larger financial institutions tend to have
  greater diversification in their sources and uses
  of funds and economies of scale.
• Regulations and competition.

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Disintermediation of Funds

• Disintermediation refers to the withdrawal of
  funds from a financial intermediary by the
  ultimate lenders (SBUs) and the lending of those
  funds directly to the ultimate borrowers (DBUs).
• Disintermediation involves the shifting of funds
  from indirect finance to direct and semidirect
  finance.

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Disintermediation of Funds
Financial Disintermediation
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Disintermediation of Funds

• Some new forms of disintermediation have appeared
  in recent years.
• Initiation by financial intermediaries Some
  banks sold off some of their loans because of
  difficulties in raising capital.
• Initiation by borrowing customers Some borrowing
  customers learned how to raise funds directly
  from the open market.

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Bank-Dominated Versus Security-Dominated
Financial Systems

• Lesser-developed financial systems are often
  bank-dominated financial systems, in which banks
  and other similar institutions dominate in
  supplying credit and attracting savings.
• The more mature systems today are becoming
  security-dominated financial systems, in which
  traditional intermediaries play lesser roles and
  growing numbers of borrowers sell securities to
  the public to raise the funds they need.

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Markets on the Net

• Bondsonline at www.bondsonline.com
• Encyclopedia.com at encyclopedia.com
• Federal Reserve Bank of Atlanta at
  www.frbatlanta.org
• Federal Reserve Bank of New York at
  www.ny.frb.org
• Moodys Investor Service at www.moodys.com

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Markets on the Net

• Money Magazine at www.money.com
• New York Stock Exchange at www.nyse.com
• Standard Poors Corporation at
  www.standardandpoor.com
• The Bond Market Association at www.investinginbond
  s.com
• U.S. Bureau of Economic Analysis at www.bea.gov

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Markets on the Net

• U.S. Bureau of Labor Statistics at www.bls.gov

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Chapter Review

• Introduction The Role of Financial Assets
• The Creation of Financial Assets
• Characteristics of Financial Assets
• Different Kinds of Financial Assets
• How Financial Assets Are Born
• Financial Assets and the Financial System

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Chapter Review

• Lending and Borrowing in the Financial System
• Money as a Financial Asset
• What is Money?
• The Functions of Money
• The Value of Money and Other Financial Assets and
  Inflation

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Chapter Review

• The Evolution of Financial Transactions
• Direct Finance
• Semidirect Finance
• Indirect Finance and Financial Intermediation
• Relative Size and Importance of Major Financial
  Institutions
• Classification of Financial Institutions

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Chapter Review

• Portfolio (Financial-Asset) Decisions by
  Financial Intermediaries and Other Financial
  Institutions
• Disintermediation of Funds
• New Types of Disintermediation
• Bank-Dominated Versus Security-Dominated
  Financial Systems