INTRODUCTION TO FINANCEMGMT 005

INTRODUCTION TO BUSINESS

AND FINANCE

DEFINITION OF FINANCE

The science that describes the management, creation and study of money, banking, credit, investments, assets and liabilities.

Finance consists of financial systems, which include the public, private and government spaces, and the study of finance and financial instruments, which can relate to countless assets and liabilities.

Some prefer to divide finance into three distinct categories: public finance, corporate finance and personal finance. All three of which would contain many sub-categories.

DEFINITION OF MONEY

An officially-issued legal tender generally consisting of currency and coin. Money is

the circulating medium of exchange as defined by a government.

Money is often synonymous with cash, including negotiable instruments such as

checks. Each country has its own money, or currency, that is used as a medium

exchange within that country (some countries share a type of currency, such as the

euro used by the European Union).

The currency of one country can be exchanged for the currency of

another via a currency exchange. The current exchange rate determines how much of

one currency must be used to purchase a specified amount of the other currency. For

example, the exchange rate between the euro and the US dollar may be 1.2596,where

1 euro can buy 1.2596 US dollars.

DEFINITION OF MONETARY POLICY

The actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply, which in turn affects interest rates.

Monetary policy is maintained through actions such as increasing the interest rate, or changing the amount of money banks need to keep in the vault (bank reserves).

MORE ON MONEY

Barter system

A system of exchange in which goods or services are traded directly for other goods or services

Money

Anything a society uses to purchase products, services, or resources

MONEY SUPPLY M-1 AND M-2

Demand deposit An amount on deposit in a checking account

Time deposit An amount on deposit in an interest-bearing

savings account

Two main measures of the supply of money M1

Currency, demand deposits, and travelers checks

M2

M1 plus savings accounts, certain money-market securities and small-denomination time deposits or certificates of deposit (CDs) of less than $100,000

FEDERAL RESERVE SYSTEM

The central bank of the United States responsible for regulating the banking industry Controlled by a seven-member board of governors

who are appointed by the president and confirmed by the Senate to serve a fourteen-year term

Composed of twelve district banks and twenty-four branch banks

District banks are owned by commercial banks that are members of the Federal Reserve system

Main function is to regulate the banking system and maintain a healthy economy

U.S.FEDERAL RESERVE SYSTEM

FEDERAL RESERVE SYSTEM

Regulation of reserve requirementsReserve requirement—the percentage of its deposits a bank must retain, either in its own vault or on deposit with its Federal Reserve District Bank

More required reserves = less money in circulation

Less required reserves = more money in circulation to stimulate the economy

FEDERAL RESERVE SYSTEM

Regulation of the discount rate

Discount rate—the interest rate the Federal Reserve System charges for loans to member banks

Lower loan rates allow banks to lend more and stimulate the economy

Higher rates slow the economy

FEDERAL RESERVE SYSTEM

Regulation of the discount rate

Discount rate—the interest rate the Federal Reserve System charges for loans to member banks

Lower loan rates allow banks to lend more and stimulate the economy

Higher rates slow the economy

THE POWER OF MONEY

https://www.youtube.com/watch?v=7Aa55y9_ifE

AMERICAN BANKING INDUSTRY

Banking and financial reform: New regulations

Goals are

Protection from unfair, abusive financial and banking practices

Close gaps that allowed large banks and financial firms to avoid strong, comprehensive federal oversight

Curb high-risk investment strategies

Require banks and financial firms to pay back bailout funds

Provide a foundation for stable economic growth

AMERICAN BANKING INDUSTRY

Commercial bank

A profit-making organization that accepts deposits, makes loans, and provides related services to its customers

National bank: chartered by the U.S. Comptroller of the Currency

State bank: chartered by the banking authorities in the state in which it operates

AMERICAN BANKING INDUSTRYOther financial institutions

Savings and loan associations (S&L)

A financial institution that offers checking and savings accounts and CDs and that invests most of its assets in home mortgage loans and other consumer loans

Credit unions

A financial institution that accepts deposits from and lends money to only those people who are its members

Members are usually employees of a particular firm, people in a particular profession, or those who live in a community served by a local credit union

AMERICAN BANKING INDUSTRY

Other financial institutions (cont’d)

Organizations that perform banking functions

Mutual savings banks

Insurance companies

Pension funds

Brokerage firms

Finance companies

Investment banking firms

TRADITIONAL BANKING SERVICES

Checking accounts

Check—a written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the check

NOW account—an interest-bearing checking account

Savings accounts

Passbook savings account

Certificate of deposit (CD)—a document stating that the bank will pay the depositor a guaranteed interest rate for money left on deposit for a specified period of time

Short- and long-term loans

Line of credit—a loan that is approved before the money is actually needed

Revolving credit agreement—a guaranteed line of credit

Collateral—real estate or property pledged as security for a loan

TRADITIONAL BANKING SERVICES

Credit-card and debit card transactionsBanks and other financial institutions charge merchants fees (a percentage of each credit card transaction) for handling the transactions for the merchant

Debit card—a card that electronically subtracts the amount of a purchase from the cardholder’s bank account at the moment the purchase is made

FUTURE OF BANKING

Changes in the banking industryAnticipated changesMore emphasis on evaluating the creditworthiness of loan applicants as a result of the recent economic crisisAn increase in government regulation of the industryA reduction in the number of banks, S&Ls, credit unions, and financial institutions because of consolidation and mergersGlobalization of the banking industry

FUTURE OF BANKING

Anticipated changes (cont’d)The importance of customer service as a way to keep customers from switching to competitors Increased use of credit and debit cards and a decrease in the number of written checks Increased competition from nonbank competitors that provide many of the same services as banks (S&Ls, credit unions)Continued growth in online banking

ONLINE BANKING

Advantages

Easy access to account regardless of time or location

Ability to obtain current account balances

Convenience of transferring funds

Ability to pay bills

Convenience of seeing which checks have cleared

Easy access to current interest rates

Simplified loan application procedures

For banks—lower processing costs

Disadvantages

Not being able to discuss financial matters with a personal banker

ELECTRONIC FUNDS TRANSFERS (“EFT’S”)

A means of performing financial transactions through a computer terminal or telephone hookup

Changing how banks do business

Automated teller machines (ATMs)

Automated clearinghouses (ACHs)

Point-of-sale (POS) terminals

Electronic check conversion (ECC)

FDIC AND NCUA

Federal Deposit Insurance Corporation (FDIC)

Created as a result of the Depression, to restore public confidence in the banking industry to insure deposits against bank failures

FDIC provides deposit insurance of $250,000 per account

National Credit Union Association (NCUA)

Insures the deposits of credit union members for up to $250,000 per account

EFFECTIVE CREDIT MANAGEMENT

The five Cs of credit management

Character—the borrower’s attitude toward credit obligations

Capacity—the borrower’s financial ability to meet credit obligations

Capital—the extent of the borrower’s assets or net worth

Collateral—borrower assets that can be pledged as security for a loan

Conditions—general economic conditions that can affect a borrower’s ability to repay the loan