Business Chapter # 8 Notes – Managing Financial Issues
What is Money?
Money – any object generally accepted by people as payment for goods and services
- Portability – Modern currency is lightweight and easy to handle
- Divisibility – Modern currency is easily divisible into smaller parts with fixed values for
- Durability – Modern currency does not spoil, it does not die, and if it wears out, it can be
replaced with new coins and paper money
- Stability – the stability of the value of the money
Money serves three functions:
- Medium of exchange – We use money as a way of buying and selling things. Without
money, we would be bogged down in a system of barter
- Store of value – Money can be used for future purchases and therefore “stores’ value
- Unit of account – Money lets us measure the relative values of goods and services. It acts
as a unit of account because all products can be valued and accounted for in terms of
Credit cars are a money substitute; they serve as a temporary medium of exchange but are not a
store of value.
Credit cards are big business for two reasons. First, they are quite convenient. Second, credit
cards are extremely profitable for issuing companies. Profits derive from two sources:
1. Some cards chare annual fees to holders. All charge interest on unpaid balances.
2. Merchants who accept credit cards pay fees to card issuers.
The Canadian Financial System
The main function of financial institutions is to ease the flow of money from sectors with
surpluses to those with deficits. They do this by issuing claims against themselves and using the
proceeds to buy the assets of – and thus invest in – other organizations.
For many years, the financial community in Canada was divided rather clearly into four distinct
legal areas. Often called the “four financial pillars”, they were: (1) chartered banks; (2) alternate
banks, such as trust companies and caisses populaires or credit unions; (3) life insurance
companies and other specialized lending and saving intermediaries, such as factors, finance
companies, venture capital firms, mutual funds, and pension funds; and (4) investment dealers.
Chartered Bank – a privately owned, profit seeking firm that serves individuals, non-business
organizations, and businesses as a financial intermediary The banking business today is a highly competitive industry. No longer is it enough for banks to
accept deposits and make loans. Most, for example, now offer bank issued credit cards and safe
deposit boxes. In addition, many offer pension, trust, international, and financial advice, and
electronic money transfer.
Most banks help customers establish savings plans for retirement. Banks serve as financial
intermediaries by receiving funds and investing them as directed by customers. They also
provide customers with information on investment possibilities.
Many banks offer trust services – the management of funds left “in the bank’s trust”. In return
for a fee, the trust department will perform such tasks as making your monthly bill payments and
managing your investment portfolio. Trust departments also manage the estates of deceased
The three main international services offered by banks are currency exchange, letters of credit,
and banker’s acceptances. For example, a Canadian company wants to buy a product from a
French supplier. For a fee, it can use one or more of three services offered by its bank:
1. It can exchange Canadian dollars for euros at a Canadian bank and then pay the French
supplier in euros
2. It can pay its bank to issue a letter of credit – a promise by the bank to pay the French
firm a certain amount if specified conditions are met
3. It can pay its bank to draw up a banker’s acceptance, which promises that the bank will
pay some specified amount at a future date.
Many banks, both large and small help their customers manage their money. Today, bank
advertisements often stress the role of banks as financial advisers.
Electronic automated teller machines (ATMs) allow customers to withdraw money and make
deposits 24 hours a day, seven days a week.
One type of deposit a customer can make in a bank is a chequable, or a demand, deposit. A
chequable deposit is a chequing account. Customer who deposit coins, paper currency, or other
cheques in their chequing accounts can write cheques against the balance in their accounts. Their
banks must honor these cheques immediately; this is why chequing accounts are also called
The other type of deposit a customer can make in a chartered bank is a term deposit. A term
deposit is one that remains with the bank for a period of time. Interest is paid to depositors for
the use of their funds.
Banks are the major source of short-term loans for business. Although banks make long-term
loans to some firms, they prefer to specialize in providing short term funds to finance inventories
and accounts receivable. A secured loan is backed by collateral such as accounts receivable or a
life insurance policy. If the borrower cannot repay the loan, the bank sells the collateral. An
unsecured loan is backed only by the borrower’s promise to repay it. Only the most creditworthy
borrowers can get unsecured loans. Borrowers pay interest on their loans. Large firms with excellent credit records pay the prime rate of interest. The prime rate of interest is the lowest
rate charged to borrowers.
Banks as Creators of Money
Banks provide a special service to the economy – they create money. By taking in deposits and
making loans, they expand the money supply. Assuming that banks have a reserve requirement,
that is, that they must keep a portion of their chequable deposits in vault cash or as deposits with
the Bank of Canada. (This is simply an assumption, since the reserve requirement was dropped
Other Changes in Banking
Fundamental changes in addition to those already described are taking place in banking. These
include deregulation, changing consumer demands, the impact of electronic technologies and
changes in international banking.
Deregulation has caused banks to shift away from their historical role as intermediaries between
depositors and borrowers. Large companies have reduced their use of bank loans. To compensate
for this loss, banks are setting up money market operations.
Consumers are no longer content to simply keep money in a bank when they can get more for it
elsewhere. They are increasingly turning to non-traditional, electronic banks like ING Direct and
President’s Choice Financial that have very few tellers or branches. Traditional banks are
responding by selling a growing array of corporate and government securities through their
Chartered banks and other financial institutions now use electronic funds transfer to provide
many basic financial services. Electronic funds transfer combines computer and
communication technology to transfer funds or information into, from, with, and among financial
One of the electronic offerings from the financial industry that has gained popularity is the debit
card. Unlike credit cards, debit cards allow only the transfer of money between accounts. They
do not increase the funds at an individual’s disposal. They can, however; be used to make retail
purchases. In stores with point of sale (POS) terminals, customers insert cards that transmit to