Chapter 1 Notes

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Published on 1 Jun 2011
Chapter 1 An Introduction to Finance Notes
finance the study of how and under what terms savings (money) are allocated between lenders and borrowers
finance requires basic understanding of securities and corporate law and institutions that facilitate and monitor exchange of funds
1.1 Real versus Financial Assets
Real Assets
real assets the tangible things that compose personal and business assets
personal assets are the values of houses (residential structures), the land the houses are on, the major appliances in the houses
(televisions, washing machines, etc), and cars
for businesses, the major assets are office towers, factories, mines, and so on (non-residential structures), the machinery and
equipment in those structures, the land they are on, and the stock or inventories of thing waiting to be used or sold
Financial Assets
financial assets a claim that one individual or institution has on another
the basic idea behind the National Balance Sheet Accounts (NBSA) is to collect financial data on the major agents in the
financial system and then track the borrowing and lending between these agents
understanding wealth distributions within a country is a complex issue, however, a good starting point is to consider how
borrowing and lending changes throughout the life cycle of individuals as they grow older
1.2 The Financial System
basic financial flow is “intermediated” through the financial system, which comprises (1) financial intermediaries that transform
the nature of the securities they issue and invest in, and (2) market intermediaries that simply make the markets work better
financial intermediaries entities that invest funds on behalf of others and change the nature of the transactions
market intermediaries entities that facilitate the working of markets and help provide direct intermediation but do not change
the nature of the transaction; also called brokers
Channels of Intermediation
the financial system transfers money from those with a surplus (lenders) to those who need it (borrowers)
intermediation the transfer of funds from lenders to borrowers
there are two ways for individuals to borrow: (1) directly from borrowers; and (2) indirectly from individuals who have first
loaned their savings to (deposited into) a financial institution, which in turn lends to the ultimate borrowers
there are two basic channels for direct intermediation:
1) the lender provides money directly to the ultimate borrower without any help from a specialist, which is a non-market
transaction because the exchange is negotiated directly between the borrower and the lender
2) the lender needs some help because no one individual can lend the full amount needed or because the borrower is not
aware of the aware lenders; as a result, the borrower needs help to find suitable lenders through market intermediaries
a market intermediary is simply an entity that facilitates the working of markets and helps the direct intermediation process
typically, market intermediaries are called brokers
the indirect intermediation channel represents financial intermediation, a situation in which the financial institution or financial
intermediary lends the money to the ultimate borrowers but raises the money itself by borrowing directly from other individuals
in this case, the ultimate lenders have only an indirect claim on the ultimate borrowers; their direct claim is on the institution
market intermediaries help financial intermediaries, as well as individuals, in their dealings with the ultimate borrowers
when market intermediaries help individuals, it is retail; when they help financial intermediaries, it is institutional
credit crunch a situation in which financial intermediaries have to raise the cost of their loans by a significant amount due to
their own inability to raise financing on reasonable terms
although Canadian banks are involved in almost all areas of financial system, their core activity is as deposit takers and lenders
although the banks are the most important financial intermediaries, the major insurance companies are also very large
chartered banks take in deposits and make loans; insurance companies take in insurance premiums and pay off when an incident
occurs, such as a death; while pension funds take in contributions and provide pension payments after plan members retire
in contrast, mutual funds simply act as a “pass-through” for individuals, providing them with a convenient way to invest in the
equity and debt markets, and receive their monies through monthly savings plan
mutual funds perform two major functions: (1) they pool small sums of money so that they can make investments that would not
be possible for smaller investors, and (2) they offer professional expertise in the management of those funds
The Major Borrowers
Crown corporations government-owned companies that provide goods and services needed by Canadians
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Document Summary

Households understanding wealth distributions within a country is a complex issue, however, a good starting point is to consider how borrowing and lending changes throughout the life cycle of individuals as they grow older. Summary of learning objectives: define finance and explain what is involved in the study of finance. Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers. Finance is not just about how resources are allocated but also under what terms and through what channels. Whenever funds are transferred, a financial contract comes into existence, and these contracts are called financial securities. The four sectors are government, business, households, and non-residents. On an aggregate level, the first 3 sectors own real assets. Households own positive net financial assets while governments and businesses own negative net financial assets, which mean net debt.