UNIT 5. OVERVIEW OF THE FINANCIAL SYSTEM
Getting started
Suppose that you want to start a business that manufactures a recently invented low-cost robot that cleans the house, mows the lawn, and washes the car, but you have no funds to put this wonderful invention into production. Walter has plenty of savings that he has inherited. If you and Walter could get together so that he could provide you with the funds, your companys robot would see the light of the day, and you, Walter, and the economy would all be better off: Walter could earn a high return on his investment, you would get rich from producing the robot, and we would have cleaner houses, shiner cars, and more beautiful lawns.
Financial markets (bond and stock markets) and financial intermediaries (banks, insurance companies, pension funds) have the basic function of getting people such as you and Walter together by moving funds from those who have a surplus of funds (Walter) to those who have a shortage of funds (you). More realistically, when Apple invents a better iPod, it may need funds to bring it to market. Similarly, when a local government needs to build a road or a school, it may need more funds than local property taxes provide. Well-functioning financial markets and financial intermediaries are crucial to the economic health.
Discuss the following points.
1. Some economists suspect that one of the reasons that economies in developing countries grow so slowly is that they do not have well-developed financial markets. Does this argument make sense?
2. The US economy borrowed heavily from the British in the nineteenth century to build a railroad system. Why did this make both countries better off?
Look through the following vocabulary notes which will help you understand the text and discuss the topic.
| 1. | a bond | |
| 2. | a capital market | |
| 3. | a claim | , |
| 4. | a commercial bank (a retail bank) | |
| 5. | a commodity exchange | - |
| 6. | a credit union | |
| 7. | a fund | |
| 8. | a government retirement fund | |
| 9. | a liability | , |
| 10. | a maturity date | |
| 11. | a money market | |
| 12. | a money market mutual fund | |
| 13. | a mortgage | |
| 14. | a mutual fund | |
| 15. | a net income | |
| 16. | a pool | , |
| 17. | a primary (secondary) market | () |
| 18. | a principal | |
| 19. | a savings and loan association | - |
| 20. | a security | |
| 21. | a shortage | |
| 22. | a stake | , , |
| 23. | a stock exchange | |
| 24. | a stock, a share, an equity | |
| 25. | a surplus | , |
| 26. | a thrift | |
| 27. | an asset | |
| 28. | an exchange | |
| 29. | an intermediary | |
| 30. | an inventory | |
| 31. | an investment bank (a merchant bank) | |
| 32. | an issuer | |
| 33. | an over-the-counter market | |
| 34. | bank branching | |
| 35. | common stocks (ordinary shares) | |
| 36. | contractual savings institutions | |
| 37. | debt instruments | |
| 38. | depository institutions | |
| 39. | efficiency | |
| 40. | efficient | , |
| 41. | equity | |
| 42. | excess | |
| 43. | funds | |
| 44. | insider trading | |
| 45. | interest payments | |
| 46. | intermediation | |
| 47. | preferred stocks | |
| 48. | principal payments | |
| 49. | return | |
| 50. | risk exposure | |
| 51. | stock | |
| 52. | to channel/ transfer/move funds | , |
| 53. | to expose | |
| 54. | to issue securities | |
| 55. | to raise funds | , |
| 56. | to time | |
| 57. | transaction costs | |
| 58. | welfare | , |
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