Part 6

Managing
Financial
Resources

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 Chapter 17
Financial
Management and
Institutions

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 Chapter Objectives
1. Identify the functions performed by a firm’s financial
managers.
2. Describe the characteristics a form of money should
have and list the functions of money.
3. Explain each of the various measures of the money
supply.
4. Explain how a firm uses funds.
5. Compare the two major sources of funds for a business.
6. Identify the likely sources of short- and long-term funds.
7. Describe the financiaCommercialand the major financial
institutions.
8. Explain the functions of the Federal Reserve System
and the tools it uses to control the money supply.
9. Describe the global financial environment.
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 The Role of the Financial Manager

 Finance—business function of planning,

obtaining, and managing a company’s funds
in order to accomplish its objectives in the
most effective possible way.

 Finance manager—employee responsible

for developing and implementing the firm’s
financial plan and for determining the most
appropriate sources and uses of funds.

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 The Role of the Financial Manager

 Chief financial officer—top finance

executive of a corporation; usually reports
directly to the firm’s CEO.
VP for Financial Management
Treasurer
Controller
 All address the risk-return trade-off

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 Organizational Structure of the Finance Function

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 The Role of the Financial Manager

 The Financial Plan

Document specifying the funds a firm will
need for a period of time, the timing of
inflows and outflows, and the most
appropriate sources and uses of funds.
 What funds will the firm require during
the appropriate period of operations?
 How will it obtain necessary funds?
 When will it need more funds?

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 Characteristics and Functions of Money

 Characteristics of Money
Money—anything generally
accepted as payment for
goods and services.

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 Characteristics and Functions of Money

 Characteristics of Money
Divisibility—Ability to be broken down into
smaller units
Portability—Ability to be easily moved
from place to place
Durability—Ability to survive repeated
usage over time

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 Characteristics and Functions of Money
 Characteristics of Money
Difficulty in Counterfeiting—Currency
should be hard for anyone, other than the
government, to produce

Stability—Should maintain a relatively

stable value

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 The New Color of Money

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 Characteristics and Functions of Money

 Basic
Functions
of Money

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 The Money Supply

 The money supply consists of coins and

currency as well as financial assets that also
serve as a medium of exchange (traveler’s
checks, bank checking accounts, other so-
called demand deposit accounts, and credit
union share draft accounts)

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 Components of M1

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 The Money Supply
 Another, broader definition of the money
supply is the M2
 M2—includes the M1 plus a number of other
financial assets that are almost as liquid as
cash, but do not serve directly as a medium
of exchange
These assets include various savings
accounts, certificates of deposit and money
market mutual funds

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 Why Organizations Need Money

 Organizations require funds to run day-to-day

operations, compensate employees and hire
new ones, pay for inventory, make interest
payments on loans, pay dividends to
shareholders, and purchase property,
facilities, and equipment

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 The Financial
Planning
Process

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 Why Organizations Need Money

 Generating Funds from Excess Cash

Many financial managers invest the
majority of their firms’ excess cash
balances in marketable securities
The most popular marketable securities
include:
 U.S. Treasury bills
 Commercial paper
 Repurchase agreements
 Certificates of deposit

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 Sources of Funds

 Debt capital—funds obtained through

borrowing.

 Equity capital—funds provided by the firm’s

owners when they reinvest earnings, make
additional contributions, or issue stock to
investors.

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 Debt and Equity Capital: Two Basic Sources
of Funds

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 Comparison of Debt and Equity Capital

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 Sources of Funds
 Short-Term Sources of Funds
Short-term sources of funds are repaid
within one year
Major sources of short-term funds include:
 Trade credit
 Short-term loans
 Commercial paper

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 Sources of Funds
 Long-term Sources of Funds
Long-term sources are repaid over many years
Three common sources of long-term funds are:
 Long-term loans
 Bonds—certificates of indebtedness sold to
raise long-term funds for a corporation or
government agency
 Equity financing—acquired by selling stock
in the company or reinvesting company
earnings

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 Sources of Funds

 Long term Sources of Funds

Public Sale of Stock and Bonds
 Sales of stocks and bonds represent a
major source of funds for corporations
 They provide cash inflows for the issuing
firm and either a share in its ownership
or a specified rate of interest and
repayment at a stated time

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 Sources of Funds
 Long term Sources of Funds
Private Placements—stock or bond
issues sold to a small, select group of large
investors such as pension funds and life
insurance companies

Venture Capitalists—raise money from

wealthy individuals and institutional
investors and invest these funds in
promising firms

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 Sources of Funds

 Long term Sources of Funds

Leverage—technique of increasing the
rate of return on an investment by
financing it with borrowed funds
 The key to managing leverage is
ensuring that the company’s earnings
remain larger than its interest payments,
which increases the leverage on the rate
of return on shareholders’ investment

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 How Leverage Works

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 The Financial System and
Financial Institutions

 Financial System—process by which funds

are transferred from savers to users.

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 Overview of the Financial System and Its
Components

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 The Financial System and
Financial Institutions

 Depository Institutions—financial
institutions that accept deposits that can be
converted into cash demand.

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 The Financial System and
Financial Institutions

 Commercial Banks
Largest and probably most important
financial institutions
Approximately 7,900 commercial banks in
the U.S.
Total Assets: $7.1 trillion
Down from over 18,000 in 1985

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 The Financial System and
Financial Institutions

 Commercial Banks
How Banks Operate
 Banks raise funds by offering checking
and savings accounts
 They then pool these deposits and lend
most of them out to consumers and
businesses

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 Types of Outstanding Bank Loans

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 The Financial System and
Financial Institutions
 Commercial Banks
Electronic Banking
More and more funds are moving through
Elections Funds Transfer Systems (EFTS)
EFTS—computerized systems for
conducting financial transactions over
electronic links
 Includes automatic teller machines
(ATMs), debit or check cards, and direct
deposit of paychecks

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 The Financial System and
Financial Institutions
 Commercial Banks
Online Banking
 Regular online bank users now 1 out of
every 5 U.S. households
 Projected to grow to 1 in 3 households
by 2010
 Two types of online banks:
Internet-only banks
Traditional bricks and mortar banks
with Web sites

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 The Financial System and
Financial Institutions
 Bank Regulation
Who Regulates Banks?
 State chartered banks are regulated by
the appropriate state banking authorities
 Most are federally insured, and also
subject to FDIC regulation
 Federally chartered banks are regulated
by the Federal Reserve, the Federal
Deposit Insurance Corporation, and the
Comptroller of the Currency

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 The Financial System and
Financial Institutions
 Bank Regulation
Federal Deposit Insurance
 Deposits are insured by the FDIC up to
a set amount – currently $100,000
 Federal deposit insurance was enacted
by the Banking Act of 1933 to restore
public confidence in the banking system

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 The Financial System and
Financial Institutions
 Bank Regulation
Recent Changes in Banking Laws
 Congress recently passed a law that
allows banks to enter into the securities
and insurance businesses
 In return, other financial services firms
are now allowed to offer banking
services

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 The Financial System and
Financial Institutions
 Savings Banks and Credit Unions
Savings banks and credit unions are also
important financial institutions
They offer many of the same services as
commercial banks
A series of crises cause many of the
predecessors of savings banks to merge
with financially stronger institutions
Credit Unions are cooperative financial
institutions, owned by their depositors, all
of whom are members

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 The Financial System and
Financial Institutions

 Nondepository Financial Institutions

Accept funds from businesses and
households, much of which they then
invest
 Insurance Companies
 Pension Funds
 Finance Companies

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 The Federal Reserve System

 Central bank of the United States. Has four

basic responsibilities:
Regulating commercial banks
Performing banking-related activities for
the U.S. Treasury
Servicing member banks
Monetary policy

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 The Federal Reserve System

 Organization of the Federal Reserve

System
Nation is divided into 12 federal reserve
districts, each with its own Federal Reserve
Bank
Each district Bank supplies banks within its
district with currency and facilitates the
clearing of checks
District banks are run by a nine-member
board of directors

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 The Federal Reserve System
 Governing body of the Fed is the Board of
Governors
The board consists of seven members,
appointed by the president and confirmed by the
Senate
The Fed is designed to be politically independent
 Fed Governors are appointed to 14-year terms
– staggered so that a president could not
appoint a majority during a single term
Federal Open Markets Committee (FOMC)

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 The Federal Reserve System
 Check Clearing and the Fed
Clearing of a check—process by which funds
are transferred from the Check writer to the
recipient
If both the writer in the recipient have accounts
at the same bank, a check will clear in house
If both have accounts at banks in the same
town, the two banks may clear the check
directly with one another
If one has an account with a bank in a state
different than the other, the check will likely be
cleared through the Federal Reserve system

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 A Check’s
Journey
through the
Federal
Reserve
System

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 The Federal Reserve System
 Monetary Policy
Monetary Policy—managing the growth
rate in the supply of money and credit,
usually through the use of interest rates.

Fed’s job is to ensure that the money

supply grows at an appropriate rate
allowing the economy to expand and
inflation to remain in check

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 The Federal Reserve System
 Monetary Policy
If money supply grows too slowly economic
growth will slow, unemployment will
increase, and the risk of recession will
increase
If the money supply grows to rapidly,
inflationary pressures build

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 Federal Reserve Tools

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 U.S. Financial Institutions:
A Global Perspective
 Major U.S. banks have extensive international
operations, with offices that lend money and
accept deposits from customers worldwide
 Only three of the 20 largest banks are U.S.
institutions
The others are based in France, Germany,
Holland, Japan, Switzerland, and the UK

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 Virtually all nations have some sort of central
bank, similar to the U.S. Federal Reserve.
 Iraq’s central banking system collapsed with
the fall of Saddam Hussein. Its old central
bank printed and distributed money at the
dictator’s bidding. Currently, three different
currencies are circulating in the country—one
of which is the U.S. dollar.

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