You are on page 1of 8

Pride/Hughes/Kapoor Business, 109th Edition

Audio Review Transcript


Chapter189UnderstandingMoney,Banking,andCredit

1.Identifythefunctionsandcharacteristicsofmoney

Businessestransformresourcesintomoney.Ifafirmhasagoodideafora
productoraservice,abankorotherlendermaylenditmoneytodevelop,produce,and
marketthegoodorservice.Theloan,withinterest,willberepaidusingfuturesales
revenue.Boththefirmandthelenderearnareasonableprofit.Andmoneyhelpsmakeit
happen.
Inthepast,peopleexchangedgoodsandserviceswithoutusingmoney.Instead
theyusedabartersystem,inwhichgoodsandservicesaretradeddirectlyforothergoods
andservices.Theproblemwiththebartersystemisthatthetwopartiesmustneedeach
othersproductsatthesametimeandthetwoproductsmustbeofsimilarvalue.To
eliminatetheseinconveniences,theconceptofmoneywasdeveloped.Moneyisanything
asocietyusestopurchaseproducts,services,orresources.Themostcommonlyused
objectstodayaremetalcoinsandpaperbills,calledcurrency.
Moneyhasthreeprimaryfunctions.Firstandforemost,itisamediumof
exchange.Amediumofexchangeisanythingacceptedaspaymentforproducts,services,
andresources.Ifabusinessneedsacertainrawmaterial,itexchangesmoneyforthe
productandtransformsitintoaproductitcansell,inexchangeformoremoney.Second,
moneyisameasureofvalue.Ameasureofvalueisasinglestandard,oryardstickused
toassignvaluesto,andcomparethevaluesof,products,services,andresources.Money
servesasameasureofvaluebecausethepricesofallgoods,services,andresourcesare
statedintermsofmoney.Thethirdfunctionofmoneyisasastoreofvalue.Astoreof
valueisameansofretainingandaccumulatingwealth.Moneyreceivedbyanindividual
orabusinessmaybeheldfornowandspentlater.Itisimportanttoremember,though,
thatthevalueofstoredmoneyisaffectedbyinflation,thegeneralriseinthelevelof

191
prices.Todeterminetheeffectofinflationonbuyingpower,economistsrefertothe
consumerpriceindex,whichshowsthepricechangesoftypicalconsumergoodsovera
periodoftime.
Tobeacceptableasamediumofexchange,moneymustbeeasytouse,trusted,
andcapableofperformingitsthreefunctions.Itmustpossessfivecharacteristics:
divisibility,soitcantobedividedintosmallerunitstoaccommodatelargeandsmall
purchases;portability,sothatitislightenoughandsmallenoughtobecarriedeasily;
stability,sothatitretainsitsvalueovertime;durability,sothatitisstrongenoughtolast
throughreasonablerepeatedusage;anddifficultyofcounterfeiting,sothatpeoplefeel
confidentaboutacceptingitaspayment.
SohowmuchmoneyisthereintheUnitedStates?Letsstartbydefiningafew
moneyconcepts.Ademanddepositisanamountondepositinacheckingaccount.Itis
calledademanddepositbecausetheownercandemanditimmediately,bypresentinga
properlymadeoutcheck,withdrawingfromanATM,ortransferringmoneybetween
accounts.Atimedepositisanamountondepositinaninterestbearingsavingsaccount.
Thetimesometimesrequiredbetweenthenoticeandthewithdrawaliswhyitiscalleda
timedeposit.Butbecausetheycanbeconvertedtocasheasily,theyarecallednear
monies.
NowletstalkabouthowmuchmoneythereisintheUnitedStates.Therearetwo
mainmeasuresofthesupplyofmoney:M1andM2.TheM1supplyofmoneyconsistsof
onlycurrencyanddemanddeposits.TheM2supplyofmoneyconsistsofM1(currency
anddemanddeposits),plussavingsaccounts,certainmoneymarketsecuritiesandsmall
denominationtimedeposits,orcertificatesofdeposit(CDs),oflessthan$100,000.
Generally,economists,politicians,andbankerstendtofocusonM1,oravariationof
M1.(LO1ends)

2.SummarizehowtheFederalReserveSystemregulatesthemoneysupply

AdiscussionofthemoneysupplygenerallyincludestalkabouttheFederal
ReserveSystem.TheFederalReserveSystem,alsosimplycalledtheFed,isthecentral

192
bankoftheUnitedStates.It'sresponsibleforregulatingthebankingindustry.Itsmission
istomaintainaneconomicallyhealthyandfinanciallysoundbusinessenvironmentin
whichbankscanoperate.TheFedhastremendouspowertoregulatethemoneysupply,
controlinflation,andregulatefinancialinstitutions.Toregulatethemoneysupply,it
controlsbankreserverequirements,regulatesthediscountrate,andrunsopenmarket
operations.
Whenmoneyisdepositedinabank,thebankmustretainaportionofittosatisfy
customerswhomaywanttowithdrawmoneyfromtheiraccountsortofundloans.The
reserverequirementisthepercentageofitsdepositsthatabankmustretain,eitherinits
ownvaultorinaFederalReserveDistrictBank.Bankscanusetheremainingfundsto
createmoremoneyandmakemoreloansbydepositexpansion,aprocessthatallows
bankstocontinuallyreloanmoneythathasbeendepositedinthebank.TheFedsetsthe
reserverequirement.Whenitincreasestherequirement,bankshavelessmoneyavailable
forlending.Whenitdecreasestherequirement,theFedcanmakeadditionalmoney
availabletostimulateasloweconomy.
TheFedalsocontrolsthemoneysupplybyregulatingthediscountrate.The
discountrateistheinterestratetheFederalReserveSystemchargesforloanstomember
banks.WhentheFedlowersthediscountrate,itiseasierandcheaperforbankstoobtain
money,increasingtheamountofmoneyavailabletoconsumersandbusinessesand
stimulatingtheeconomy.WhentheFedraisesthediscountrate,banksbegintorestrict
loans,raisetheirlendingrates,andtightenloanrequirements,whichslowstheeconomy
andchecksinflationbymakingmoneymoredifficultandexpensivetoobtain.
ThethirdwaythattheFedcontrolsthemoneysupplyisinopenmarket
operations.ThefederalgovernmentfinancesitsactivitiespartlybysellingUS
governmentsecurities.Thesesecuritiespayinterest,andareavailabletoanindividualor
organization,includingtheFed.OpenmarketoperationsisthebuyingandsellingofUS
governmentsecuritiesbytheFederalReserveSystemforthepurposeofcontrollingthe
moneysupply.Toreducethenationsmoneysupply,theFedsellsgovernmentsecurities
ontheopenmarket.Themoneyitreceivesfrompurchasersistakenoutofcirculation,
makinglessmoneyavailableforinvestment,purchases,orlending.Toincreasethe

193
moneysupply,theFedbuysgovernmentsecurities,whichputsmoneybackinto
circulationandmakesitavailabletoindividualsandfirms.Thegoalofbuyingandselling
securitiesistoaffectthefederalfundsrate,theinterestrateatwhichabanklends
immediatelyavailablefundstoanotherbankovernightinordertomeettheborrowing
banksreserverequirements.Inadditiontoregulatingthemoneysupply,theFedalso
servesasthegovernmentsbank,clearschecksandelectronictransfers,inspects
currency,andappliesselectivecreditcontrols,includingsettingthemarginrequirements
forstocktransactions.Themarginistheminimumamountofthepurchasepricethat
mustbepaidincashoreligiblesecurities.(LO2ends)

3.Describetheorganizationsinvolvedinthebankingindustry

Oneofthemajorplayersinbankingisthecommercialbank,aprofitmaking
organizationthatacceptsdeposits,makesloans,andprovidesrelatedservicestoits
customers.Itsmissionistomeettheneedsofitscustomerswhileearningaprofit.They
earnaprofitbyacceptingmoneyfromdepositors,forwhichtheypayinterest,andthen
bylendingittoqualifiedindividualsandbusinessesthatpayinterestontheborrowed
money.Commericalbanksarecharteredbythefederalgovernmentorstategovernments.
AnationalbankisacommercialbankcharteredbytheUSComptrollerofthecurrency,
andastatebankisacommercialbankcharteredbythebankingauthoritiesinthestatein
whichitoperates.Bothnationalandstatebanksarecarefullyregulatedandsubjectto
unannouncedinspectionsbyfederaland/orstateauditors.
Inadditiontocommercialbanks,thereareatleast8othertypesoffinancial
institutionsthatperformeitherfullorlimitedbankingservices.Letslookbrieflyateach.
(1)SavingsandloanassociationsoffercheckingandsavingsaccountsandCDs.They
investmostoftheirassetsinhomemortgageandotherconsumerloans.(2)Creditunions
acceptdepositsfromandlendmoneytoonlythosepeoplewhoaretheirmembers.(3)
Mutualsavingsbanksareownedbytheirdepositorsandoffermanyofthesameservices
offeredbysavingsandloanassociations.Mutualsavingsbanksgenerallyhavestate
charters,andtheirprofitsarereturnedtothedepositors,usuallyintheformofhigher

194
interestratesonsavings.(4)Insurancecompaniesprovidelongtermfinancingfor
commercialrealestateprojects.(5)Pensionfundsaresetupbyfirmstoguaranteetheir
employeesaregularmonthlyincomeonretirement,andmayearnadditionalincomefrom
conservativeinvestments.(6)Brokeragefirmsoffercombinationcheckingandsavings
accountsathigherthanusualinterestrates,calledmoneymarketrates.(7)Finance
companiesprovidefinancingtoindividualsandfirmsthatmaybeunabletogetfinancing
fromotherlenders.And(8)investmentbankingfirmsassistcorporationsinraisingfunds
bysellingnewissuesofstocks,bonds,orothersecurities.(LO3ends)

4.Identifytheservicesprovidedbyfinancialinstitutions

Financialinstitutionsprovidecustomerswithawiderangeofservices.Oneofthe
mostcommonisacheckingaccount.Acheckisawrittenorderforabankorother
financialinstitutiontopayastateddollaramounttothebusinessorpersonindicatedon
thefaceofthecheck.Todaymostfinancialinstitutionsofferinterestpayingchecking
accounts,oftencalledNOWaccounts.NOWstandsfornegotiableorderofwithdrawal.
Inadditiontocheckingaccounts,savingsaccountsprovideasafeplacetostoremoney
untilitisneeded.Adepositorwhoiswillingtoleavemoneyondepositwithabankfora
setperiodoftimecanearnahigherrateofinterestbybuyingacertificateofdeposit,or
CD,whichisadocumentstatingthatthebankwillpaythedepositoraguaranteedinterest
rateformoneyleftondepositforaspecifiedperiodoftime.Theserateschangeweekly.
Financialinstitutionsalsooffershorttermandlongtermloans.Shortterm
businessloansmustberepaidinoneyearorless.Theyaretypicallyusedtopurchase
inventory,financepromotionalneeds,andsolvecashflowproblems.Toensurethat
shorttermmoneywillbeavailablewhenneeded,manyfirmsestablisheitheralineof
credit,aloanthatisapprovedbeforethemoneyisactuallyneeded,orarevolvingcredit
agreement,whichisaguaranteedlineofcredit.Longtermbusinessloansarerepaidover
alongerperiod,usually3to7years.Theyaremostoftenusedtofinanceexpansionof
facilities,replaceequipment,ordevelopthefirmsproductmix.Mostlendersrequire

195
collateral,realestateorpropertypledgedassecurityforaloan,forlongtermloans.Ifthe
borrowerfailstorepaytheloan,thelendercanrepossessthecollateral.
Finally,financialinstitutionsoffercreditcardanddebitcardtransactions.Credit
iswelcomedbybusinessesbecausecredittransactionsareeasilyconvertibletocash.In
returnforthis,thebankchargesthemerchantafee.Individualslikecreditcardsbecause
theyallowpurchaserstobuyimmediatelyandhavealmostamonthtorepaywithoutany
penalty.Adebitcard,ontheotherhand,electronicallysubtractstheamountofyour
purchasefromyourbankaccountatthemomentthepurchaseismade.Othertraditional
servicesincludefinancialadvice,payrollservices,certifiedchecks,trustservices,and
safedepositboxes.(LO4ends)

5.Understandhowfinancialinstitutionsarechangingtomeettheneedsofdomesticand
internationalcustomers

Bankingisundergoingenormouschanges,particularlyasaresultoftechnology.
Amongthelawsenactedduringthelastthirtyyearstoderegulatethebankingindustry,
probablythemostimportantistheFinancialServicesModernizationBankingAct.This
actallowedbankstoestablishonestopfinancialsupermarketswherecustomerscan
bank,buyandsellsecurities,andpurchaseinsurancecoverage.Becauseofthisact,
competitionamongbanks,brokeragefirms,andinsurancecompanieshasincreased.
MoreandmoreAmericansvisitATMsforcashanddosomeoralloftheirbanking
electronically.Manyofthesechangesbegansome30yearsago,whenCongressenacted
anumberoflawsdesignedtoderegulatethebankingindustry,includingallowingsavings
andloanstoofferNOWaccounts,phasingoutinterestceilingsondeposits,eliminating
ceilingsonhomemortgages,andraisingthedepositinsuranceceilingto$100,000.Inthe
nextdecades,increasedtechnologyandtheneedtohelpAmericanbusinessescompetein
theglobalmarketplacewillmeanthatfinancialinstitutionswillofferanevenwiderarray
ofservices.Onlinebankingincludessuchactivitiesaselectronicfundstransfer(EFT),
whichisameansofperformingfinancialtransactionsthroughacomputerterminalor
telephonehookup.EFTactivitiesareexpectedtogrowsubstantially,andincludetheuse

196
ofATMs,automatedclearinghousesorACHs(usedbylargecompaniestotransferwages
andsalariesdirectlytoemployeesbankaccounts),andpointofsale(orPOS)terminals,
whicharecomputerizedcashregisterslocatedinretailstoresandconnectedtoabanks
computer.Asimilarprocesshappenswhenastoreuseselectroniccheckconversionto
processapapercheck.Electroniccheckconversion(ECC)isusedtoconvertinformation
fromapapercheckintoanelectronicpaymentformerchandise,services,orbills.
Internationalbankingservicesareextremelyimportant.Abankcanhelpafirmin
twoways,byproviding(1)aletterofcredit,whichisalegaldocumentissuedbya
financialinstitutionguaranteeingtopayasellerastatedamountforaspecifiedperiodof
time,ifcertainconditionsaremet,or(2)abankersacceptance,whichisawrittenorder
forabanktopayathirdpartyastatedamountofmoneyonaspecifieddate.Bothaletter
ofcreditandabankersacceptancearepopularmethodsofpayingforimportandexport
transactions.Banksalsoprovideforinternationalcurrencyexchange.
LongbeforeCongressenactedlawsthatbeganthederegulationprocess,itpassed
theBankingActof1933toprotectdepositorsfromtheriskofbankfailure.Italso
organizedtheFederalDepositInsuranceCorporation,orFDIC,whichinsuresdeposits
againstbankfailures.TheFDICinsuresalldepositsinallmemberfinancialinstitutions
upto$100,000.AllbanksthatarepartoftheFederalReservesystem,mustbelongtothe
FDICandpayinsurancepremiums,andmanyotherschoosetojoin.(LO5ends)

6.Explainhowdepositinsuranceprotectscustomers

TheFederalDepositInsuranceCorporation(FDIC)andtheNationalCreditUnion
Association(NCUA)insureaccountsinmemberfinancialinstitutionsforupto$100,000
fornonretirementaccountsand$250,000forsometypesofretirementaccounts.Note:
TheEmergencyEconomicstabilizationActof2008increasedFDICandNCUA
coveragefrom$100,000to$250,000perdepositorthroughDecember31,2009.Deposits
maintainedindifferentcategoriesoflegalownershipareinsuredseparately.Themost
commonownershipcategoriesaresingleownershipandjointownership.Itisalso
possibletoobtainadditionalcoveragebyopeningseparateaccountsindifferentbanks,

197
S&Ls,orcreditunions.TheFDICandNCUAhaveimprovedbankingintheUnited
States.Wheneitheroftheseorganizationsinsuresafinancialinstitutionsdeposits,they
reservetherighttoexaminethatinstitutionsoperationsperiodically.Ifabank,S&L,or
creditunionisfoundtobepoorlymanaged,itisreportedtotheproperbankingauthority.
(LO6ends)

7.Discusstheimportanceofcreditandcreditmanagement
Howdobanksandotherlendersdecidetowhomtheyaregoingtolendmoneyor
extendcredit?Theyevaluateallapplicantsbylookingatseveralfactors.Creditis
immediatepurchasingpowerthatisexchangedforapromisetorepayborrowedmoney,
withorwithoutinterest,atalaterdate.LendersgenerallylookatthefiveCsofcredit
management.Thefirstischaracter,whichistheborrowersattitudetowardcredit
obligations.Thesecondiscapacity,theborrowersfinancialabilitytomeetthecredit
obligations.Thethirdiscapital,whichreferstotheborrowersassetsornetworth.The
fourthiscollateral,whichyoumayrecallisrealestateorpropertypledgedassecurity;
andthefifthisconditions,whichreferstothegeneraleconomicconditions.
Thelenderthenverifiestheaccuracyoftheborrowersclaimbyconsultingglobal
orlocalcreditreportingagencies,checkingindustryassociationsorotherfirmsthathave
extendedtheapplicantcredit.(LO7ends)

198

You might also like