Chapter No.

16
The Financial System
Presented By
Muhammad Shahid Iqbal
MP-13-20

The Financial System

The process by which money flows
from savers to users.
Financial
Institutions

Users

Savers

Financial
Markets

Types of Securities
Securities are financial instruments
that represent obligations on the part
of the issuers to provide the
purchasers with expected stated
returns on the funds invested or
loaned.
Also called financial instruments

Money Market
Instruments
Money market instruments are shortterm debt securities issued by
governments, financial institutions,
and corporations.
Matures within one year
Pay interest to the investor
Treasury bills, commercial paper, and
bank certificates of deposit.

Bonds
Bondholders are creditors of a
corporation or government body.
Types of Bonds:
Government bonds
State and local governments
(municipal bonds)
revenue bond
general obligation bond

Bonds
Corporations (Secured bonds).
debentures (Unsecured bonds).
mortgage pass-through security
Quality Ratings for Bonds:
Bonds with the lowest level of risk
are rated AAA.
As ratings descend, risk increases.

Bonds
Investment grade:
AAA, AA, A , BBB
Speculative grade:
BB, B, CCC, CC, C
Bond price is effected by Interest rate
Bond price is also effected by
marketed Interest rate
Call Provision.

Stocks
Common stock, The basic form of
corporate ownership.
Preferred Stock, stocks whose
holders receive preference in the
payment of dividends.
Convertible Securities, the right to
exchange the bond or preferred stock
for a fixed number of shares of
common stock.

Financial Markets
financial markets, market in which
securities are issued and traded.
primary markets, financial market in
which firms and governments issue
securities and sell them initially to the
general public.
Initial public offering (IPO),
company offers stock for sale to the
general public for the first time.

Financial Markets
Underwriters , institutions purchase the
issue from the firm or government and
then resell the issue to investors.
secondary market, collection of financial
markets in which previously issued
securities are traded among investors.
The New York Stock Exchange (NYSE), The
Karachi Stock Exchange are examples of
secondary market.

Financial Markets

Electronic communications
networks (ECNs), buyers and sellers
meet in a virtual stock market and
trade directly with one another. No
specialist or market maker is involved.
Market order, instructs the broker to
obtain the best possible pricethe
highest price when selling and the
lowest price when buying.
limit order, price ceiling when buying
or a price floor when selling.

Financial Institutions
financial institutions, the intermediary
between savers and borrowers,
collecting funds from savers and then
lending the funds to individuals,
businesses, and governments.
Commercial Banks, provides various
services that includes a wide range of
checking and savings deposit accounts,
consumer loans, credit cards, home
mortgage loans, business loans, and
trust services.

Financial Institutions
Electronic Banking, computerized
systems for conducting financial
transactions over electronic links.
Automated teller machine (ATM),
allow customers to make banking
transactions at any time by inserting
an electronic card into the machine
and entering a personal identification
number (PIN).

Financial Institutions
Online Banking, in which
consumers do some or all of their
banking on the Internet.
Federal Deposit Insurance
Corporation (FDIC), federal agency
that insures deposits at commercial
and savings banks.

Savings Banks and Credit

Unions
Also called savings and loan
associations or thrift institutions,
raised funds by accepting only
savings deposits and then lent these
funds to consumers to buy homes.
Credit unions are cooperative
financial institutions that are owned
by their depositors, all of whom are
members.

Savings Banks and

Credit Unions
Credit unions are not-for-profit
institutions, they often pay savers
higher rates of interest, charge lower
rates of interest on loans, and have
fewer fees than other financial
institutions.

Non-depository Financial
Institutions
Insurance Companies
Pension Funds
Mutual Funds:
Mutual funds are financial
intermediaries that raise money from
investors by selling shares.

The Role of the State Bank of

Pakistan
The State Bank of Pakistan is the
central bank and is an important part
of the nations financial system and
has four basic responsibilities:
1- Regulating commercial banks
2- performing banking-related
activities
3- providing services for banks
4- setting monetary policy

Monetary Policy
The SBPs most important function is
controlling the supply of money and credit,
or monetary policy.
The two common measures of the money
supply are called M1 and M2.
M1 consists of currency in circulation and
balances in bank checking accounts.
M2 equals M1 plus balances in some
savings accounts and money market
mutual funds.

Monetary Policy
The SBP has four major policy tools
for controlling the growth in the
supply of money and credit.
Reserve requirements
Discount rate
Open market operations.
Term Auction Facility loans

Monetary Policy
The Fed requires banks to maintain
reserves, a certain percentage of
what the banks hold in deposits.
The higher the reserve requirement,
the less banks can lend out to
consumers and businesses and Vice
versa.

Monetary Policy
Discount rate, the interest rate at
which Central Bank make short-term
loans to member banks. If Central
Bank wants to slow the growth rate
in the money supply, it increases the
discount rate.
Open market operations, the
technique of controlling the money
supply growth rate by buying or
selling the securities.

Monetary Policy
Term auction facility, the Central
Bank makes extra funds available to
banks at low interest rates. The more
funds Central Bank offers, and the
lower the rate, the greater the
impact on market interest rates, the
supply of credit, and economic
activity.