General Economics
Economic Systems
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An economic system is a mechanism (social
institution) which deals with the production, distribution and consumption of
goods and services in a particular society.
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The basic economic systems
are:
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Market economy: "right-wing"
systems, such as capitalism that give more power to certain private individuals (or
corporations) to make economic distribution decisions, rather than leaving them
up to society as a whole, often limit government involvement in the economy,
and stress private property
o
Mixed economy: the "centrist"
economic system
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Planned economy: "left-wing"
systems, such as communism and socialism that involve a greater role for
society and/or the government to determine what gets produced, how it gets
produced, and who gets the produced goods and services, with the stated aim of
ensuring social justice and a more equitable distribution of wealth (egalitarianism)
o
Traditional economy: a generic term for the
oldest and traditional economic systems
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Definitions
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Recession: More
than 2 quarters (6 months) of negative growth.
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Laffer Curve: Invented by Arthur Laffer, shows the relationship between tax rates and
tax revenue. Tax rates increasing after a certain point (T*) would cause people
not to work as hard or not at all, thereby reducing tax revenue.
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American economist James Gwartney demonstrated the direct
relation between tax burden and economic growth. The higher the level of
taxation, the lower the growth rate. The explanation is as logical as it is
simple. The higher the tax level, the lower the incentives to make productive
contributions to society. The higher the fiscal burden, the more resources flow
from the productive sector to the ever more inefficient government apparatus
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Interest rates
dictate the cost of capital – how much companies must pay to borrow money for
capital improvement.
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Interest rates
also determine how much consumers much pay to borrow for home mortgages or
consumer purchases.
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Today there is
less spread between the interest rates of A-rated companies and “junk” rated
companies. This allows for more
borrowing by poor credit risk companies.
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A combination of
globalization, innovation, and good old-fashioned competition among markets has
made it easier and cheaper to raise and deploy money. Borrowers now can draw
funds from around the globe. And derivatives let financial institutions and
traders manage their risks with mind-blowing precision. With
Central Banks
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A central bank
is an entity responsible for the monetary policy of its country. Its primary
responsibility is to maintain the stability of the national currency and money
supply, but more active duties include controlling interest rates and acting as
a lender of last resort to the banking sector during times of financial crisis.
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Functions of a
central bank (not all functions carried out by all banks):
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Monopoly on the
issue of banknotes
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The Government's
banker and the bankers' bank ("Lender of Last Resort")
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Manages the
country's foreign exchange and gold reserves and the Government's stock
register
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Regulation and
supervision of the banking industry
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Setting the
official interest rate
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An
"independent central bank" is one which operates under rules designed
to prevent political interference; examples include the US Federal Reserve, the
Bank of England (since 1997), Reserve Bank of
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Instruments of
monetary policy
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Open Market
Operations: Central bank influences the money supply directly. Each time it
buys securities, exchanging money for the security, it raises the money supply,
while selling of securities lowers the money supply. It also includes Foreign
exchange operations such as forex swaps.
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All of these
interventions can also influence the foreign exchange market and thus the
exchange rate. For example the People's Bank of China and the Bank of Japan
have on occasion bought several hundred billions of U.S. Treasuries, presumably
in order to stop the decline of the U.S. dollar versus the Renminbi and the
Yen.
o
Interest rates:
Used to manage both inflation and the country's exchange rate, and influence
the stock- and bond markets as well as mortgage and other interest rates.
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Capital and Reserve
Requirements: Commercial banks are required to delegate a percentage of their
deposits as reserves to reduce the risk of banks overextending themselves and
suffering from bank runs. For international banks, the threshold is 8%
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Banking
supervision and other activities: for example examining the banks' balance
sheets. It also provides banks with services such as transfer of funds, bank
notes and coins or foreign currency. Thus it is often described as the
"bank of banks".
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One of the
oldest banks that performed some of the duties of a central bank was the Bank
of Sweden that was opened in 1668 with help from Dutch businessmen. This was
followed in 1694 by the Bank of England, created by a businessman in the City
of London at the request of the English government to help pay for a war. The
US Federal Reserve was created by the U.S. Congress through the passing of the
Glass-Owen Bill, signed by President Woodrow Wilson in 1913.
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The word bank is derived from the Italian banca,
which means bench.
- The terms bankrupt and "broke" are similarly derived from banca
rotta, which refers to an out of business bank, having its bench
physically broken.
- Money lenders in
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A bank aggregates the activities of many borrowers and
lenders. A bank accepts deposits from lenders, on which it pays the interest.
The bank then lends these deposits to borrowers from whom it collects interest.
Banks allow borrowers and lenders of different sizes to coordinate their
activity.
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Banks
incorporate in
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Investment banks assist public and private
corporations in raising funds in the capital markets (both equity and
debt), as well as in providing strategic advisory services for mergers,
acquisitions and other types of financial transactions. They also act as
intermediaries in trading for clients.
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Commercial banks which take deposits and
make commercial and retail loans.
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Universal banks, more commonly known as
a financial services company, engage in several of these activities.
- For example, Citigroup, a very large American bank, is involved in
commercial and retail lending; it owns a merchant bank (Citicorp Merchant
Bank Limited) and an investment bank (Salomon Smith Barney); it operates a
private bank (Citigroup Private Bank)
- In recent years the lines between investment and commercial banks have
blurred, especially as commercial banks have offered more investment
banking services.
- In the
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Brokerages assist in the purchase
and sale of stocks, bonds, and mutual funds. In some cases, brokerages and
investment banks are integrated into single firms.
Investment Banks
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Investment banks
"underwrite" (guarantee
the sale of) stock and bond issues and advise on mergers
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Merchant banks were traditionally banks which engaged in trade financing. The modern
definition, however, refers to banks which provide capital to firms in the form
of shares rather than loans.
o
Unlike Venture
capital firms, they tend not to invest in new companies.
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A key role of investment banks is to help companies raise
capital in the capital markets by arranging the issuance of new securities.
There are two ways to do this: through a public offering or through a private placement.
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A public offering involves selling securities to a
wide range of investors. The investment bank can sell the company's stock in an
initial public offering (IPO) or secondary offering, or they can arrange a bond
issue.
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A private placement is an offering of securities
to a small group of sophisticated investors. The distribution of investments in
venture capital or private equity, acquisitions and other strategic investments
by companies is usually done through private placement
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Bulge bracket refers to the first group listed on the
'tombstone'. That is, the group of firms in an underwriting syndicate (a group
of investment banks) who are responsible for selling the largest amounts of the
stock to investors. Their names appear first in the advertisement listing,
called the tombstone. The term 'bulge bracket' loosely translates into the
largest full service brokerages/investment banks.
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Goldman Sachs, Morgan Stanley, and Merrill Lynch are
considered the ultimate examples (sometimes called the “Super Bulge Bracket.”)
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Citigroup/Salomon Smith Barney, CSFB, JPMorgan Chase,
Bear Stearns, and Lehman Brothers are considered to have joined the
o
Globally, JPMorgan Chase, Deutsche Bank and UBS
Warburg/PaineWebber are typically thrown with the
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Finance is the management of debts and assets through the use of appropriate
financial instruments
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Finance is used by individuals (personal finance), by
governments (public finance), by businesses (corporate finance), etc., as well
as by a wide variety of organizations.
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Investment is related to saving or deferring
spending or consumption. An asset is usually purchased, or loaned (i.e. a
deposit is made in a bank), in hopes of getting a future return or interest
from it.
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A security is a fungible, negotiable interest
representing financial value.
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Securities are broadly categorized into debt and equity securities.
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Debt securities may be called debentures, bonds, notes or
commercial paper depending on their maturity and certain other characteristics.
The holder of a debt security is typically entitled to the payment of principal
and interest, together with other contractual rights under the terms of the
issue, such as the right to receive certain information. Debt securities are
generally issued for a fixed term and redeemable by the issuer at the end of
that term.
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An equity security is a share in the capital stock of a
company. The holder of an equity is a shareholder, owning a share, or
fractional part of the issuer. Equity securities are not entitled to any
regular payment. In bankruptcy, they share only in the residual interest of the
issuer after all obligations have been paid out to creditors. However, equity
generally entitles the holder to a pro rata portion of control of the company,
including voting rights.
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The company or other entity issuing the security is
called the issuer.
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Securities may be represented by a certificate or, more
typically, by an electronic book entry interest.
o
Certificates may be bearer, meaning they entitle the
holder to rights under the security merely by holding the security, or
registered, meaning they entitle the holder to rights only if he or she appears
on a security register maintained by the issuer or an intermediary.
o
Securities include shares of corporate stock or mutual
funds, bonds, stock options or other options, limited partnership units, and
various other formal investment instruments that are negotiable and fungible
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Bonds and stocks are both securities, but the difference is that stock holders own a part of
the issuing company (have an equity stake), whereas bond holders are in essence
lenders to the issuer.
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Also bonds usually have a defined term, or maturity,
after which the bond is redeemed whereas stocks may be outstanding
indefinitely.
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The public securities markets can be divided into primary
and secondary markets.
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In the primary market,
the money for the securities is received by the issuer of those securities from
investors, whereas in the secondary market,
the money goes from one investor to the other.
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When a company issues public stock for the first time,
this is called an Initial Public Offering (IPO). A company can later issue more
new shares, or issue shares that have been previously registered in a shelf
registration. These later new issues are also sold in the primary market, but
they are not considered to be an IPO.
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Issuers usually retain investment banks to assist them in administering the IPO, getting
SEC approval, and selling the new issue.
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When the investment bank buys the entire new issue from
the issuer at a discount to resell it at a markup, it is called an underwriting, or firm commitment.
However, if the investment bank considers the risk too great for an
underwriting, it may only assent to a best effort agreement, where the
investment bank will simply do its best to sell the new issue.
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In order for the primary market to thrive, there must be
a secondary market, or aftermarket, where holders of securities can sell them
to other investors. Organized exchanges
constitute the main secondary markets. Many smaller issues and most debt
securities trade in the decentralized, dealer-based over-the-counter markets.
o
Growth in informal electronic trading systems has
challenged the traditional business of stock exchanges. Large volumes of
securities are also bought and sold "over the counter" (OTC). OTC
dealing involves buyers and sellers dealing with each other by telephone or
electronically on the basis of prices that are displayed electronically, usually
by commercial information vendors such as Reuters and Bloomberg.
o
There are also
eurosecurities, which are securities that are issued outside their domestic
market into more than one jurisdiction. They are generally listed on the
Luxembourg Stock Exchange or admitted to listing in
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· In the primary markets, securities may be offered to the public in a