Please answer the following question(s) with a minimum of 150 – 200 word count total. A cover page/title page is not needed. Use APA format with scholarly articles to support your answer, include in-text citations and a reference page. Please use the reference that I provided in the attached file, here is the reference: Ferrell, O., Hirt, G., & Ferrell, L. (2009). Business in a Changing World. (7th ed.) pg. XX. New York, NY: McGraw-Hill Irwin. (Do not forget the page number where you’re using the reference) Please use additional scholarly articles, total of 2 references required, the one I provided you and another from your research! No PLAGIARISM and let me know if you have any questions or concerns! “Please review the attached file before proceeding”A) How would you market a new product?B) How does product quality and the customer’s expectations factor in your marketing strategy?C) Share some examples of a product you use that has good quality and exceeds your expectation and share an example of a product that is poor quality.
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15
Money and the
Financial System
Learning Objectives
After reading this chapter, you will be able to:
W
LO 15-1
LO 15-2
Define money, its functions,
and its characteristics.
R
LO 15-3
Specify how the Federal
G Reserve Board manages the money
supply and regulates the American banking system.
Describe various types
I of money.
H
LO 15-4 Compare and contrast
T commercial banks, savings and loan
associations, credit unions, and mutual savings banks.
LO 15-5
,
Distinguish among nonbanking institutions such as insurance
companies, pension funds, mutual funds, and finance companies.
S
H
LO 15-7 Recommend the most appropriate financial institution for a
E
hypothetical small business.
R
R
Y
LO 15-6 Investigate the challenges ahead for the banking industry.
Chapter
Outline
Introduction
Money in the Financial System
Functions of Money
Characteristics of Money
Types of Money
The American Financial System
The Federal Reserve System
Banking Institutions
Nonbanking Institutions
Electronic Banking
Future of Banking
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2
7
9
3
B
U
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Enter the World of Business
The Good and the Bad of a Cashless Society
The rise of alternative payment methods is making people wonder whether
W
further development and integration R
of technology, big data, and cashless
I
payment methods. However, we see evidence
of this occurring with the use of
G as Bitcoin, PayPal, and Mastercard’s
virtual money and payment methods such
Paypass. More than 80 percent of consumer
transactions in the United States
H
are electronic, and Sweden estimates T
that only 3 percent of its transactions are
made with actual currency.
,
our future is headed toward a cashless society. Such a society would involve
Critics feel that a cashless society could be used to control consumer
purchasing. For instance, algorithms are currently used to alert debit and
S
H
and MasterCard are also using them to prohibit credit and debit transactions in
E
online gambling, even if it is not illegal. Could this type of consumer regulation be
R
applied to all purchases? For example, if an overweight person tries to purchase
a sugary drink, could data about the R
person be used to deny the purchase?
Yprotect consumers from bad decision
While this might seem to be a way to
credit card users of fraud. While these technologies protect customers, Visa
making, it also limits consumer choice.
On the other hand, there are many2advantages. Governments support the
idea of a cashless society because it eliminates
the cost of printing money and
7
makes monetary policy easier. It can save
9 consumers in costs as well. People
lose approximately $200 billion through various ATM fees, theft, and taxes.
3
B
perhaps leading to less crime. There is still one major benefit for using cash,
U
Controls can be used to protect electronic currency and guard against theft,
however. Psychological research has shown that people tend to make wiser
purchasing decisions when they use cash over any other payment method.1
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458
Part 6
Financing the Enterprise
Introduction
finance
the study of money; how it’s
made, how it’s lost, and how
it’s managed
LO 15-1
money
anything generally accepted
in exchange for goods and
services
From Wall Street to Main Street, both overseas and at home, money is the one tool
used to measure personal and business income and wealth. Finance is the study of
money: how it’s made, how it’s lost, and how it’s managed. This chapter introduces
you to the role of money and the financial system in the economy. Of course, if you
have a checking account, automobile insurance, a college loan, or a credit card, you
already have personal experience with some key players in the financial world.
We begin our discussion with a definition of money and then explore some of the
many forms money may take. Next, we examine the roles of the Federal Reserve Board
and other major institutions in the financial system. Finally, we explore the future of
the finance industry and some of the changes likely to occur over the course of the next
several years.
W
R
Money in the Financial
System
I
Strictly defined, money, or currency,
is anything generally accepted in exchange
G
for goods and services. Materials as diverse as salt, cattle, fish, rocks, shells, cloth,
as well as precious metals suchH
as gold, silver, and copper have long been used by
various cultures as money. Most
T of these materials were limited-supply commodities that had their own value to society (for example, salt can be used as a preserva,
tive and shells and metals as jewelry).
The supply of these commodities therefore
determined the supply of “money” in that society. The next step was the development of “IOUs,” or slips of paper that could be exchanged for a specified supply
S
of the underlying commodity. “Gold”
notes, for instance, could be exchanged for
gold, and the money supply was
Htied to the amount of gold available. While paper
money was first used in North America in 1685 (and even earlier in Europe), the
E
concept of fiat money—a paper money not readily convertible to a precious metal
such as gold—did not gain full R
acceptance until the Great Depression in the 1930s.
The United States abandoned its gold-backed currency standard largely in response
R
to the Great Depression and converted to a fiduciary, or fiat, monetary system. In
the United States, paper moneyY
is really a government “note” or promise, worth the
value specified on the note.
2
7 uses for money, its primary purpose is to enable
No matter what a particular society
a person or organization to transform
9 a desire into an action. These desires may be
for entertainment actions, such as party expenses; operating actions, such as paying
for rent, utilities, or employees;3investing actions, such as buying property or equipment; or financing actions, suchB
as for starting or growing a business. Money serves
three important functions: as a medium of exchange, a measure of value, and a store
U
of value.
Functions of Money
Medium of Exchange. Before fiat money, the trade of goods and services was
accomplished through bartering—trading one good or service for another of similar
value. As any school-age child knows, bartering can become quite inefficient—
particularly in the case of complex, three-party transactions involving peanut butter
sandwiches, baseball cards, and hair barrettes. There had to be a simpler way, and that
was to decide on a single item—money—that can be freely converted to any other
good upon agreement between parties.
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Chapter 15
Money and the Financial System
459
Measure of Value. As a measure of value, money serves as a
common standard or yardstick of the value of goods and services.
For example, $2 will buy a dozen large eggs and $25,000 will buy a
nice car in the United States. In Japan, where the currency is known
as the yen, these same transactions would cost about 185 yen and
2.3 million yen, respectively. Money, then, is a common denominator
that allows people to compare the different goods and services that
can be consumed on a particular income level. While a star athlete and
a “burger-flipper” are paid vastly different wages, each uses money as
a measure of the value of their yearly earnings and purchases.
Store of Value. As a store of value, money serves as a way to
accumulate wealth (buying power) until it is needed.W
For example, a
person making $1,000 per week who wants to buy aR
$500 computer
could save $50 per week for each of the next 10 weeks. Unfortunately,
I health of the
the value of stored money is directly dependent on the
economy. If, due to rapid inflation, all prices double in
Gone year, then
the purchasing power value of the money “stuffed in the mattress”
H when prices
would fall by half. On the other hand, deflation occurs
of goods fall. Deflation might seem like a good thingTfor consumers,
but in many ways it can be just as problematic as inflation. Periods
, increases in
of major deflation often lead to decreases in wages and
2
debt burdens. Deflation also tends to be an indicator of problems in
the economy. Deflation use indicates a very slow growth or shrinking
S Over the past
economy with high unemployment and falling prices.
25 years, we have seen deflation in Japan and more H
recently Ireland
in 2009.
For centures, people on the Micronesian island of
Yap have used giant round stones, like the ones
shown here, for money. The stones aren’t moved,
but their ownership can change.
E
R
Characteristics of Money
To be used as a medium of exchange, money must beRacceptable, divisible, portable,
stable in value, durable, and difficult to counterfeit. Y
Acceptability. To be effective, money must be readily acceptable for the purchase of goods and services and for the settlement of debts. Acceptability is probably
the most important characteristic of money: If people2do not trust the value of money,
businesses will not accept it as a payment for goods and
7 services, and consumers will
have to find some other means of paying for their purchases.
9
Divisibility. Given the widespread use of quarters, dimes, nickels, and pennies in
3
the United States, it is no surprise that the principle of divisibility is an important one.
B preferable trades imposWith barter, the lack of divisibility often makes otherwise
sible, as would be an attempt to trade a steer for a loaf
U of bread. For money to serve
effectively as a measure of value, all items must be valued in terms of comparable
units—dimes for a piece of bubble gum, quarters for laundry machines, and dollars
(or dollars and coins) for everything else.
Portability. Clearly, for money to function as a medium of exchange, it must be
easily moved from one location to the next. Large colored rocks could be used as
money, but you couldn’t carry them around in your wallet. Paper currency and metal
coins, on the other hand, are capable of transferring vast purchasing power into small,
easily carried (and hidden!) bundles. Few Americans realize it, but more U.S. currency
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Part 6
Financing the Enterprise
is in circulation outside the United States than within. Currently, about $1.280 trillion
of U.S. currency is in circulation, and the majority is held outside the United States.3
Some countries, such as Panama, even use the U.S. dollar as their currency. Retailers
in other countries often state prices in dollars and in their local currency.
Stability. Money must be stable and maintain its declared face value. A $10 bill
should purchase the same amount of goods or services from one day to the next. The
principle of stability allows people who wish to postpone purchases and save their
money to do so without fear that it will decline in value. As mentioned earlier, money
declines in value during periods of inflation, when economic conditions cause prices
to rise. Thus, the same amount of money buys fewer and fewer goods and services. In
some countries, people spend their money as fast as they can in order to keep it from
W destroys confidence in a nation’s money and its
losing any more of its value. Instability
ability to store value and serve as an effective medium of exchange. Ultimately, people
R
faced with spiraling price increases avoid the increasingly worthless paper money at
I in the form of real assets such as gold and land.
all costs, storing all of their savings
Durability. Money must be G
durable. The crisp new dollar bills you trade at the
music store for the hottest new Blu-ray
H movie will make their way all around town for
about six years before being replaced (see Table 15.1). Were the value of an old, faded
T
bill to fall in line with the deterioration
of its appearance, the principles of stability
and universal acceptability would
, fail (but, no doubt, fewer bills would pass through
the washer!). Although metal coins, due to their much longer useful life, would appear
to be an ideal form of money, paper currency is far more portable than metal because
of its light weight. Today, coins S
are used primarily to provide divisibility.
H
TABLE 15.1 Life Expectancy of E
Money
How long is the life span of U.S. paper
Rmoney?
When currency is deposited with a Federal Reserve Bank, the quality of each note is evaluated by
R that meet our strict quality criteria—that is, they are still in
sophisticated processing equipment. Notes
good condition—continue to circulate, while
Y those that do not are taken out of circulation and destroyed.
This process determines the life span of a Federal Reserve note.
Life span varies by denomination. One factor that influences the life span of each denomination is how
the denomination is used by the public.2
For example, $100 notes are often used as a store of value. This
means that they pass between users less frequently than lower denominations that are more often used
for transactions, such as $5 notes. Thus,7$100 notes typically last longer than $5 notes.
Denomination
$ 1
$ 5
$ 10
9
3
B
U
Estimated Life Span*
5.9 years
4.9 years
4.2 years
$ 20
7.7 years
$ 50
3.7 years
$100
15.0 years
*Estimated life spans as of December 2012. Because the $2 note does not widely circulate, we do not publish its estimated life span.
Source: Board of Governors of the Federal Reserve System, “How Long Is the Life Span of U.S. Paper Money?” www.federalreserve.
gov/faqs/how-long-is-the-life-span-of-us-paper-money.htm (accessed June 12, 2014).
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Chapter 15
Money and the Financial System
461
W
R
I
G
H stable and enjoy universal
Difficulty to Counterfeit. Finally, to remain
acceptance, it almost goes without saying that money
T must be very difficult to
counterfeit—that is, to duplicate illegally. Every country takes steps to make coun,
terfeiting difficult. Most use multicolored money, and
The U.S. government redesigns currency to stay ahead of counterfeiters and protect the public.
many use specially watermarked papers that are virtu- DID YOU KNOW? Around 75 percent of counterfeit
ally impossible to duplicate. Counterfeit bills represent currency is found and destroyed before it ever reaches
less than 0.03 percent of the currency in circulationSin the public.4
the United States,5 but it is becoming increasingly easy
H
for counterfeiters to print money. This illegal printing of money is fueled by hunE
dreds of people who often circulate only small amounts
of counterfeit bills. To
thwart the problem of counterfeiting, the U.S. Treasury
R Department redesigned the
U.S. currency, starting with the $20 bill in 2003, the $50 bill in 2004, the $10 bill in
R
2006, the $5 bill in 2008, and the $100 bill in 2010. For the first time, U.S. money
includes subtle colors in addition to the traditional green,
Y as well as enhanced security features, such as a watermark, security thread, and color-shifting ink.6 Although
counterfeiting is not as much of an issue with coins, U.S. metal coins are usually
2 begun to cost more to manuworth more for the metal than their face value. It has
facture coins than what they are worth monetarily. 7
As Table 15.2 indicates, it costs more than a penny to manufacture a penny, resulting in a call to discontinue it. Because it costs more9to produce pennies and nickels
than what they are worth, these coins have generated
3 losses of $573.5 million in a
seven-year period.7 The redeeming feature of printing money is that the U.S. mint
Bonly costs 5.4 cents to make a
makes money on dimes, quarters, and dollars. Also, it
$1 bill and 10.2 cents to make a $20 or $50 bill. So what
U the U.S. Mint loses on pennies and nickels, the Treasury makes up on paper money.
Types of Money
While paper money and coins are the most visible types of money, the combined value LO 15-2
of all of the printed bills and all of the minted coins is actually rather insignificant
when compared with the value of money kept in checking accounts, savings accounts,
and other monetary forms.
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462
Part 6
TABLE 15.2
Fiscal Year
Costs to Produce Pennies
and Nickels
checking account
money stored in an account
at a bank or other financial
institution that can be
withdrawn without advance
notice; also called a demand
deposit
FIGURE 15.1
Financing the Enterprise
Cent Unit Cost (¢)
Nickel Unit Cost (¢)
Revenue from Coins (millions)
2013
1.83
9.40
($104.5)
2012
1.99
10.1
($109.2)
2011
2.41
11.18
($116.70)
2010
1.79
9.22
($42.60)
2009
1.62
6.03
($22.00)
2008
1.42
8.83
($47.00)
2007
1.67
9.53
($98.60)
W
2006
1.21
5.97
($32.90)
R
Total
($573.5)
I
Source: Various annual reports of the U.S. Mint.
G
H
You probably have a checking account (also called a demand deposit), money
stored in an account at a bank T
or other financial institution that can be withdrawn
without advance notice. One way to withdraw funds from your account is by writing a
,
check, a written order to a bank to pay the indicated individual or business the amount
specified on the check from money already on deposit. Figure 15.1 explains the significance of the numbers found S
on a typical U.S. check. As legal instruments, checks
serve as a substitute for currency and coins and are preferred for many transactions
H
E
R
R
JuneY23,
A Check
XYZ Corporation
530 W. Adams
Chicago, IL 60606
No. 177
20 13
70-1669/719
Pay to the
order of
Kristin Piotrowski
Two hundred fifty and no/100
FIRST BANK OF CHICAGO
312/555-8400
1245 S. State St.
Chicago, IL 60607
Memo
Temp secretarial
Clearing
number
Bank
number
Check sum
(a number used to
verify that everything
is correct)
fer79397_ch15_456-483.indd 462
Account
number
2
7
9
3
B
U
Check
number
$ 250.00
Dollars
Clearing number
Bank number
Regional bank
number
This gets put on
when the check clears.
It represents the
dollar amount,
in this case, $250.00.
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Chapter 15
Money and the Financial System
463
due to their lower risk of loss. If you lose a $100 bill, anyone who finds or steals it
can spend it. If you lose a blank check, however, the risk of catastrophic loss is quite
low. Not only does your bank have a sample of your signature on file to compare with
a suspected forged signature, but you can render the check immediately worthless by
means of a stop-payment order at your bank.
There are several types of checking accounts, with different features available for
different monthly fee levels or specific minimum account balances. Some checking savings accounts
accounts earn interest (a small percentage of the amount deposited in the account that accounts with funds that
the bank pays to the depositor). One such interest-bearing checking account is the usually cannot be withdrawn
NOW (Negotiable Order of Withdrawal) account offered by most financial institu- without advance notice; also
known as time deposits
tions. The interest rate paid on such accounts varies with the interest rates available
in the economy but is typically quite low (more recently less than 1 percent but in the money market accounts
W
past between 2 and 5 percent).
accounts that offer higher
Savings accounts (also known as time deposits) are
R accounts with funds that usu- interest rates than standard
ally cannot be withdrawn without advance notice and/or have limits on the number of bank rates but with greater
restrictions
I
withdrawals per period. While seldom enforced, the “fine print” governing most savings
accounts prohibits withdrawals without two or three days’
G notice. Savings accounts are certificates of
not generally used for transactions or as a medium of exchange, but their funds can be deposit (CDs)
H
savings accounts that
moved to a checking account or turned into cash.
T
Money market accounts are similar to interest-bearing
checking …
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