Elements Of Finance 2

ELEMENTS OF FINANCE

Prepared by Ayobami Adeloye

Definitions of Finance  The

commercial activity of providing funds and capital  The branch of economics that studies the management of money and other assets  obtain or provide money for; "Can we finance the addition to our home?"  sell or provide on credit  The management of money and credit and banking and investments

Essential characteristics of money  It

must be a medium of exchange

 It

must be a unit of account

 It

must be a store of value

Desirable features of money  It

must have a stable value.  It must be difficult to counterfeit.  It must be easily divisible and transportable.  It must be fungible. That is, one artifact of the token or good must be equivalent to another.

Modern forms of money  When

using money anonymously, the most common methods are  cash (either coin or banknotes)  stored-value

cards.

Banks A

Bank is basically a financial intermediary that bridges the gap between people with excess funds and those in need of funds at a price  The essential function of a bank is to provide services related to the storing of deposits and the extending of credit.

Services typically offered by banks  Directly

taking deposits from the general public and issuing checking and savings accounts  Lending out money to companies and individuals  Cashing cheques  Facilitating money transactions such as wire transfers and cashiers checks  Issuing credit cards, ATM, and debit cards  online banking  Storing valuables, particularly in a

Types of banks

Central banks usually control monetary policy and may be the lender of last resort in the event of a crisis. They are often charged with controlling the money supply, including printing paper money. Examples of central banks are the Central Bank of Nigeria, Bank of England, the European Central Bank and the U.S. Federal Reserve Bank.  Commercial bank, is the term used for a normal bank to distinguish it from an investment bank. Since the two no longer have to be under separate ownership, some use the term "commercial bank" to refer to a bank or a division of a bank that mostly deals with corporations or large businesses.  Community development bank are regulated banks that provide financial services and credit to underserved markets or populations.  Investment banks "underwrite" (guarantee the sale of) stock and bond issues and advise on mergers. Examples of investment banks are IBTC of Nigeria, Goldman Sachs of the USA or Nomura Securities of 

Types of banks (Contd) Merchant banks were traditionally banks which engaged in trade financing. The modern definition, however, refers to banks which provides capital to firms in the form of shares rather than loans. Unlike Venture capital firms, they tend not to invest in new companies.  Universal banks, more commonly known as a financial services company, engage in several of these financial activities. Hence the term financial supermarket  Islamic Banks,Islamic banking revolves around several well-established concepts - based on Islamic canons. Concept of Interest, in Islam is forbidden. Hence, all banking activities must avoid interest. Instead of interest, the Bank earns profit (mark-up) and fees on financing facilities it extends to customers. Also, depositors earn a share of the 

Role in the money supply 





A bank raises funds by attracting deposits, borrowing money in the inter-bank market, or issuing financial instruments in the money market or a capital market. The bank then lends out most of these funds to borrowers. However, it would not be prudent for a bank to lend out all of its balance sheet. It must keep a certain proportion of its funds in reserve so that it can repay depositors who withdraw their deposits. Bank reserves are typically kept in the form of a deposit with a central bank. This behaviour is called fractional-reserve banking and it is a central issue of monetary policy. Some governments (or their central banks) restrict the proportion of a bank's balance sheet that can be lent out, and use this as a tool for controlling the money supply. Even where the reserve ratio is not controlled by the government, a minimum figure will still be set by regulatory authorities as part of

Money supply 



  

Because (in principle) money is anything that can be used in settlement of a debt, there are varying measures of money supply. The narrowest (ie. more restrictive) measures count only those forms of money held for immediate transactions. Broader measures include money held as a store of value. Different measures of money have different technical definitions. The most common measures are named M0, M1, and M2 (from narrow to broadly defined). In the United States, as defined by the Federal Reserve System, they are as follows: M0: The total of all coins 'minted' and paper 'printed' cash in circulation. (ie Currency) M1: M0 + the amount in checking or demand deposit accounts M2: M1 + other various savings account types, money market accounts, and

Bank regulation  Banks

are subject to certain bank regulations and requirements that aim to uphold the soundness and integrity of the financial system. These are:  Reserve requirements  Capital requirements

Reserve requirements  Reserve

requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at the central bank, rather than, perhaps, lend out. Reserve requirements represent a cost to the banking system. Bank reserves, meanwhile, are used in the day-to-day implementation of monetary policy by the Central Bank  As of 2005, in Nigeria, the reserve requirement (Cash Reserve) are 10% on all deposits, As "a tool of monetary policy", they are one way of influencing the country's financial behavior, borrowing, and interest rates.

Reserve Requirements and Money Creation

 Reserve

requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a N100 deposit may lend out N90 of that deposit. If the borrower then writes a check to someone who deposits the N90, the bank receiving that deposit can lend out N81. As the process continues, the banking system can expand the initial deposit of N100 into a maximum of N1,000 of money (N100+N90+81+N72.90+...=N1,000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial N100 deposit into a maximum of N500 (N100+N80+N64+N51.20+...=N500). Thus, higher reserve requirements should result in