5 core principles and 6 parts of financial system -ECON 3311

CP 1

Time has value

CP 2

Risk requires compensation

CP 3

Information is the basis for all decisions

CP 4

Markets determine prices and allocate resources

CP 5

Stability improves welfare

6 Parts of Financial System

1. Money

2. Financial Instruments

3. Financial Markets

4. Financial Institutions

5. Regulatory Agencies

6. Central Banks

Commodity Monies

Things with intrinsic value

• Usable by most

• Easily transportable

• Divisible into smaller amounts

• Durable

• Can be made into standardized qty.

GOLD IS THE MOST COMMON

Fiat Money

Value comes from government decree, or fiat

• These bills are accepted because the government stands behind it

• Can pay taxes to governments

Financial Instruments

The written legal obligation of one party to transfer something of value to another party at some future date, under specified conditions

Uses of Financial Instruments

• Means of payment

• Store of value

• Transfer of risk

Role of Financial Markets

• Ensures owners can buy/sell financial instruments cheaply; keeps transactions costs low

• Gathers information about issuers of financial instruments

• Provides individuals a place to buy/sell risk

Role of Financial Institutions

• Reduces transactions costs

• Reduce the information costs of screening and monitoring powers

• Give savers ready access to their funds

Efficient Market Hypothesis

Prices reflect all available information

High-Frequency Trading

Algorithm-based rapid trading, which increases speed but may reduce market stability

Financial Markets

A platform where financial instruments are bought and sold

Financial Institutions

Organizations that provide financial services by channeling funds from savers to borrowers