Introduction to Finance Markets, Investments, and Financial Management Sixteenth Edition by Ronald W. Melicher and Edgar A. Norton

Introduction to Finance Markets, Investments, and Financial Management Sixteenth Edition by Ronald W. Melicher and Edgar A. Norton

PART 1

INSTITUTIONS AND MARKETS
Introduction
Ask someone what he or she thinks “fi nance” is about. You’ll probably get a variety of 
responses: “It deals with money.” “It is what my bank does.” “The New York Stock Exchange 
has something to do with it.” “It’s how businesses and people get the money they need—you 
know, borrowing and stuff like that.” And they’ll all be correct!
Finance is a broad fi eld. It involves national and international systems of banking and the 
fi nancing of business. It also deals with the process you go through to get a car loan and what 
a business does when planning for its future needs.
It is important to understand that while the U.S. fi nancial system is quite complex, it gen-

erally operates very effi ciently. However, on occasion, imbalances can result in economic, real 
estate, and stock market “bubbles” that, when they burst, cause havoc on the workings of the 
fi nancial system. The decade of the 2000s began with the bursting of the “tech” or technology 
bubble and the “dot.com” bubble. Then, in mid-2006, the real estate bubble, in the form of 
excessive housing prices, burst. This was followed by peaking stock prices in 2007 that were, 
in turn, followed by a steep decline that continued into early 2009. Economic activity began 
slowing in 2007 and deteriorated into an economic recession beginning in mid-2008, which was 
accompanied by double-digit unemployment rates. The result was the 2007–09 “perfect fi nan-

cial storm” that produced the most distress on the U.S. fi nancial system since the Great Depres-

sion years of the 1930s. Of course, new economic and fi nancial concerns will continue to occur.
Within the general fi eld of fi nance, there are three areas of study—fi nancial institutions 
and markets, investments, and fi nancial management. Financial institutions collect funds from 
savers and lend them to, or invest them in, businesses or people that need cash. Examples 
of fi nancial institutions are commercial banks, investment banks, insurance companies, and 
mutual funds. Financial institutions operate as part of the fi nancial system. The fi nancial sys-

tem is the environment of fi nance. It includes the laws and regulations that aff ect fi nancial 
transactions. The fi nancial system encompasses the Federal Reserve System, which controls 
the supply of money in the U.S. economy. It also consists of the mechanisms that have been 
constructed to facilitate the fl ow of money and fi nancial securities among countries. Financial 
markets represent ways for bringing those who have money to invest together with those who 
need funds. Financial markets, which include markets for mortgages, securities, and curren-

cies, are necessary for a fi nancial system to operate effi ciently. Part 1 of this book examines the 
fi nancial system, and the role of fi nancial institutions and fi nancial markets in it.
Securities markets play an important role in helping businesses and governments raise 
new funds. Securities markets also facilitate the transfer of securities between investors. A 
securities market can be a central location for the trading of fi nancial claims, such as the New 
York Stock Exchange. It may also take the form of a communications network, as with the 
over-the-counter market, which is another means by which stocks and bonds can be traded. 

When people invest funds, lend or borrow money, or buy or sell shares of a company’s stock, 
they are participating in the fi nancial markets. Part 2 of this book examines the role of secur-

ities markets and the process of investing in bonds and stocks.
The third area of the fi eld of fi nance is fi nancial management. Financial management 
studies how a business should manage its assets, liabilities, and equity to produce a good or 
service. Whether or not a fi rm off ers a new product or expands production, or how to invest 
excess cash, are examples of decisions that fi nancial managers are involved with. Financial 
managers are constantly working with fi nancial institutions and watching fi nancial market 
trends as they make investment and fi nancing decisions. Part 3 discusses how fi nancial con-

cepts can help managers better manage their fi rms.
The three areas of fi nance interact with, and overlap, one another. Financial institutions 
operate in the environment of the fi nancial markets, and work to meet the fi nancial needs of 
individuals and businesses. Financial managers do analyses and make decisions based on 
information they obtain from the fi nancial markets. They also work with fi nancial institutions 
when they need to raise funds and when they have excess funds to invest. Participants invest-

ing in the fi nancial markets use information from fi nancial institutions and fi rms to evaluate 
diff erent investments in securities such as stocks, bonds, and certifi cates of deposit. A person 
working in one fi eld must be knowledgeable about all three. Thus, this book is designed to 
provide you with a survey of all three areas of fi nance.
Part 1, Institutions and Markets, presents an overview of the fi nancial system and its important 
components: policy makers, monetary system, fi nancial institutions, and fi nancial markets. Finan-

cial institutions operate within the fi nancial system to facilitate the work of the fi nancial markets. 
For example, you can put your savings in a bank and earn interest. But your money just doesn’t 
sit in the bank. The bank takes your deposit and the money from other depositors and lends it to 
Kathy, who needs a short-term loan for her business; to Ian for a college loan; and to Roger and 
Jayden, who borrow the money to help buy a house. Banks bring together savers and those who 
need money, such as Kathy, Ian, Roger, and Jayden. The interest rate the depositors earn and the 
interest rate that borrowers pay are determined by national and even international economic forces. 
Just what the bank does with depositors’ money and how it reviews loan applications is determined 
to some extent by bank regulators and fi nancial market participants, such as the Federal Reserve 
Board. Decisions by the president and Congress relating to fi scal policies and regulatory laws may 
also directly infl uence fi nancial institutions and markets and alter the fi nancial system.
Chapter 1 provides an overview of the fi nancial environment. Chapter 2 covers the role 
and functions of money, money market securities, and the interaction of money supply and 
economic activity in the monetary system. Depository institutions, such as banks and savings 
and loan associations, as well as other fi nancial institutions involved in the fi nancial inter-

mediation process are the topics of Chapter 3. The Federal Reserve System, the U.S. central 
bank that controls the money supply, is discussed in Chapter 4. Chapter 5 places the previous 
chapters in perspective, discussing the role of the Federal Reserve and the banking system in 
helping meet national economic goals for the United States, such as economic growth, high 
levels of employment, and stable prices. Part 1 concludes with a discussion of the international 
monetary system, currency exchange markets and rates, and international trade in Chapter 6.

Introduction to Finance Markets, Investments, and Financial Management Sixteenth Edition by Ronald W. Melicher and Edgar A. Norton