Thursday, April 30, 2009

Asset liquidity of banks

The liquidity of an asset can be defined as being the ease and certainly with which it can be turned into money. The most liquid asset of all, therefore, must be money itself. THE next most liquid assets are called near-money, or secondary reserves, as contrasted with primary cash reserves. Secondary reserves are money market assets, such as treasury bills, which have no credit risk and have little market risk. that is, these assets will be turned into money within a year by reason of a short-term maturity date. if they need to be sold before maturity, there is little capital loss involved , inasmuch as the market price is not subject to wide fluctuations. All banks need such secondary reserve to protect against either regular or unexpected cash withdrawals. Furthermore, the higher the proportion of term loans (business loans of over one-year maturity) in the loan portfolio of a bank, the more urgent was the necessity, it was thought, for that bank to have an adequate amount of highly liquid assets in the investment portfolio.

Monetization of debt

whenever commercial banks exchange their debt (demand deposits) for a private or governmental debt, they are creating money. It does not matter whether an individual or business firm is securing anew loan from a bank, or whether the bank is buying an outstanding U.S. government security; the result is the same ; debt has been monetized. The bank secure an earning asset, whereas the increase in their liabilities ( demand deposits)means that someone else now has money that he did not have before.
Commercial banks once had the privilege of printing bank notes, which were used as money in hand-to-hand circulation, but the bank note privilege is now restricted to the Treasury and the federal Reserve System. Nevertheless, the great growth in recent years in the use of checks for payment of goods, services, financial assets, and so on has meant that the banking system has kept its importance as the immediate source of most new money. the bank can still create money, but they do it by making changes in their balance sheets rather than by resorting to a printing press. However, before we examine the mechanics of bank deposit creation, let us first consider the major kinds of bank assets and liabilities, inasmuch as we use the balance sheet approach in our explanation of bank deposit creation.

factors effecting the money supply Determined by the central bank

Three of these six factors affecting the money supply are determined by the central bank,i.e., the total bank reserves, the legal reserve ratio behind demand deposit,and the legal reserve ratio behind time deposits. Two other factors, the demand for currency and the desired ratio of time deposits to demand deposits,are under the control of the public, whereas the demand for excess reserves is a function of commercial bank behavior. Only if we regard the public is bank is portfolio policies as being constant,i.e., not effected by interest rate and income demand changes, can we regard the money supply as being exogenously or externally determined by the central bank.

process of money creation

the creation of money seem much less mysterious after the process is examined step by step. It may then be realized that this process of money creation depends upon (1) a fractional legal reserve requirement, so that banks do not have to maintain 100 per cent reserves against their demand deposits,(2) a fractional legal reserve ratio against time deposits, (3) the provision of added reserves by the central bank,i.e., the federal Reserve System,(4) the demand for currency on the part of the public, which may be viewed as a ratio of demand deposits held by the public, (5) the demand for time deposits by the public, which again may be viewed as ratio of demand deposits, and (6) the demand for excess reserve by commercial banks.

the multiple expansion of bank deposits

of all financial intermediaries commercial banks are unique in that they can create demand deposits, which provide the bulk of the money supply in the United States. Furthermore, there is a multiple relationship between the amount of bank deposits a given bank can have in terms of cash reserves. it is this fractional reserve requirement for commercial banks that makes it possible for them to create added money, even though each individual bank only lends out its excess reserve. Because each bank can lend only funds that it has, how can the entire banking system create new money? Money creation by the banking system sometimes strikes the student as being almost as mysterious as the processes of the medieval alchemist, who was trying to create gold out of baser metals.

call loan participation

call loan participations extended by city to their country correspondents is another avenue of entrance into the money market that is available for banks outside the money market centers. Although loan participations with city correspondents have long been standard practice, only in recent years have city banks been willing to extend this participation to call loans. This major innovation was generally introduced in the mid-1950 ’S and is now usually a vailable to country correspondents. When available, such call loan participations represent an attractive employment of short-term funds, because the call feature makes the loan available within one day of call. Furthermore, the interest return on such loan is considerably above the lower yields at the short end of the money market. Country banks sharing in these call loan participations, however, are usually expected to leave their funds in such employment at least a week or two. In some cases country banks have continuously employed funds in call loan participations for a number of months at a time.

correspondent balances of commercial bank

correspondent balances also are a form of primary reserves, or cash, of commercial banks. A city correspondent requires its country correspondent to maintain a balance sufficient to cover the cost of services that are furnished to the country correspondent. Despite these services, however, it is always in the interest of the country bank to keep its city correspondent balances as low as possible. These correspondent balances sometimes get so low in relation to the cost of the services being performed that the city bank finds it necessary to encourage the country bank to maintain a balance somewhat larger than it has been running. if the account continues to be unprofitable, the city correspondent may even terminate the relationship, though such extreme action is unlikely. Correspondent accounts normally yield a comfortable profit for the city bank. Indeed, the likelihood of profit from such accounts leads most large city banks to seek out actively correspondent deposit business.

forecasting Bank Reserve Requirements

The money desk managers, who manage the cash reserve position in large commercial banks must still keep close track of the factors that determine reserve requirements, mainly a change in both demand and time deposits. Often, for large city banks at least, future required reserve are projected for several weeks ahead with daily or even hourly revisions of the projections. the money desk must also make certain that the bank has an adequate amount of highly liquid assets, such as treasury bills, that can be liquidated, if needed, to add to the supply of loanable funds, or to restore the legal reserve position of the bank.

Managing the money position of a bank

the entry of a commercial bank into the money market comes in connection with the management of its money position, which means the management of the liquid assets of the bank in such a manner as to avoid either excesses or deficiencies of required reserves on an average daily basis for a reserve period, which is now a week-Thursday to Wednesday for all member banks. Required reserves for the current week are now determined by the average deposits of the bank in the reserve week two weeks prior to the current week. This change to a lagged period in computing reserve requirements for member banks was made by the federal Reserve Board in 1968. This change greatly assists the money desk manager in the minimization of excess reserve. Moreover, both excess reserves and reserves deficiencies may now be carried over into the next reserve week.

clearing procedures and securities markets(3)

By holding securities in street name and using clearing houses, brokers can reduce the cost of transfer operations. But even more can be done: certificates can be immobilized almost completely. The Depository Trust Company (DTC) accomplishes this by maintaining computerized records of the securities "owned" by its member firms (brokers,banks,etc.) Member deposit certificates, which are credited to their accounts. The certificates are transferred to the DTC on the books of the issuing corporation and remain registered in its name unless a member subsequently withdraws them. Whenever possible, one member will " deliver" securities to another by initiating a simple bookkeeping entry in which one account is credited and the other debited for the shares involved. Dividends paid on securities held by DTC are simply credited to member's accounts based on their holdings and may be withdrawn in cash.
The Securities Acts Amendments of 1975 instruct the Securities and Exchange commission to develop a central system of this sort to eliminate the movements of stock certificates and possibly eliminate stock certificates entirely. Eventually, at dividend time, corporations’ computers may deal directly with other computers that are in touch with still other computers in banks, brokerage firms, and so on. Moreover, the central market system may be integrated with the central clearing system, so that agreement of two parties to the terms of a transaction will automatically bring about the transfer of ownership required to complete the trade.

Wednesday, April 29, 2009

clearing procedures and securities markets(2)

the process can be facilitated even more by a clearing house, the member of which are security brokerage firms, banks, and the like. Records of transaction made by members during a day are sent there. At the end of the day both sides of the trades are verified for consistency, then all transactions are netted out. Each member receives a list of the net amounts of securities to be delivered or received along with the net amount of money to be paid or collected. Every day each member settles once with the clearing house instead of many times with various other firm.
A centralized clearing house, operated by the national Securities Clearing Corporation , handles trades made on the New York and American stock exchanges and in the over-the-counter market. Some regional exchanges also maintain clearing houses. Not all exchange members. join such organization; some choose to use the services of other members. Some banks belong, in order to facilitate delivery of securities which serve as collateral for call loans and so on .

clearing procedures and securities markets(1)

Most securities are sold the"regular way." which requires delivery of certificates within five business days. On rare occasions a sale may be made as a "cash"transaction,requiring delivery the same day,or as a "seller's option,"giving the seller the choice of any delivery day within a specified period (typically,no more than 60 days).
It would be extremely inefficient if every security transaction had to end with the physical transfer of certificates from the seller to the buyer. On a given day, a brokerage firm might sell 500 shares of American Telephone and Telegraph stock for Mr. A and buy 300 shares for Ms. B. Mr.A's 500 shares could be delivered to the buyer's broker,and Ms. B's 300 shares obtained by accepting delivery from the seller's broker. but it would be much easier to transfer 300 of Mr. A's shares to Ms. B,send the other 200 to the first broker,and instruct the second broker to deliver the 300 shares directly to the first broker. This would be especially helpful if the firm's clients maintained their securities in street name. for the 300 shares kept within the firm would not have to be moved or have their ownership transferred on the books of the issuing corporation.

why understanding value company is important?

valuing companies is usually seen more as a task for the stockbroker,merchant banker or financial analyst than the humble lending banker. But understanding company value and how it is created can be very important to undertaking a proper credit assessment of a company because:
- good management teams manage their businesses to increase their value and it is helpful to know whether they are succeeding or not. A management team that seems to be disinterested in improving the value of the business is one that should be questioned.
- a business that is increasing in value is likely to be a better credit risk than one that is falling.
- a business that has a value as a going concern can be sold-the ultimate test of the value of security.
- a number of banking propositions involve the acquisition of a business or parts of a business and the banker should be able to have a view on whether such deals make sense or not. The same can be said about the impact of disposals.
- it is a topic that the fully educated banker should be able to discuss in an informed way with customers in order to have a meaningful contribution to a debate on their business.

credit transfers

This is a popular method of payment in much of Western Europe but has yet to find a wide audience in the UK. A person wishing to pay a sum of money to another person can, if he or she knows the details of the beneficiary's bank branch and account number,go into a branch of any bank and complete a form crediting the beneficiary's account with that sum. if the credit has to go to another bank or branch,the form used is a bank giro credit. This seems very simple but one problem is that the form is sometimes incorrectly completed,so that it is impossible to trace the beneficiary. Customers and others are therefore strongly encouraged to use slips pre-printed by the bank or the beneficiary. Examples of these can be found at the food of every gas,electricity and telephone bill,and some organizations, eg hire purchase companies and local authority rent departments, provide their borrowers and tenants with pre-printed books of bank giro credits. The banks process the transactions,as we shall see later,and subsequently credit the beneficiary's account. However,the beneficiaries may not be advised of the receipt until they read their statements because the receiving bank assumes that the advice was sent by the person making the payment. Even if this is the case,the advice notice does not always specify the date on which payment will be made.
Credits transferred electronically are a major part of Internet and direct banking.payment details of regular bills are held by the bank and customers trigger these,often adding the amount to be paid via an Internet or telephone connection with the bank. A development of the bank giro system, using electronic methods of funds transfer,is BACS .it is available to large organizations with their own computers.

ATM cards(2)

we shall discuss ATM cards again later in the book. because they are now widely issued by building societies. in 2000, there were 24170 bank ATMs (over 7,000 of which were located away from bank branches)plus well over 4,000 building society ATMs; 50m bank debit cards;and 50m bank credit cards. The statistics show that there is increasing demand for ATMs situated at supermarkets,motorway services and airports and increasing use of 'cash back' facilities offered by retailers.
ATM queries were,at first,the largest single type of complaint handled by the Banking Ombudsman,now the Financial services Ombudsman (banking and loans)and PINs must never be revealed to third parties or written where they might be seen by anyone other than the customer. Revealing a PIN would constitute 'gross negligence' on the part of a customer.
It is widely acknowledged now that 'phantom withdrawals' are possible without customers being either dishonest or negligent.Number of ATM complaints to the banking Ombudsman have fallen considerably in recent years, especially since the banks agreed to limit customer loss on card fraud to English pound 50 (in line with credit cards)where cards are lost or stolen and the customer has not been negligent with the PIN.
Many debit cards in issue are also members of Europe-wide or worldwide networks such as MAESTRO and CIRRUS (both linked to MasterCard) to allow use overseas.

ATM cards(1)

ATM stands for automated teller machine, "teller" being the American and Scottish word for cashier. Such cards are issued to customers, on completion of an application form, and a confidential four-digit personal identification number (PIN) is sent separately a few days after the card. When the customer acknowledges, in writing, receipt of the PIN, the computer is instructed to permit cash withdrawals. These are activated by the card and authenticated by the PIN number being keyed in at the ATM.
the first generation of ATM cards were plastic cards to permit withdrawls from cash dispensers away from branch counters. they now also enable statements and cheque books to be ordered, as well as also giving the balance on the account, and are Known as " dedicated ATM cards". second-generation ATM cards are multifunctional, being also debit cards and cheque guarantee cards. Both first and second generation ATM cards operate on a customer is bank account.
credit card also frequently permit cash withdrawals from ATMs but these, of course, operate on the credit card account and not the bank account.

Tuesday, April 28, 2009

prices as information sources(2)

On the other hand, any firm trying to buy or sell a large number of shares that it considers mispriced should try to conceal either its motives, its identity, or both (and many do try). Such attempts may be ineffective, however, as those asked to take the other side of such traders try to find out exactly what is going on (and many succeed).
Since offers may effect other offers other offers, the way in which a market functions can effect the prices at which trades are made.And different markets function in different ways. for example, the new york stock exchange specialist is books contain information on both the prices and the quantities specified in standing orders, but only the lowest ask price and the highest bid price in the book and quantities associated with each are revealed by the specialist to the general market. In the over-the-counter market, dealers publicly announce bid and ask prices that are firm for small quantities, but they negotiate prices for larger quantities. Orders for some stocks on the Paris Bourse are placed in a book with both prices and quantities specified, while for other stocks the book contains only the prices of orders.
The extent to which standing orders are made public may thus affect the prices at which such orders are executed, the extent to which investors will place them with brokers, and the extent to which brokers will place them in central"book" where they can be seen by others.
Some investors depend almost entirely on price for information about value. This raises the possibility that a clever trader could make money by placing orders to trigger foolish responses from such investors. While this may occur in isolated instances, it is limited by the presence of informed traders who use external information sources to assess value. Given a large enough number of people who study fundamental aspects, it is possible for most investors to assume that market price refracts value .

prices as information sources

The usual description of market assumes that every trader wishes to purchase or sell a known quantity at each possible price. ALL the traders come together, and in one way or another a price is found that clears the market-i.e., makes the quantity demanded as close as possible to the quantity supplied.
This may or may not be an adequate description of the market for consumer goods, but it is clearly inadequate when describing security markets. The value of any capital asset depends on future prospects that are almost always uncertain. Any information that bears on such prospects may lead to a revised estimate of value. the fact that a knowledgeable trader is willing to buy or sell some quantity of a security at a particular price is likely to be information of just this sort. Offers to trade may thus affect other offers. Prices may both clear markets and convey information.
The dual role of prices has number of implications. For example, is behooves the liquidity-motivated trader to publicize his or her motives and thereby avoid an adverse effect on the market. Thus an institution purchasing securities for a fund intended to simply hold a representative cross section of securities should make it clear that it does not consider the securities under-priced.

the impact of unexpected inflation on the price of a common stock

A company is financial statements can be used to obtain a rough estimate of the impact of a divergence between actual and expected inflation on the value of the firm is common stock. Each item can be classified as either a real, short-term monetary, or long- term monetary asset or liability. in some cases the classification is fairly obvious; in others it is some-what arbitrary. However, detailed Knowledge of a company and\or sumer price index in recent years, but there is probably more to it than this.
One cannot help be struck with the fact that those who invested in short-term securities over this period frequently ended up with less purchasing power than they started with: real return was negative in 23 of the 53 years. perhaps even more surprising, the average real return over the period was zero!
while expected real returns may vary from year to year, the variation may be relatively small. if so, investors may well have been willing to invest in short-term highly liquid securities even though they expected to earn nothing at all in real terms. if they are willing to do so still, such securities will be priced to give an expected real return of approximately zero.
if this assumption is made, the "market’s" predicted rate of inflation over the near future can be estimated by simply looking at the current annual yield on short-term government securities. In a sense, Treasury bill yields represent a consensus prediction of inflation-a prediction likely to be more accurate in many cases than the predictions of any single forecaster.

regulation of security markets (4)

Initially, security regulation in the united states was the province of state governments. Beginning in 1911, state blue sky laws were passed to prevent " speculative schemes which have no more basis than so many feet of blue sky. " While such statutes vary substantially from state to state, most outlaw fraud in security sales, require registration of brokers and dealers(and,in some cases, investment advisers) and the registration of nonexempt securities. Some order has been brought by the passage in many states of all or part of the Uniform Securities Acts proposed by the National Conference of Commissions on Uniform State laws in 1959.
Securities traded in interstate commerce, fall under the provisions of federal legislation (although some have been explicitly exempted under its terms). A considerable domain still comes under the exclusive jurisdiction of the states. Moreover, federal legislation only supplements state legislation, it does not supplant it. Some argue that the investor is overprotected as a result, while other suggest that regulatory agencies in general, and especially those that rely on " self-regulation" by powerful industry organizations, in fact protect the members of the regulated industry against competition, thereby damaging the interests of their customers rather than promoting them. Both positions undoubtedly contain elements of truth.

regulation of security markets (3)

Federal securities legislation relies heavily on the principle of self-regulation. The SEC has delegated to exchange its power to control trading practices for listed securities, while retaining, however, the power to alter or supplement any resulting rules or regulations. The commission is power to control trading in over-the-counter securities Dealers (NASD), a private association of brokers and dealers in OTC securities. IN practice the SEC staff usually discusses proposed changes with both the NASD and the exchanges in advance, and few rules are formally altered or rejected by the commission.
AN important piece of legislation that makes security markets markets in the United states different from those in many other countries is the (Glass-steagall) Banking Act of 1933, which separates commercial banking from investment banking. While exceptions are granted, and affiliated firms owned by bank holding companies are subject to fewer restrictions, Because of this act banks have not played as prominent a role in security markets in the united states as elsewhere.

Monday, April 27, 2009

regulation of security markets (2)

The Bankruptcy Act of 1938 specified that the commission should advice the court in any reorganization of firm under Chapter X whenever there is substantial public interest in the firm is securities. The trust indenture Act of 1939 gave the Commission power to insure that bond indenture trustees were free from conflict of interest. The investment Company Act of 1940 extended disclosure and registration requirements to investment Company Act of 1940 extended disclosure and registration requirements to investment companies. the investment Advisers Act of 1940 required the registration of most advisers and the disclosure of any potential conflicts of interest of interest.
The securities Investor protection Act of 1970 provided for the coverage of losses in the event of failure of a brokerage firm.

regulation of security markets

Directly or indirectly, security markets in the united states are regulated under both federal and state lows.
the securities Act of 1993 was the first major legislation at the federal level. Sometimes called the "truth in securities" law, it requires registration of new issues and disclosure of relevant information by the issuer and prohibits misrepresentation and fraud in security sales.
The Securities Exchange Act of 1934 extended the principle of the earlier Act to cover secondary markets and required national exchanges and brokers and dealers to be registered.
Since 1934, both Acts (and subsequent amendments) have been administered by the Securities and Exchange Commission (SEC),a quasi-judicial agency of the U.S. government. It is run by five commissioners appointed by the president and confirmed by the Senate; each Commissioner serves for a five-year term. the commision is aided by a large permanent staff of lawers,accountants, economists , and others.
The SEC is the prime administrative agency for a number of other pieces of federal legislation. The public Utility Holding Company Act of 1935 brought such corporations under the Commission is Jurisdiction.

information-motivated and liquidity-motivated transactions (2)

In the absence of foolish investors,the very existence of a dealer market depends on investors desires for liquidity. A dealer must select a bid-ask spread wide enough to limit the number of trades with customers possessing superior information,but narrow enough to attract an adequate number of liquidity-motivated transactions.
A dealer can take either a passive or an active role.For example,a bid-ask spread can be established and a tentative price set. As orders come in and are filled,the dealer,s inventory (position)will vary and may even become negative when promises to deliver securities exceed promises to accept delivery. But any clear trend suggests that the price should be altered. In effect,a passive dealer lets the market indicate the appropriate price. An active dealer tries to get as much information as possible and to alter bid and ask prices advance to keep the flow of orders more in balance.The better a dealer,s information,the smaller the bid-ask spread required to make a profit. when there is competition among dealers,those who are not well informed either price themselves out of the market by requiring too high a bid-ask spread or go out of business after incurring heavy losses. In general,the interests of investors are best served by a market in which dealers with unlimited access to all sources of information compete with one another.

information-motivated and liquidity-motivated transactions

there are two major reasons for security transactions. An investors may believe that a security has become mispriced ,that its value is outside the current range between (1)the total proceeds from a sale and (2)the total cost of a purchase. One who feeds this way believes that he or she has information not known to (or understood by)the market in general and may be termed an information-motivated trader.On the other hand,an investor may simply want to sell securities to buy a new car,buy some securities with recently inherited money.alter a portfolio to better conform to a recent change in job,or the like. Such a person may be termed liquidity-motivated:although feeling that value is also outside the proceeds/cost range.he or she does not presume that others in the market have evaluated the prospects for the security incorrectly.
dealers can make money by trading with liquidity-motivated traders or with stupid information-motivated traders. But,on average,they can only lose money by trading with clever information-motivated traders.
The larger a dealer,s bid-ask spread,the less business he or she will do;but whatever the spread, when a clever information-motivated investor makes a trade,the dealer may expect to lose.

continuous versus call market(2)

Such a situation could be exploited by anyone willing to take temporary positions in securities,ironing out transitory variations in demand and supply and making a profit thereby. This is the role of a dealer or market-maker,whether officially identified as such or not.Only greed and avarice are required to attract such people,but in the pursuit of personal gain they generally reduce fluctuations in price unrelated to changes in value,thereby providing liquidity for investors. In some markets dealers compete with each other in order to offer the best possible terms for a given security. The London stock Exchange is,in essence,a physical location where dealers ("jobbers")take orders from brokers. In the over-the-counter market in the United States,dealers,bid and ask prices are communicated to brokers via a computer network.On the floor of the Chicago Board of trade dealers in commodities mingle with brokers in the "pits". The New York stock Exchange,to facilitate a continuous market,as-signs specialists to stocks.The specialist is allowed to deal for his or her own account.but only if no better offer is forthcoming from '"the floor" --i.e.,from brokers acting for their customers or themselves. The specialist its allowed to make a profit but is also charged with maintaining a "fair and orderly market"---a requirement both ill-defined and difficult,if not impossible,to enforce. In return,specialists are allowed to maintain books of unexcited limit (and stop-loss)orders. Whenever possible,a specialist executes orders from the book,crossing them with orders from the floor,or simply trading directly ,using his or her own account receiving in return a commission for serving as a "broker,s broker".

continuous versus call market

No market is ever truly continuous.for trades occur at discrete times. However ,some markets are explicitly organized to group trades at specific times. In such call markets,when a security is called,all who wish to buy and sell are brought together. Enough time is allowed to elapse between calls(e.g.,an hour or more )to accumulate a substantial number of offers to buy and sell. In some call markets there is an explicit auction in which prices are called out until the quantity demanded is as close as possible to the quantity supplied (this procedure is used by the Paris Bourse for Major stocks).In other call markets,orders are left with a clerk between calls and"crossed"at a price that allows the maximum number to be executed (this procedure is used for some stocks by the Paris Bourse and the Tokyo stock Exchange).
In a continuous market trades may occur at any time. While such a market could function with only investors and brokers,it would not be very effective,for an individual who wished to consummate a sale or purchase very quickly would either have to spend a great deal of money searching for a good offer or run the risk of accepting a poor one. Since orders from investors arrive more or less randomly,prices in such a market would vary considerably ,depending on transitory relationships between desired purchases and sales.

Types of orders in Securities market (2)

A limit order " on the books" is executed only when a security is price becomes more favorable. A stop-loss order operates in the opposite direction. for example, a stop-loss order at $30 per share might be placed to sell 100 shares of stock currently trading at 40$ per share. AS long as the price remains above $30, a nothing happens. But as soon as the price reaches (or drops below)$30, the order is converted to a market order, to be executed on the best possible terms. A stop-loss order to purchase shares becomes a market order when the price reaches or rises above the level indicated.
A dollar- value order is a market order to purchase as many shares as possible for a given dollar amount even though fractional holdings may result. Accounts are consolidated internally, and the brokerage firm takes positions in securities as needed. Sales of fractional shares are also allowed (of course only whole shares can be delivered to customers; fractional holdings are simply records in a computer).
The standard unit in which a stock is traded is termed a round lot (usually 100 shares). Any smaller quantity is odd lot. An investor who wishes to purchase or sell an odd lot. An investor who wishes to purchase or sell an odd lot generally does business with a dealer instead of another investor.For example, certain brokerage firms will usually purchase an odd lot of a stock listed on the New York Stock Exchange at the price currently quoted on the exchange for a purchase and sell an odd lot for the price currently quoted on the exchange for a sale . Specialists on most exchanges also handle odd lots, using similar procedures.

Sunday, April 26, 2009

Types of orders in Securities market

Brokers will accept instructions of various types concerning the condition under which a security is to be purchased or sold. Some of the procedures are institutionalized; others are simply agreements between the investor and his or her account executive .
By far the most common procedure is that used for a market order.The broker is instructed to buy or sell a stated number of securities at the best available price or prices (as low as possible for a purchase, as high as possible for a sale). it is incumbent on the broker in such a situation to act on a "best efforts" basis to get the best possible deal in time.
In most cases there is fairly good information concerning the likely price at which a market order might be executed. if this is unacceptable, a limit order may be placed instead. Both a quantity and an acceptable price are specified. The broker is to purchase or sell the stated number of shares only at the indicated price or better (higher for a sale, lower for a purchase). If a limit order cannot be executed immediately, it is usually kept by the broker or placed by the broker on the books of another broker to be executed as soon as the requisite price can be obtained .
Some limit orders are day orders-canceled if not executed by the end of the day they are placed. However, an investor may specify that an order be considered good-till-canceled (GTC) or that it be canceled immediately if not executed (this is termed a fill-or-kill[FOK]order).

insurance in securities markets

in the late 1960s many brokerage firms were confronted with an unexpectedly large volume of transaction and a lack of proven computerized systems able to handle the workload. This gave rise to back-office problems and resulted in a rash of " fails to deliver"- situations in which a seller is broker did not deliver certificates to a buyer is broker on or before the required settlement date.
Worse yet, several brokerage firms subsequently failed, and some of their clients discovered for the first time that certificates " in their accounts" were not necessarily physically available. Such events led to serious concern about the desirability of any procedure that kept certificates out of the hands of the investor. To avoid erosion of investor confidence, member firms of the New York Stock Exchange spent substantial sums to cover the losses of failed firms and\or to merge them into successful firms. But such remedies were only temporary ; insurance provided a more permanent solution.
The securities Investor Protection Act of 1970 established the securities Investor protection Corporation (SIPC), a quasi-governmental agency that insures the accounts of clients of all broker-dealers and members of exchange registered with the Securities and Exchange Commission against loss due to the firms‘s failure. Each account is insured up to a stated amount. The cost of the insurance is supposed to be borne by the covered brokers and dealers through premiums, but up to 1$ billion may be borrowed from the U.S. Treasury .
A number of brokerage firms have gone farther. arranging for additional coverage from private insurance companies. Many have policies that, together with SIPC coverage, insure accounts up to $500.000.

broker and dealers (2)

It is a simple matter to open an account with a brokerage firm:simply appear at (or call) the local office. An account with executive will be assigned to you and will take care of the formalities . Transactions will be posted to your account as they would to a bank account. You may deposit money, purchase securities using money from the account, add the proceeds from security sales to the account, borrow money, and so on. after the initial forms have been signed, everything can be done by mail and\or telephone. Brokers exist (and charge fees) to make securities transactions as simple as possible.
A broker acts as an agent for investors, but dealer (or market-maker) buys and sells securities for his or her own account, taking at least temporary positions and maintaining at least small and transitory inventories of securities. Like a used-car dealer, a security dealer runs risks and ties up capital in order to make it easy for individuals to buy or sell on a moment is notice.Dealers are usually compensated by the spread between the bid price at which they buy a security and the ask price at which they sell it. The percentage spread is typically larger, the smaller the amount of trading activity and the greater the volatility in security is price.
To facilitate the coming together of traders (be they investors, brokers or DEALERS), physical locations and\or communications facilities are required. security exchange are physical locations where trading is done on a person-to-person basis (usually by brokers and\or dealers)under specified rules. Communications networks, formal or informal, are often termed markets. some have clearly defined boundaries; others do not.
Often a firm or even an individual will play more than one role in this process. Most retail brokerage firms hold some inventories of securities and may thus act as dealers (but the law requires that they inform their customers if they do so ). some exchanges have specialists, who serve as brokers for some traders and as dealers for others. Brokers may employ other brokers, dealers may deal with other dealers, and so on.

broker and dealers

when a security is sold, many people are likely to be involved. Although it is possible for two investors to trade with each other directly, the usual transaction employs the services provided by brokers, dealers, and\or markets.
A broker acts as an agent and is compensated via a commission.Like a marriage broker or real estate broker, an investment broker tries to bring two parties together and to obtain the best possible terms for his or her customer. Most individual investors deal with brokers in large retail or "wire"house--firms with many offices connected by private wires with their own headquarters and, through the headquarters,with major markets. The people in brokerage firms with prime responsibility for individual accounts are termed account executives,registered representatives,or(in the vernacular)customer,s men and women.
institutional investors deal with both large firms offering retail brokerage service and smaller firms that maintain only one or two offices and specialize in institutional business. There are also regional brokerage firms and discount broker. The former concentrate on transactions in a geographic area;the latter provide "bare-bones"service at low cost.An account executive,s compensation is typically determined party by the amount of commissions paid by his or her customers--an amount that is usually greater,the greater the turnover in an account. This provides some temptation to recommend changes in investors holdings and,since the commission rates on various types of investments differ,to recommend particular types of changes. In the long run,account executives who encourage excessive churning should lose customers. Nonetheless, such behavior may be advantageous for them in the short run.

why Bother About inflation ? (7)

we can sum up by saying that inflation needs to be prevented because it redistributes income ans wealth in arbitrary and potentially unjust way; because it complicates the task of the individual who wishes to smooth out his lifetime patterns of consumption and income; because it is a potential source of difficulty in the balance of payments ; because it imposes a variety of real costs both on individuals and on firm; and because it distorts the basic institutions of modern capitalist society.
some economists argue that these troubles would not be serious if inflation were steady and if exchange rates were flexible. For if the inflation rate were to settle at, say, a steady 5 per cent annum , year-in-year-out,an annual 5 per cent inflation rate would come to be generally expected, "interest rates would ultimately reflect the pace of inflation; salaries and other sticky incomes and the entire institutional framework would be increasingly adjusted, that is the bad redistributive effects of inflation would disappear. and if exchange rates were flexible, the ill effects on the balance of payments of more rapid inflation than in the rest of the world could always be nullified by an appropriate adjustment of the exchange rate.

why Bother About inflation ? (6)

A final reason for rejecting inflation is that it distorts the institutions which lie at the heart of modern capitalist society. Once again it is hard to improve on Hick is treatment . He says :
The habits- business habits as well as personal habits- which are based on the assumption of stable prices are too strong to be easily broken. Nor is it just habits... it is also institutions. The accounting system, the tax system, even the general legal system, all are based on the assumption of stable value of money ; if the value of money is seriously changeable, they are twisted out of shape. The accountant is "profits" cease to be true profits; the taxes that are imposed are different to what was intended; the fines and penalties imposed by the courts, as well as the compensations which they award, lose their proper effect. now it is of course true that these things can be put right (for a time) by legislation; but only by re-opening issues that had been taken to be closed. There is waste of time in re-discussing them-surely a much more serious waste of time and energy than is involved in holding "too small" money balance.

why Bother About inflation ? (5)

A fifth reason for rejecting inflation, Which is closely related to the one just discussed has been well expressed by Hicks in the following way:
If one examines the balance-sheet of the business "at a moment of time" it will usually be found to have among its assets not only some money which is not earning interest, but also some debts owing to it on which it is not charging interest. If one asks why it should hold assets in this latter from, the answer is surely that it is a matter of convenience, Just like the reason for holding money. A debt that is due from a regular customer is not regarded in isolation; it is part of the regular relation between customer and supplier, which it is to the interest of both to maintain in way that is convenient to both. On This, as on the money holding, inflation exercises a pressure. when money rates of interest are high.... the loss of interest that is involved in unpaid debts becomes more serious. It thus becomes profitable to take more trouble in collecting debts promptly, exerting pressure on debtors which would otherwise not need to be exerted. There is a real loss, measurable in lab our-time, in exerting such pressure. And since the debtor himself has a similar incentive to delay payments, it is easily intelligible that the loss can be considerable.

why Bother About inflation ? (4)

we turn now to a fourth reason for thinking that inflation should be prevented. When the general price level rises the real value of a given sum of money decline. For example if the price level rises by 10 per cent between the beginning and the end of a particular year, a sum of $100 expressed in beginning-of-year prices will be $100\1.1 at the end of the years as compared with $100 at the beginning of the year. That is, the real value of $100 will decline by a little over 9 per cent in the course of the year. Because of this fact, wealth-holders have a strong incentive, under inflationary conditions, to keep as a little of their wealth as possible in the from of money and as much as possible in the from of assets whose price rises at least as rapidly as the general price level, and which, therefore, do not decline in real terms. This means, in turn, that both individuals and firms face if prices were stable. first, there is the time and effort (physical and mental) which they put into the task of economizing on money balance; then there is the inconvenience associated with liquidity which they suffer if they are successful in this task. If the rate of inflation is moderate-say less than 5 per cent per annum - these real costs will probably not matter very much. however, once the inflation rate climbs to something like 15-20 per cent per annum they can no longer be ignored. And in extreme inflation,when the loss of real wealth consequent on holding money become a major consideration and people seek to pass on money as quickly as possible after receiving it, the real costs in question are undoubtedly very large indeed.

why Bother About inflation ? (3)

A third reason why most governments are anxious nowadays to avoid inflation is that it may lead to balance-of-payments difficulties.This, of course, is an especially important consideration for countries like the United kingdom, where foreign trade plays a major role in the economy inflation can weaken the balance of payments both by stimulating imports and by restricting exports. Imports will be stimulated because when the price of the domestic product rises, the foreign product becomes more attractive to the domestic purchaser, other things remaining the same, than was previously the case. On the other hand, the growth of exports will be checked by rising domestic costs and prices because, ceteris paribus, rising costs weaken the competitive position of domestic producers in foreign markets.
Of course, if the costs and prices of foreign producers are also rising,along with those of domestic producers, the consequences of inflation for the balance of payments will be less serious than if the costs of foreign producers are stable or falling. For, in the former case, the competitive position of foreign producers in the home market will be strengthened less, and the competitive position of domestic producers in the foreign markets weakened less, by inflation than in the latter case. Thus from the point of view of the balance of payments it is not inflation as such which is undesirable but rather more rapid inflation than in the rest of the world.

Saturday, April 25, 2009

why Bother About inflation ? (2)

A second reason for regarding inflation as undesirable is that it face a person who wishes to save in order to provide an income for his old age, or to educate his children, or to build a house, with avery serious dilemma. IF he invests his savings in life-assurance policy or in government bonds, or if he place them with a bank on fixed deposit, he can be sure that on certain dates in the future certain fixed sums of money will be forthcoming. But he takes the risk that inflation will reduce the real value of these sums to such an extent that he will find it impossible to meet the needs for which the savings have been made. On the other hand, if he invents his savings in some from of real property he avoids the inflation risk because it is reasonably certain that property values will rise at least as rapidly as the general price level. But he lacks the assurance that certain fixed sums of money will become available to him at certain Specified dates in the future because, while the value of property in general is likely to rise with the general price level, the value of his property may well fall, for example because of the establishment of some source of noise, or other pollution in the vicinity, or because bridge connecting the suburb in which his property is located with the rest of the city collapses. This is the dilemma referred to earlier; and the fact that inflation faces the ordinary, prudent individual with a choice between such unpleasant alternatives is strong argument for trying to prevent it.

why Bother About inflation ?

perhaps the main reason for trying to prevent the persistent upward movement in the general price level, which constitutes inflation according to our definition, is that it leads to a redistribution of real income which is arbitrary and which, therefore, may well be socially unjust. people whose money income rises less rapidly than the general price level will lose relatively in times of inflation, while those whose money income rises more rapidly than the price level will again. The losers will probably include pensioners, people whose main source of income is interest or rent, professional people such as lawyers, doctors and academics and the producers of some primary products sold on world markets. the gainers will include other primary producers, strongly organized wage-earners and businessman. while some of this redistribution may be socially desirable, it is clear that much of it will not be.
The redistributive effects of inflation are not confined to real income; they extend also to real wealth. people or institutions whose wealth is comprised mainly of assets with a fixed, or virtually fixed, money value, such as bank deposits, government bonds and private debt of various kinds, will lose relatively in terms of wealth under inflationary conditions. persons whose assets consist mainly of real property or whose liabilities remain fixed in money terms will gain relatively. Once again, while some of this redistribution may be in a socially desirable direction, much of it will not be.

Central Bank credibility in the united states and japan

Since WORLD war 11,the U.S.federal reserve system frequently stated an anti-inflation policy.During the second half of the 1970s,when inflation rose steadily,the credibility of the fed,s promise to fight inflation eroded in October 1979,the fed announced that it would focus on targets for the growth rates of monetary aggregates and that target ranges would be reduced significantly to reduce inflation.
The fed experienced difficulty in achieving its targets,owing in part to deregulation and the wave of financial innovation in the early 1980s. The fed,s announced intention to combat inflation indeed succeeded over time.inflation fell from double-digit levels in 1979 to about 4%per year by 1982 and has remained relatively low since then. In part because of the fed,s lack of credibility at that time,disinflation was not without cost,however. In response to the contractionary monetary policy initiated in late 1979,output and employment declined and real interest rates increased. The economy experienced a severe recession in 1981 and 1982.
Because Japan relied wholly on imported oil,the oil shocks of 1973 and 1974 led to wholesale price inflation of more than 30% by 1974 in 1975 the bank of Japan (the Japanese central bank)announced that it would target the growth rate of the Japanese M2 in order to reduce inflation. The consistency with which the Bank of Japan fulfilled its promises quickly bolstered its credibility. The central bank did indeed succeed in
reducing inflation in the 1980s and did so without large losses in output and employment. What do these episodes tell us?the experiences of the United States and Japan illustrate that a prolonged effort by the central bank to reduce the rate of growth of the nominal money supply will reduce inflation. The importance of credibility in determining the costs of disinflation is striking. on the one hand,the U.S.federal reserve system,with low initial credibility and a poor performance in hitting its announced money growth targets a recession and significant unemployment. on the other hand,the highly credible bank of Japan managed to reduce inflation with little direct output loss.

Central Bank credibility

We have shown that,in order to achieve disinflation at a low cost,the public,s expectation of the inflation rate must be reduced. This will shift the SRAS curve down so that lower inflation is not "paid for"by lost output and jobs.However,merely announcing a disinflationary policy may not be enough to change the public,s expectations.An additional,crucial factor is the central bank credibility: For households and businesses to respond to an announced "commitment" to reducing inflation,the public must believe that the central bank will in fact carry out its disinflationary promises. The public might not believe the central bank because disinflationnary entails economic costs--lost output and jobs--which are likely to be politically unpopular. If the public believes that policymakers will back off,inflationary expectations will change very slowly until the central bank convinces the public of its credibility. The Other times, other places box illustrates the role of credibility in reducing inflation in the United States and Japan.

Friday, April 24, 2009

financial institutions

Every day, people lend money to a large number of borrowers, including the U.S. government, IBM, the local hardware store, or their neighbors, without even knowing it. They don‘t approach these borrowers directly through financial markets, but indirectly through financial institutions acting as intermediaries. Financial intermediaries are institutions such as commercial bank, credit union, savings and loan associations, mutual savings banks, mutual funds, finance companies, insurance companies, and pension funds that borrow funds from savers and lend them to borrowers. When you deposit money in savings account, the bank can lend it to a local business. Similarly, when you contribute to a pension plan, the fund managers invest your retirement savings in shares of Mitsubishi,U.S. Treasury bonds, or other financial instruments .
Problems in financial institutions have been big news in the united states recently, particularly the deposit insurance crisis in the 1980s and early1990s. The eventual cost to taxpayers for this crisis is estimated to be as high as $200 billion. this crisis led to bank regulatory reforms, the effects of which are the subject of vigorous political debate. anther controversy has arisen over whether other financial institutions , especially pension funds, insurance companies, and mutual funds, may also be heading for financial crises that would require even more tax funds to resolve.

can credibility enhance central bank flexibility ?

Achieving credibility in the conduct of monetary policy brings benefits in terms of future flexibility. Once a central bank establishes a credible reputation for carrying out its promise, inflexible rules may no longer be required. the successful track record of the German central bank in fighting inflation has convinced participants in international financial markets to believe that price stability will be the Bundesbank is dominant concern this credibility has given the bank some flexibility in responding to short-term changes such as those raised by German reunification in the early 1990s.
A case in which a central bank is lack of credibility led to economic problem is the Reserve Bank of new Zealand is announcement in 1989 of policy to reduce inflation nearly to zero by 1993.
The salary of the governor of the central bank was actually tied to the central bank is success in reducing inflation. however, the Reserve Bank of new zealand lacked credibility because of its past behavior. Although the central bank exceeded its targets in 1991 and 1992 in bringing down inflation, the early lack of credibility gave the central bank little room to react to the decline in economic activity that began in 1990. in fact, the reserve bank had to pursue a contractionary monetary policy (worsening the recession ) to convince the public of its commitment to lower inflation .

the implicit deflator of GNP

The implicit deflator of G.N.P. is not a price index in the ordinary sense,and,before attempting to assess its suitability for the purpose of measuring inflation,it may be desirable to explain the way in which it is calculated. The implicit deflator of G.N.P., SAY for any quarter,is obtained by dividing the G.N.P.for the quarter in terms of current prices by the G.N.P.for the quarter in terms of constant prices. For example,Australia,s G.N.P.for the September quarter 1968 was $6446 million in current prices and $6133 million at average 1966-7 prices. Hence the implicit deflator of G.N.P.for this quarter was 1.051 (=6446/6133)on the base 1966-7=1.
It will be clear from this explanation that,while the implicit deflator of not a genuine price index,it can be interpreted in the same way as a price index.
Specifically,it can be thought of as a price index relating to all goods and services comprising G.N.P., that is to all goods and services produced within Australia.For example, Australia,s implicit deflator for the September quarter 1968(1.051)can be interpreted as indicating that the prices of all goods and services produced within Australia was a little over 5 per cent higher,in this quarter,than the average level for 1966-7.
Since the implicit deflator is,in effect,a price index relating to the goods and services comprising G.N.P.,it clearly stands up well on the first two of our four requirements;it relates only to goods and services produced within Australia and it relates to all such goods and services. On the other hand, it is rather unsatisfactory from the point of view of the third and fourth requirements. Let us take them in turn.
From the explanation, given earlier,of the way in which the implicit deflator is calculated for any period,it is apparent that a critical element in the calculation is the estimate of G.N.P. at constant prices for the period. In the Australian case this estimate is obtained by making estimates of constant prices,exports at constant prices and imports at constant prices and then using the identity: constant prices= G.N.E. at constant prices plus exports at constant prices less imports at constant prices. Thus whether or not the deflator makes proper allowance for quality improvements (third requirement)depends,in the end,on whether or not there is due allowance for quality improvement in the constant-price estimate of G.N.E., exports and imports. In particular it depends on whether there is proper allowance for quality improvement in the constant-price estimate of G.N.E. is the dominant element in the right-hand side of the G.N.P. indentity. If inadequate allowance is made for quality improvement in the constant-price estimate of G.N.E.,the figure for constant prices will tend to be too low and the figure for the implicit deflator too high. For example,in revaluing the X motor-cars purchased in year t in terms of the prices ruling in some base year (this would be part of the job of making the constant-price estimate of G.N.E.for one year t)one would have to recognise that the number of "base-year"motor-cars purchased in year t was really more than x because the year t motor-car was of better quality than the base-year motor-car.If one failed to take the quality improvement into account, one,s estimate of expenditure on motor-cars in year t in terms of base-year prices would be too low,and,to this extent,one,s figure for the implicit G.N.P. deflator for tear t would be too high.
To determine whether in fact due allowance is made for quality improvement in the Australian constant-price estimates of G.N.E. one must examine the procedures which the statistician uses to make these estimates. If this is done one is forced to the conclusion that,through no fault of his own, the statistician makes a quite inadequate allowance for quality improvement in his constant-price estimate of G.N.E.,and hence that this estimate understates the true constant-price figure,and in tum that the implicit deflator of G.N.P.overstates the extent of the rise in the general price level over any specified time period.
The implicit deflator of G.N.P. falls down,then,in relation to the third of our four requirements. Nor is it satisfactory in terms of the fourth requirement. The main reson is that since G.N.P.includes the value of production of the Australian farm sector as well as the value of production of the non-farm sector,the figure for current prices for any quarter,say,will reflect price increases caused by production difficulties of a temporary kind in the farm sector. And since the G.N.P. deflator for any quarter is obtained simply by dividing the figure for current prices by the figure for G.N.P. in constant prices,the deflator must also reflect the temporary price increases,contrary to the fourth of our requirements for an ideal index. A second reason why the implicit G.N.P.deflator is unsatisfactory in terms of the fourth requirement is that,since G.N.P. measures the value of production in the Australian economy as a whole in terms of market prices,the figure for current prices will reflect price increases caused by the imposition or stiffening of indirect taxes or the removal of subsidies. Hence the implicit deflator of G.N.P. will reflect these price increases also,contrary to the fourth requirement for an ideal index once again.

the W.P.I.S or some component

The C.P.I. and its component indexes are retail price indexes. As alternatives for the purpose of measuring inflation, one could consider one of the two wholesale price indexes (the index of materials used in house-building, or the index of materials used in building other than house-building), or possible one of the component indexes from which the W.P.I.S are constructed. However,all of these indexes fall far below the ideal in relation to the second requirement since even the most comprehensive of them is restricted to some class of building materials.
In addition, since they all cover imported, as well as locally produced building materials, they are less than ideal from the standpoint of the first requirement.

some component of the C.P.I.

Instead of using the C.P.I itself, one could use one of the five component indexes from which it is built up, namely the indexes for food, clothing and drapery,housing, household supplies and equipment,and miscellaneous. However,all of these fall down on the score of comprehensiveness,being worse in this respect,of course,than C.P.I.itself.Also,all are deficient in relation to at least one of the other three requirements. For example,the housing index is deficient in relation to the first requirement - the problem of allowing for improvements in quality is especially acute in relation to a housing price index and is only partially solved in the case of the housing component of C.P.I. Again,the household-supplies index covers most of the commodities which are subject to sales tax,and for this reason does not stand up well in relation to the fourth requirement. The food index is deficient in this respect also,since it covers all of the important raw foods.

Thursday, April 23, 2009

the consumer price index (c.p.I)

while the c.p.i stands up reasonably well in relation to the third requirement, it appears to fall well short of the ideal when considered in relation to the first two and the last. Many imported goods are included in the C.P.I regimen. Also,since the index is intended to measure only variations in the retail prices of those goods and services which attract a substantial proportion of the aggregate expenditure of wage-earner, it is far from comprehensive. finally, the index covers all important raw foods and all commodities whose whose prices are subject to significant variation through fiscal action, as is only to be expected given the purpose for which it is designed. as a result the index is by no means unaffected by the type of temporary price increase that we exclude in our definition of inflation.

costs of reducing inflation

When policymakers are more concerned with maintaining high levels of output and employment growth than with maintaining a low inflation rate, they may exert an inflationary bias on monetary policy. (Another possibility-not considered here- is that the fed may incorrectly estimate the growth rate of velocity over long periods of time, allowing an inflationary money supply growth.) Suppose that, whatever the cause, policymakers decide at some point that the economy is sustained inflation rate is too high. How to achieve disinflation (a decline in the long-run rate of inflation) and whether there are costs to the economy from reducing inflation are viewed differently in the new classical and new Keynesian approaches.

full employment targets and inflationary basic

low inflation may be desirable, but it also brigs significant social costs, in terms of lost output and jobs when the economy is not operating at or near full capacity. Angry voters pressure elected officials to do something when recessions idle factories and swell unemployment lines.
the full employment act 1946 and the Humphrey-Hawkins Act of 1978 committed the federal government to promoting full employment and a stable price level. particularly during the 1960s and 1970s, U.S. policymakers often pressed for full employment even at the expense of inflation. two types of inflationary pressures resulted:cost-push inflation , which results from workers‘ pressure for higher wages; and demand-pull inflation,which results from policymakers‘ attempts to increase aggregate demand for current output above the full employment level .

expected inflation rate

Uncertainty about the rate of inflation can introduce the most serious costs of inflation. In a market economy, households and businesses look to prices of goods and assets as signals for resource allocation. For example, an increase in the price of beef relative to chicken encourages farmers to produce more beef and individuals to consume more chicken. An increase in stock market prices relative to the general level of prices is a signal that businesses, prospects are good and that there are opportunities for profitable investment. Relative prices, not individual prices,provide these signals.When inflation fluctuates significantly,relative prices may change in response to general price-level changes, distorting the valuable signals provided by markets. Variations of relative prices because of uncertain inflation cause households and businesses to waste resources investigating price differences.
An extreme case of uncertain inflation occurs in a "hyperinflation,in which the rate of inflation is hundreds or thousands or more percentage points per year for a significant period of time. The costs of hyperinflation are extremely high. Households and businesses must minimize currency holdings,and firms must pay employees frequently. Employees must spend money quickly or convert it to more stable foreign currencies before prices increase further.
A classic example of hyperinflation occurred in Germany after World War I. A burst of money creation by the government ignited inflation,increasing the price level by a factor of more than 10 billion between August 1922 and November 1923. For example, if a candy bar cost the equivalent of 5 cents in August 1922,this increase in the price level would have raised its cost to more than $500,000,000 by November 1923. Our analysis of money balances should plummet. In Germany that proved to be the case; By October 1923,real money balances had shrunk to only about 3% of their August 1922 value. The German hyperinflation ended suddenly in late 1923,with a strong government commitment to stop the printing presses. With a significant decline in growth of the money supply, hyperinflation ended.
Confusing signals from prices are particularly problematic during hyperinflation. With overall prices riding very rapidly,merchants change prices as often as possible. Prices therefore quickly fail to indicate value or direct resource allocation. The government,s tax-collecting ability diminishes significantly during hyperinflation. Because tax bills typically are fixed in nominal terms, households and businesses have a major incentive to delay payment of taxes in order to reduce their real tax burdens.

why policymakers allow inflation to occur

Despite the fact that inflation can generate tremendous costs for the economy, in order to achieve other goals (such as full employment of the economy is resources), governments sometimes pursue inflationary monetary policies . In particular, measures related to current output (such as the levels of GDP,households incomes, and the unemployment rate) capture the attention of voters and public officials alike. Indeed, movements in current output can greatly influence presidential elections, creating a temptation on increase aggregate demand in the short run.Ray Fair of Yale University has noted that significant GDP growth and a falling unemployment rate increased the reelection chances of incumbent president and other candidates of the same party.

Unexpected inflation

Many contracts in labor,goods and financial markets are written in nominal terms, cover a substantial period of time, and take expected inflation into account. However, unexpected inflation, or the difference between actual and expected inflation, redistributes wealth. for example, Suppose that a borrower and lender expect no inflation and agree to a one-year,$1000 loan at 4% interest. Regardless of the inflation rate for the year, the lender receives ($1000)(1.04)=$1040 from the borrower at the end of the year. If the actual rate of inflation is 7%, the lender is real return (the return in terms of purchasing power) is- 3%.Conversely, the borrower is real interest rate is -3%. the unexpected inflation of 7% (7%-0%)effectively transferred $70 of real purchasing power from the lender to the borrower. Another example of this redistribution occurs when unexpected inflation reduces real wages for employees with nominal wage contracts.
the implications of unexpected inflation are more difficult to gauge than those of expected inflation for the macro economy. Losses to some parties are matched by gains to others. Nonetheless, for individuals that are risk-averse, the possibility of redistribution can distort behavior.For example, amounts that businesses or households spend on forecasting inflation in order to protect themselves against unfavorable redistributions represent a cost of unexpected inflation.

expected inflation rate and financial decisions (2)

Expected inflation also can distort financial decisions because lenders pay taxes on nominal rather than real returns. Suppose that expected inflation is 4% and that an individual faces a marginal tax rate of 30%. A nominal interest rate of 8% yields the individual a real after-tax return of (1-0.30)(8%)-4%=1.6%. Suppose that the expected inflation rate rises to 8%and that the nominal interest rate rises by the same amount to 12%. The real after -tax return falls to (1 -0.30) -8%=0.4%. Hence nominal interest rates would have to increase by more than the change in inflation (8%-4%)to maintain the real return of 1.6%. Conversely, borrowers such as corporations and individual home buyers benefit from expected inflation, because borrowers deduct nominal interest payments (not real interest payments)in calculating their income tax liabilities. Changes in expected inflation can change the real after-tax cost of borrowing. For example, with high expected inflation,corporations find debt financing more attractive,because nominal interest payments are deductible. Households find housing investment more attractive relative to stocks,because home mortgage interest is deductible for tax purposes.
A third cost of expected inflation in the new Keynesian approach arises from so-called "menu costs",or costs to firms of changing prices(reprinting p[rice lists,informing customers,and so on). Faced with different menu costs,not all firms change prices at the same time;that is,price changes brought on by inflation are not synchronized throughout the economy. Even so,expected inflation can change relative prices in the short run and affect the allocation of the economy,s resources.

expected inflation rate and financial decisions

expected inflation can effect the allocation of the economy is resources in three ways. First, inflation places a tax on money balances when those balances pay less than the market rate of interest. This tax is loss in purchasing power. For example, If you held $100 in currency in 1992 when the rate of inflation was about 3%, you lost $3 of purchasing power over the year. By imposing a tax on money balances, inflation reduces the public is demand for real money balances. One cost of this tax, known as shoe leather costs, is the cost to consumers and business of making more trips to the bank to avoid holding significant amounts of currency or of shifting fund from interest-bearing assets into money. when the public is shoe lather costs exceed the government is revenue gain from the inflation tax, inflation generates an "excess burden," or social loss. Stanley Fischer of M.I.T. has estimated that the annual excess burden in the UNITED STATES of a modest inflation rate of 5% is approximately 0.3% of GDP, or about $18 billion in 1992 dollars.
A second cost of expected inflation arises because the u.s. Tax system is defined in nominal terms. This definition means that the individual income tax is progressive and not fully indexed against inflation. AS a result, higher nominal incomes (for constant real incomes) can lead to a higher tax burden relative to income. this problem, called bracket creep, was particularly severe in the 1970s, when the individual income tax was more progressive than it is in the early 1990s. the failure of the tax code to adjust values of inventories and the value of depreciation allowances for inflation also raises corporate tax burdens.

inflation and Unemployment

Why should we think about inflation and unemployment together? in an inflation article, A.W. Phillips analyzed data on British inflation and unemployment rates from 1861 to 1957 and reported a statistical regularity which quickly was dubbed the Phillips curve. The unemployment rate tended to be high when the inflation rate was law, and vice versa. this finding raised a tantalizing possibility: Could a policymaker choose between inflation and unemployment (depending on the relative social concern over the two problem), tolerating a higher value of one to obtain a lower value of another? Exploiting this trade-off, U.S. economic policy in the 1960s favored a steadily declining unemployment rate accompanied by a gradually increasing inflation rate. Events of the 1970s and since fundamentally changed this relationship.
To analyze whether there is trade-off between inflation and unemployment, we need to examine the relationships between (1)output changes and the unemployment rate and (2) price adjustment and output changes. AS we consider these relationships, note that analysis of an inflation-unemployment trade-off follows closely the development of the aggregate demand-aggregate Supply model.

Wednesday, April 22, 2009

the only thing constant in the financial system

the only thing constant in the financial system is change, the pace of change in the activities of financial intermediaries accelerated in the 1980s and early 1990s. when I was an undergraduate money and banking student in 1979, small savers (as I definitely was) could invest in checking account (which paid no interest) and passbook savings accounts (which paid no interest) and passbook savings accounts (which paid a low rate of interest limited by regulation). higher yielding treasury bonds and corporate bonds were available only in large denominations to wealthy savers. By contrast, in the mid 1990s, financial intermediaries offer a broad array of products with market yields for small savers, including money market mutual funds and interest-bearing checking accounts. these new products are the result of financial innovation by and competition among banks and other financial intermediaries.
in 1979,government tightly regulated the lines of business of banks and other financial intermediaries. however, the pace of competitive innovation by financial intermediaries has led to calls for major changes in regulation.
Understanding the risk-sharing,liquidity, and information services provided by intermediaries helps in understanding the types of regulation needed and to predict how those intermediaries will respond to new regulation. because the pace of changes in the financial system is so rapid, that understanding provides a way to assess developments in financial intermediaries in order to analyze new financial products, to get job in the financial services industry, or to be informed about investment opportunities.

why ideal stabilization by speculators is optimal

we can now use the tools of marginal utility to show how speculation would maximize total utility over time. Suppose every consumer has a utility schedule that holds for each year independently of any other year. Now suppose that in the first of two years there were a big crop-say, 3units per person- and in the second a small crop of only 1 unit person. if this crop deficiency could be foreseen, how should the consumption of the two-year 4-unit total be spread over the two years?
if we agree,for simplicity,to neglect all storage,interest,and insurance charges and all questions of utility commen sur ability over time,we can prove this: Total utility for the two years together will be maximized only if consumption is equal in each year.
Why is uniform consumption better than any other division of the available total? Because of the law of diminishing marginal utility. Here is the reasoning:"Suppose i consume more in the first year than in the second.My last unit,s marginal utility in the first year will be low,and then in the second it will be high. So if i carry some crop from the first to the second year,i shall be switching from low to high marginal utilities-and that will maximize my total utility."
But is not that exactly what the following ideal speculation pattern would accomplish? Yes,it is
If speculators can neglect interest,storage,and insurance charges and happen to forecast accurately next year,s low crop,what will they do? They will figure it pays to carry goods over from this year,s low price resulting from the high crop,hoping instead to sell at next year,s scarcity price. But as each speculator subtracts from this year,s supply and adds to next year,s what must finally happen?Equilibrium can be reached only when the two prices have been equalized!Then there will be no further incentive to carry over more crop. (Of course,a small payment for the speculator,s effort might have to be included-but we have agreed to waive all costs just to keep the example simple.)flesh-and-blood speculators can guess the future infallibly. They often make mistakes and often are prey to rumors and mass enthusiasms.So the process is not as ideal as here pictured. Still,to the degree that speculators can intelligently foresee the future-and those who have a terrible batting average may get eliminated fast as their capital is lost-they (and for that matter,farsighted government agencies,too)may help to provide a useful stabilizing function.

stabilizing fiscal and monetary policy

we are know , an important function performed by modern governments involves the control of runaway price inflation and the prevention of chronic unemployment and stagnant growth. Two principle weapons are used: monetary and fiscal policy.
A central bank- which is a bank for banker and which is given the power to issue currency-either is directly in the executive branch of government or, more commonly, is a public not-for-profit organization ultimately responsible to the legislature. we shall study how our version of it, the federal Reserve banks and Board, exercise money and credit policies designed for high production and price stability.
Since the beginning of recorded history, governments have had constitutional authority over money. but only in the last 40 Years has it become generally recognized that fiscal policy of government-variations in public expenditure and tax totals, which create a surplus or deficit rather than a balanced budget-has profound effects on unemployment, total production, money and real incomes, and the level of prices. Bad fiscal policy can make the business cycle worse. Stabilizing fiscal policy can moderate the ups and downs of business. Now that governments are large, claiming to have no fiscal policy is like claiming to be dead: left to themselves, budgets will definitely not balance; a policy of trying to balance the budget in every month,year,decade, or over the whole business cycle involves deliberate (and rash!) social choice.

Tuesday, April 21, 2009

science of stocks (2)

5- Are there then no good tricks? Alas, few indeed. because inflation and growth push the country ahead. a random investment will probably show capital gains in the long run. Not much more can be said.
Statisticians have demonstrated that the day-to-day changes in stock prices are very much like a"random-walk"-like the Brownian motion you see in a microscope due to the chance impacts of invisible and unpredictable atoms on on just-visible huge molecules or colloidal particles. Wall street dos n‘t believe this random-walk theory, but the PhD.D is in the business schools laugh at their disbelief. (computer calculations show that the "gun-slinging performers" do better than the averager in rising bull market; they pat for this by doing worse in falling bear markets. why? because the performance-happy money managers tend to buy stocks that are volatile in both directions-highly leveraged Chrysler versus General Motors, Memorex versus IBM or study AT&A.)
6- to have unusual performance,you must be able to predict increases in the per share earnings of companies before the marketplace in general is aware of them. After is too late. for each stock tends to sell at certain "price-earnings multiple"-e.g., standing and cyclical U.S. Steel at 12\1, glamorous IBM at 40\1. and if you are correct in foretelling an unanticipated rise in earnings, the market will probably mark up the stock price once those earnings become visible. (As a kicker, IF you are early in recognizing an area of glamorous earnings growth, you may find the market putting higher and higher price-earning multiples on your holdings-and after that has happened, it is a good time to get out. Describing this " greater fool theory," in which you hope to unload on some other sucker is easier than for all to practice it successfully.)
7- the above strategy of anticipating changes in earnings is easy to state, but practically impossible to put into practice even if you have a vast research staff and inside management contacts. Hence, unless you like the fun of investing your own money-and are willing to pay something for that fun in the from of bad performance-most amateurs would be well advised to buy shares in some mutual fund. A mutual fund buys 30to100 stocks deemed best by professional money mangers and gives you your prorated share in them. if the market goes up, your mutual fund shares will probably go up; but it works both ways. ( WARNING: Most mutual funds are sold by salesman who get a fat commission for doing so-usually an 8 per cent "load" skimmed off your principal. Through the mail you can buy no-load funds involving no sales commission at all, and which experience shows do about the same on the average as the heavy-load funds. How do the no-loads manage this? Simply by paying the same management fees to money managers but cutting out the selling expenses-the equivalent in finance of the " discount retail store" that quotes low prices for cash-and-carry. you can recognize no-loads on the financial pages by equality of bid and asked. )
for an amusing, but well-informed, account of the modern stock market, the reader might refer to the money Game (random House,New York,1967) by "Adam Smith," or to Smith is Super money (Random House, New york 1972);or to Burton G. Malkiel, A Random walk Down wall street (Norton, New York,1973).

science of stocks

Buying common stocks is an art, not a science. No one can draw the line between risky speculation and safe investment. But an art a craft, being science in A Still-primitive state, has it general rules of behavior. Here are a few gleaned from scientific study of this unscientific field.
1- you can‘t compile a good track record by consulting the stars. Don‘t laugh. financial services have become rich-their clients haven‘t though-by selling astrological advice, and one man made a fortune purporting to interpret the signals being given in the comic strips!
2- Hunches work out to nothing in the long run.
3- The best brains in wall street scarcely do as well as the averages(Standard & poor ‘s,etc.). At first this seems surprising. they have all the money needed for any kind of research and digging. But remember, they are all competing with each other; and if here is a bargain for one man to see, it is also there for another; and hence it will already have been wiped out of existence by competitive bids.
4- Chartists claim to see in plots of stock prices " resistance levels," "gaps" head-and-soulder formations , "flag" "pennants" "channels"-all of which are supposed to improve your odds of guessing right. Knowing investors say: "the chartists generally end up with holes in their shoes. So forget it. "

can banks really create money?

We now turn to one of the most interesting aspects of money and credit, the process called"multiple expansion of bank deposits" Most people have heard that in some mysterious manner banks can create money out of thin air,but few really understand how the process works. Few understand that all our money arises out of debt and IOU operations. Actually,there is nothing magical or incomprehensible about the creation of bank deposits.At every step of the way,one can follow what is happening to the bank,s accounts. The true explanation of deposit creation is simple. What is hard to grasp are the false explanations that still circulate.
According to these false explanations, the managers of an ordinary bank are able, by some use of their fountain pens, to lend several dollars for each dollar deposited with them. No wonder practical bankers see red when such power is attributed to them. they only wish they could do so. AS every banker knows, he cannot invest money that he doesn,t have;and money that he invests in buying a security or making a loan soon leaves his bank.
Bankers,therefore,often go to the opposite extreme,and sometimes argue that the banking system cannot(and does not)create money. "After all,"they say, "we can invest only what is left with us. We don,t create anything. We only put the community,s savings to work." Bankers who argue in this way are wrong. They have become enmeshed in our old friend the fallacy of composition:what is true for each is not thereby true for all .
The banking system as a whole can do what each small bank cannot do:it can expand its loans and investments many times the new reserves of cash created for it,even though each small bank is lending out only a fraction of its deposits.

measurement of inflation: Choice of price index

the measurement of inflation, as defined in the previous section ( a persistent upward movement in the general price level ), involves three main problem :
1-The problem of choosing the price index which is to represent " the general price level ";
2- The problem of measuring the extent of the upward movement in the chosen index over any specified period of time;and
3- The problem of measuring variations in the speed of the upward movement in the chosen index over the specified time period.
In this and the two following sections we shall consider each of these three problems in turn. The discussion will be developed in the Australian context,but it will be applicable, with small modifications, to most advanced industrial economies.
In most countries the choice of a price index to represent the general price level in the measurement of inflation is quite wide. In the case of Australia the main possibilities are as follows:
(a) the consumer price index(C.P.I.)
(b) some component of C.P.I.;
(c) either of the wholesale price indexes (W.P.I.)or some component of either;
(d) the implicit deflator of G.N.P.;
(e) the implicit deflator of some category of gross national expenditure (G.N.E.);
(f) the implicit deflator of non-farm factor cost.
The problem to be considered in this section is the problem of deciding which of these six indexes is the most appropriate. We shall approach this problem by first listing the characteristics of a price ind. which would be ideal for the purpose in hand (the measurement of inflation)and then examining each index to determine the extent to which it possesses these characteristics.
The first characteristic of an indeal index is that it would relate only to commodities produced within the economy or group of economies whose inflation is being measured. For example, if we are attempting to measure the extent of inflation in Australia or in Western Europe, we should like the price index which we use for the purpose to relate only to commodities produced within Australia or within Western Europe,as the case may be. Thus an index which covers imported,as well as
domestically produced commodities,is less than ideal for the purpose of measuring inflation.
Second,an ideal index would be comprehensive in the sense that it would relate to all goods and services produced within the economy,or economies,being studied. For example,an index which relates only to retail goods would fall short of the ideal in the present context,as would one relating,say,to goods consumed by wage-earners.
Third, an ideal index would take proper account of improvements in the quality of the various commodities covered by the index, whether they be goods or services. In other words,it would be recognised,in constructing the index,that over a ten-or fifteen-year period,say,the nominal rise in the price of a commodity may considerably overstate the true rise in price. For example,suppose that in constructing an index it is assumed that the rise in the price of medical services between any two points in time is equal to the rise in the cost of medical services between the same two points in time. Such an index would be less than ideal because,in constructing the index, no allowance is made for improvements in the quality of medical services. Because of quality improvements the true rise in the price of medical services will be less than the nominal price rise, that is less than the rise in cost. By equating the two the index would overstate the rise in the price of medical services over any period, which means that it would overstate the rise in the general price level over that period and in turn the extent of inflation as we have defined it the previous section.
The final characteristic of an ideal index is that it would not be affected by price increases which are temporary, in the sense that they are likely to be reversed at some time in the future, for example price rises which can be attributed to unfavourable weather conditions or to government fiscal action. This requirement is necessary because of the way in which inflation has been defined According to our definition reversible price increases are not part of the upward movement in the price level which constitutes inflation,and for this reason we would like them to have no affect on the index which is to be used to represent the general price level in the measurement of inflation.
We shall now consider each of the indexes in the list presented earlier,in the light of these four requirements, with a view to deciding which of them is the most appropriate for the purpose of measuring inflation.

Monday, April 20, 2009

the cleavage between saving and investment motivations

the most important single fact about saving and investment activities is that in our industrial society they are generally done by different people and done for different reasons.
this was not always so. and even today, when a farmer devotes his time to draining a filed instead of to planting and harvesting a crop, he is saving and at the same time investing. he is "saving" because he is abstaining from present consumption in order to provide for larger consumption in the future-the amount of his saving being measured by the difference between his net real income and his consumption. but he is also " investing" ;i.e., he is undertaking net capital formation, improving the productive capacity of his farm. not only are saving and investment the same things for a self-sufficient farmer, but his reasons for undertaking them are the same. he abstains from present consumption (saves) only because he wants to drain the field (to invest). If there were no investment opportunity whatsoever, it would never occurto him to save; nor would there be any way to save for the future, should he be so foolish as to wish to.
in our modern economy, net capital formation or investment is largely carried on by business enterprises, especially corporations. when a corporation or small business has great investment opportunities, its owns will be tempted to plow back much of its earnings into the business. to an important degree, therefore, some business saving does still get motivated directly by business investment.
Nevertheless,saving is primarily done by an entirely different group: by individuals, by families, by households. An individual may wish to save for a great variety of reasons: to provide for his old age or for a future expenditure (a vacation or an automobile). Or he may feel insecure and wish to guard against a rainy day. Or he may wish to leave an estate to his children or to his children ’s children. Or he may be an eighty-year-old misr with no heirs who enjoys the act of accumulating for its own sake. Or he may already have signed himself up to a savings program because an insurance salesman was persuasive. Or he may desire the power that greater wealth brings. Or thrift may simply be a habit, almost a conditioned reflex, whose origin he does not himself know.
whatever the individuals ’s motivation to save, it often has little to do with the investment opportunities of society and business.
this truth is obscured by the fact that in everyday language "investment" does not always have the same meaning as in economic. we have defined " net investment," or capital formation, to be the net increase in the community ’s real capital ( equipment, buildings,inventories). But the plain man speaks of "investing" when he buys a piece of land, an old security, or any title to property. for economists these are clearly transfer items. what one man is buying, someone else is selling. there is net investment only when additional real capital is created.
In short, even if there are no real investment opportunities that seem profitable, an individual may still wish to nonconsume-to save. he can always buy an existing security asset; he can accumulate, or try to accumulate, cash.

Effects of changing price on output and employment

Aside from redistributing incomes, inflation may effect the total real income and production of the community .
An increase in price is usually associated with high employment. IN mild inflation the wheels of industry well lubricated, and output is near capacity. private investment is brisk, job are plentiful. such has been the historical pattern.
Thus, many businessmen and union Spokesmen, in appraising a little deflation and a little inflation, used to speak of the latter as the lesser of the two evils. The losses to fixed-income groups are usually less than the gains to the rest of the community. Even workers with relatively fixed wages are often better off because of improved employment opportunities and greater take-home pay; a rise in interest rates on new securities may partly make up any losses to creditor; and increases in social security benefits, indexed to adjust for price-level changes, make up losses to the retired .
In deflation, on the other hand, the growing unemployment of labor and capital causes the community ’s total well-being to be less; so, in a sense, the gainers get less than the lessors lose. AS a matter of fact, in deep depression, almost everyone-including the creditor who is left with uncollectible debt-suffers.
the above remarks show why an increase in consumption or investment spending is thought a good thing in times of unemployment, even if there is some upward pressure on prices. When the economic system is suffering from acute depression, few criticize private or public spending on the ground that this might be inflationary Actually, most of the increased spending will then go to increase production and create more job and more real income .
But the same reasoning shows that once full employment and full plant capacity have been reached, any further increase in spending are likely to be completely wasted in price-tag increase .

financial markets

Actual events in would of high finance in mid-September 1992 resembled a thriller novel.Confusion seemed to dominate international financial markets. The British pound and the Italian lira sank in foreign-exchange markets,while the U.S. dollar and German mark rose. Stock prices fluctuated around the would,and interest rates on bonds rose and fell as traders,bankers,and finance ministers tried to maintain stability.Also,the 1980s and early 1990s were volatile times in financial markets in the United States. Interest rates on bonds,stock price,and the value of the U.S. dollar relative to other currencies fluctuated significantly.To understand the roller coaster behavior of domestic and global financial markets,you need to understand the role that financial markets play in the economy and what movements in financial markets tell savers and borrowers.
Financial markets such as the stock or bond markets are one way in which savers surpluses are transferred to borrowers. Moreover,financial markets extend beyond any single country,s borders. Indeed,the international capital markets,that is,the market for lending and borrowing across national boundaries, grew rapidly during the past twenty years. In addition to helping businesses and governments around the world raise fund,financial markets communicate important information through the prices of financial assets.

the Financial System and the economy(3)

The reason that savers and borrowers use the financial system is that each gets something in return: Borrowers can use savers, funds productively until the savers
themselves need the fund. and borrowers are willing to pay savers for that privilege
privilege.moreover. the financial system provides three key financial services ; risk
sharing.liquidity.and information.risk refers to the degree of uncertainty of an asset,s ,s return.Most of us do not gamble with our saving,seeking a relatively steady return on our assets as a whole. When we borrow we also want the cost of borrowing to be predictable. The financial system provides risk sharing by giving savers and borrowers ways to reduce the uncertainty to which they are exposed.
Second,most people care about how easily they can exchange their assets for cash,a feature known as "liquidity".For example,if you used all your savings to buy a plot of land in Arizona,you might find it difficult to sell it quickly if you need money to fix your car or pay your tuition. The financial system enables people to hold assets in liquid from,such as checking accounts,stocks,or bonds.
Finally,the financial system plays an important role in gathering and communicating information about borrowers,circumstances,so that individual savers do not have to search out prospective borrowers. The financial system provides this information to make sure that funds are allocated efficiently.
An understanding of these three key services helps explain how the financial system has developed and how it will likely change in the future. Changes in financial system may well affect your opportunities to save or borrow,or even your career choices. The financial system matches savers and borrowers and provides risk-sharing,liquidity,and information services through two channels: financial markets financial institutions. In this chapter we merely sketch the features of these two channels. We present a more complete picture of the financial system throughout the rest of this book.
The financial system is a relatively small but important source of jobs and income for the U.S. economy. the financial system accounts for about 6% of all private employment in the United States and more than 7% of total employee compensation. In addition, jobs in the financial services sector pay relatively well.At 122% of the national average,the pay is better than the average in wholesale and retail trade, manufacturing,agriculture,mining,construction,and government.