Introduction to Finance

fi nancial system 
interaction 
of intermediaries, markets, 
instruments, policy makers, and 
regulations to aid the fl ow from 
savings to investments 
FIGURE 1.2
 Graphical View 
of the Major Components of the 
U.S. Financial System
Policy Makers
President, Congress, and U.S. Treasury
Federal Reserve Board
Role: pass laws and set fiscal and
monetary policies
Monetary System
Federal Reserve Central Bank
Commercial Banking System
Role: create and transfer money
Financial Markets
Debt Securities Markets
Equity Securities Markets
Derivative Securities Markets
Foreign Exchange Markets
Role: market and facilitate 
transfer of financial assets
Financial Institutions
Depository Institutions
Contractual Savings Organizations
Securities Firms
Finance Firms
Role: accumulate and
lend/invest savings

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12 
C H A PT E R 1 The Financial Environment
laws and make decisions relating to fi scal and monetary policies. These policy makers include 
the president, Congress, and the U.S. Treasury, plus the Federal Reserve Board. Since the 
United States operates within a global economy, political and economic actions of foreign 
policy makers infl uence, although indirectly, the U.S. fi nancial system and its operations. 
Major economic goals are identifi ed and policy-maker actions designed to achieve those goals 
are discussed in Chapter 5.
Second, an eff ective fi nancial system needs an effi
cient monetary system that is composed 
of a central bank and a banking system that is able to create and transfer a stable medium of 
exchange called money. In the United States, the dollar is the medium of exchange, the central 
bank is the Federal Reserve System, and the banking system is commonly referred to as the 
commercial banking system. Characteristics of money and the monetary system are discussed 
in Chapter 2, and the Federal Reserve System is covered in Chapter 4.
Third, an eff ective fi nancial system also must have fi nancial institutions, or interme-
diaries, that support capital formation either by channeling savings into investment in real 
assets or by fostering direct fi nancial investments by individuals in fi nancial institutions and 
businesses. 
Four types of fi nancial intermediaries are listed in Figure 1.2. Depository institutions, con-
tractual savings organizations, securities fi rms, and fi nance fi rms are discussed in Chapter 3. 
The process of accumulating and then lending and investing savings is referred to as the savings-
investment process. We cover the types of fi nancial asset instruments and securities used in 
the United States throughout the text and discuss how the savings-investment process works 
in Chapter 7.
Fourth, an eff ective fi nancial system must also have fi nancial markets that facilitate 
the transfer of fi nancial assets among individuals, institutions, businesses, and governments. 
Figure 1.2 identifi es three types of fi nancial markets—debt securities markets, equity secur-
ities markets, and derivative securities markets. We briefl y discuss these markets later in this 
chapter and then provide more-detailed coverage of the various securities markets throughout 
the text. Foreign exchange markets are discussed in Chapter 6.
Financial System Components and Financial Functions
As previously noted, the role of policy makers is to pass laws and to set both fi scal and mone-
tary policy. Here we focus on the monetary system, fi nancial institutions, and fi nancial 
markets components by expressing their roles as fi nancial functions that are necessary 
in an eff ective fi nancial system.