CHAPTER 1
1. NATURE OF THE PH FINANCIAL SYSTEM
NATURE AND IMPORTANCE OF FINANCIAL
SYSTEM
FINANCIAL SYSTEM
Can be thought of as being composed of the
myriad markets and institutions
through which funds flow between
lenders and borrowers .
It is composed of the legal and tax
framework, savers, corporate investors,
and financial institutions. It is a network
of various institutions that generate,
circulate and control money and credit.
Some of these institutions, such as
households, firms, or governments,
spend more during a given period than
they earn, while other institutions
spend less. Some business firms, for
Examples, usually spend more during a
specific period than they earn while
households spend less on current
consumption than they earn.
As a result, an intermediation between the
suppliers and users of credit or a
mechanism is needed to facilitate the
transfer of savings for those institutions
with a surplus to those with a deficit.
Function of financial system =which is to
allocate or match the supply of savings in
the economy to the demanders (users) of
those savings in a safe and efficient
manner.
DIVERSIFICATION =The spreading of assets
into many assets to make up a portfolio
The principle of efficient diversification
holds that bundles of assets should be
combined to mitigate market risks.
The financial system provides risk sharing
by allowing savers to hold diversified
assets.
Financial markets have the capacity to
create instruments that can transfer risk
from savers or borrowers who do not favor
uncertainty in their returns or payments to
savers or investors who are willing to bear
the risk.
The ability of the financial system to share
risk_makes savers more willing to
buy the borrower's IOUS.
This willingness, in turn, increases a
borrower's ability to raise funds within the
financial system.
NATURE AND IMPORTANCE OF
FINANCIAL SYSTEM KEY SERVICES
PROVIDED BY FINANCIAL SYSTEM
Aside from providing matching services to
individuals with excess funds to those that need
them, the financial system also provides three key
services for savers and borrowers, namely: risk
sharing, liquidity, and information.
1. Risk sharing=The term risk is generally referring
to "general uncertainty, doubt, an insured object,
or chance of loss”. For our purposes, risk is
defined as the chance that the value of
financial assets will change relative to what
you expect.
PORTFOLIO= Individuals prefer stable returns
on the collection of assets they hold which
may consist of investment holding such as T-
bonds, some shares of stock and some shares in a
mutual fund.
The performances of these assets will vary
in terms of their ability to generate income.
Some may perform well and earn much,
while another set of assets belonging to the
same portfolio may turn out to be no so
good or bad performers.
