Introduction to Finance

• Financial Management
Financial managers borrow from com-
mercial banks and depend on the banking system to help support 
day-to-day operating activities involving producing and selling their 
products and services. Materials must be purchased from suppliers 
and are usually paid for by writing checks. Sales made to consumers 
also are often paid by check. Business fi rms depend on the banking 
system having a highly effi
cient check clearing system so that cash 
outfl ows and infl ows can be reasonably balanced. Financial managers 
also rely on mutual funds, insurance companies, and pension funds to 
buy their new security issues.
Summary
LO 3.1 
Beginning in 2006, declining housing prices led to higher 
unemployment rates and defaults on mortgage loans by homeown-
ers. Many banks and other fi nancial institutions that held mortgage 
loans and mortgage-backed securities as assets suff ered liquidity and 
solvency problems when the values of these loans and securities fell 
to such low levels that there was concern whether the fi nancial insti-
tutions could meet their liability obligations.
LO 3.2 
The four categories of fi nancial institutions are depository 
institutions, contractual savings, organizations, securities fi rms, and 
fi nance fi rms. Individual savers and investors make deposits in com-
mercial banks, purchase shares in mutual funds, purchase securities 
through investment banks and brokerages, pay premiums to insurance 
companies, and make contributions to pension funds. Commercial 
banks, in turn, make loans to, and purchase debt securities from, busi-
ness fi rms. Investment banks and brokerage fi rms purchase securities 
on behalf of individuals from business fi rms. Mutual funds, insurance 
companies, and pension funds purchase debt and equity securities 
from business fi rms. 
LO 3.3 
A commercial bank accepts deposits, issues check-writing 
accounts to facilitate purchases and paying bills, and makes loans 
to individuals and businesses. An investment bank helps businesses 
sell their new debt and equity securities to raise fi nancial capital. A 
universal bank, which is currently permitted in the United States, 
can engage in both commercial banking and investment banking 
activities. Banks and the banking system perform fi ve functions: 
(1) accepting deposits, (2) granting loans, (3) issuing checkable 
deposit accounts, (4) clearing checks, and (5) creating deposit 
money. For banks that also off er investment banking activities, 
an additional function, (6) raising fi nancial capital for businesses, 
would be added.
LO 3.4 
Banking prior to the Civil War was controversial in terms of 
whether the central government or individual states should have the 
power to charter and regulate banks. The First Bank of the United States 
received a 20-year charter in 1791. In 1816, a 20-year charter was gran-
ted to the Second Bank of the United States. The next federally chartered 
bank did not occur until 1863. During the period prior to the Civil War, 

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