Introduction to Finance

fi nancial assets 
money, debt 
securities and fi nancial contracts, 
and equity securities that are backed 
by real assets and the earning power 
of the issuers
Central Bank
Federal Reserve System
Board of Governors
Federal Reserve Banks
Other Banks
First Bank
Banking System
1. creates money
2. transfers money
3. provides financial intermediation
4. processes/clears checks
Last Bank
Defines and regulates 
money supply
Facilitates the transferring of money
through check processing and clearing
FIGURE 2.2
The U.S. Monetary System

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2.4 Importance and Functions of Money
27
assets of the issuer. A mortgage loan to you will be backed by the house against which the 
loan is being made.
Money
is anything generally accepted as a means of paying for goods and services and for 
paying off debts. For something to serve successfully as money, it must be easily divisible so 
that exchanges can take place in small or large quantities, relatively inexpensive to store and 
transfer, and reasonably stable in value over time. Money must perform three basic functions, 
serving as a medium of exchange, a store of value, and a standard of value.
Money was fi rst developed to serve as a 
medium of exchange
to facilitate transactions. 
Primitive economies consisted largely of self-suffi
cient units, or groups, that lived by means of 
hunting, fi shing, and simple agriculture. There was little need or occasion to exchange goods 
or services. As economies developed, however, the process of exchange became important. 
Some individuals specialized, to a degree at least, in herding sheep, raising grain, or shaping 
gold as metal smiths. To aid in the exchanging of goods for goods, called 
barter
, tables of rel-
ative values were developed from experience. For example, a table might show the number of 
furs, measures of grain, or amount of cloth agreed to equal one cow. This arrangement eased 
exchanges, but the process still had many serious drawbacks. For example, if a person had a 
cow and wanted to trade it for some nuts and furs, he or she would need to fi nd someone who 
had an excess of both these items to trade. The need for a simpler means of exchange led to 
the development of money, with its relatively low storage and transfer costs, to be used as a 
medium of exchange.
Money also may be held as a 
store of value
. That is, money may be spent immediately 
after it is received or after it has been held for some time. While money is held, it is a liquid 
asset and provides its owner with fl exibility, but the owner pays for this fl exibility by giving 
up the potential return that could be earned through investment or the satisfaction that could 
be gained from spending it for goods and services.