Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.

PART 9 The Real Economy in the Long Run

Chapter 26 of 36 Saving, Investment, and the Financial System

Section 5 of 25

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The financial system consists of various financial institutions that coordinate money flow between savers and borrowers.

Financial institutions are grouped into two categories

1 · financial markets, direct finance, including the bond market and the stock market

2 · financial intermediaries, indirect finance: including banks and mutual funds

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The two most important financial markets are

A · the bond market

B · the stock market

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B · The stock market.

Another way besides selling bonds for Intel to raise funds to build a new semiconductor factory is selling stock (shares) in the company.

Stock represents partial ownership of a firm.

It is a claim to the profits the firm makes, paid in the form of dividends.

If Intel sells one million shares of stock, each share represents ownership

of one millionth of the corporation.

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The sale of shares of stock to raise money is called equity finance.

The owner of Intel shares is a part owner of Intel.

The sale of bonds to raise money is debt finance.

The owner of Intel bonds is a creditor of (lender to) Intel, to whom Intel is a debtor (borrower).

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If Intel is profitable the shareholders enjoy benefits of these profits, including higher share price and dividends.

Bondholders get interest payments on, and eventual principle repayment of, their bonds.

If Intel has financial difficulty the bondholders are paid in full what they are due before shareholders receive anything.

In the case of bankruptcy of a company stockholders lose their entire investment.

Bondholders receive some of the proceeds of sales the remaining bankrupt company’s assets.

Compared to bonds, stocks offer the holder both greater risk and greater reward.

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Do U.S. banks buy shares of corporations? Chat GPT:

Yes — U.S. banks can buy shares of corporations, but limited ability because of regulations.

1) What banks are allowed to do

Large banks in the United States like JPMorgan Chase or Bank of America can hold stocks, but typically in limited and specific ways:

-On behalf of clients

Through wealth management or brokerage arms, banks buy and hold stocks for customers, not for themselves.

-Market-making & trading

Large banks may buy and sell shares as part of trading operations helping provide liquidity in markets [this is discussed below].

-Investment arms / subsidiaries

Some banks own or operate investment divisions that can hold equities under separate regulatory structures, e.g. services rendered to companies the bank is arranging incorporation for.

2) What banks are restricted from doing

Since the Volcker Rule, part of Dodd-Frank Act of 2010:

-Banks are restricted from proprietary trading

They generally cannot freely speculate in stocks for their own profit.

-Limits on owning large equity stakes

Banks usually cannot take big ownership positions in non-financial corporations

3) Why these limits exist

Historically, mixing banking and stock speculation led to instability — notably before the Great Depression.

The rules aim to:

Protect depositors’ money

Reduce banking systemic risk

4) Exceptions and gray areas

Banks still have some flexibility:

Private equity / venture investments, within limit)

Temporary ownership, e.g. if a borrower defaults and the bank takes shares as pay back

Bottom line

Yes, U.S. banks do buy and hold stocks

But mostly for clients or limited purposes, not as speculating investors

Regulations tightly control how much risk they can take with stock shares

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“Large banks may buy and sell shares as part of trading operations helping provide liquidity in markets.” – explanation. CGPT:

When large banks like Goldman Sachs or JPMorgan Chase act as market makers [see below], they continuously quote prices at which they’re willing to buy (bid) and sell (ask) stocks, and they will step in to complete trades even when a natural buyer or seller isn’t immediately available.

For example, if an investor wants to sell shares of a company but no other investor is ready to buy at that moment, the bank may purchase those shares itself, hold them briefly in inventory, and later sell them when a buyer appears.

This process keeps the stock market running smoothly by ensuring trades can happen quickly without large price swings, narrowing the gap between buying and selling prices, and providing what’s called “liquidity” — the ability to convert stocks into cash easily.

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"Market maker" - one sentence explanation, CGPT:

A market maker is a firm —mainly banks— that stand ready to buy and sell securities at quoted prices, ensuring investors can trade quickly and markets remain active.

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How do banks make money from being market makers? CGPT:

Banks make money as market makers mainly from the bid-ask spread —the small difference between the price they’re willing to buy a stock for and the price they’re willing to sell it for.

For example, a bank like JPMorgan Chase might quote $100.00 to buy and $100.05 to sell.

If it buys from one investor and sells to another, it earns the $0.05 difference per share.

They also generate profits by managing inventory smartly —buying when prices are slightly favorable and selling when demand picks up— and by handling large volumes of trades, where even tiny spreads add up.

In addition, they may earn fees for facilitating trades and use sophisticated algorithms to adjust prices in real time, balancing risk while capturing consistent, small gains across many transactions.

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bondholders are paid before stockholders

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