1. Intro to Financial Institutions and the Economy

Question 1

What does the capital market include?

Answer 1

1. Equity markets (stocks)
2. Bond markets (long term securities)
3. Money market (short term securities)

Question 2

Functions of financial markets

Answer 2

• disseminate information (price discovery)
• trading mechanism
• pool resources for diversification
• manage risk
• enable the execution of agreements
• deal with incentive problems

Question 3

Types of market efficiency

Answer 3

• allocative efficiency
• operational efficiency
• informational efficiency
• portfolio efficiency

Question 4

Allocative efficiency

Answer 4

•where the highest aggregate output possible is achieved

Question 5

Operational efficiency

Answer 5

The level of transaction costs

Question 6

Informational efficiency

Answer 6

How efficiently do prices transmit information?

Question 7

Portfolio efficiency

Answer 7

Mean variance trade off: investors prefer high returns but low risk

Question 8

What are the two different microstructures of financial markets?

Answer 8

• Quote driven (dealer) markets

* Order driven (agency or auction) markets

Question 9

What are quote driven (dealer) markets

Answer 9

Markets where dealers quote bid and ask prices at which they are prepared fo buy or sell. Trades take plafe sequentially and thus the observed transaction price depends on whether a sale or purchase takes place

Question 10

What are Order driven (agency or auction) markets

Answer 10

Participants issue orders to huy or sell at a stated price. There is discrete trading wuth an auctioneer adjusting the price

Question 11

What is the relationship between assets and liabilities

Answer 11

Assets=liabilities
Because
Equity= assets- other liabilities

Question 12

When is the firm solvent and insolvent

Answer 12

Solvent when equity is positive

Insolvent when equity is negative

Question 13

Why do companies use debt?

Answer 13

• it means they can maintain control of the ehole company
• debt can be leveraged
• debt has high priority that means shareholders get what is left. Thus it offers strong incentives to shareholders to protect the interests of debtholders

Question 14

Forward contract

Answer 14

A way for two people to agree on a fixed price for a future trade

Question 15

Options

Answer 15

A (call/put) option allows the investor to (buy/sell) an asset within a fixed period of time at a fixed price for a small fee

Question 16

Swaps

Answer 16

It is exchanging contracts. You can do interest swaps or exchange rate swaps

Question 17

Short selling

Answer 17

It is where the investor “borrows” shares and sells them. The investor will face margin calls if the price moves up to cover the position