Capital Markets Flashcards
Financial Market
1) institutions through which a person who wants to save can directly supply funds to a person who wants to borrow.
2) bond market and the stock market
Bond
1) certificate of indebtedness that specifies obligations of borrower to buyer of bond
2) IOU w. date to be repaid (date of maturity)
Principal
1) original amount borrowed
How do bonds differ
1) Term = some long term (30+ years) while some short (months)
2) Credit risk = probability that borrower will pay to pay some of interest or principle (if high chance of default –> need higher interest rate)
3) tax treatment = most bonds are taxable BUT municipal bonds don’t require fed tax (and in some cases state/local) –> tend to have lower interest rates
4) Inflation protection = principal + payments indexed to rise proportional to interest BUT these types of bonds have lower interest rates as a result
Stock
1) partial ownership of firm + claim to profits of firm
Equity finance vs debt finance
1) sale of stock to raise money = equity
2) sale of bonds = debt finance
Prices of stocks based on:
1) supply + demand
2) if people think company will be profitable –> stocks rise + vice versa
Risk vs Benefit analysis of stocks/bonds
1) Stocks = high risk, high reward
2) If company does really well –> stockholders share benefits BUT bond holders only get stipulated interest rate
3) If company has financial problems –> bond holders paid before stockholders
Stock indexes
1) Track overall level of stock prices (average of group of stocks)
2) DOW JONES –> stock prices of 30 major US companies (Walmart, Apple, Microsoft)
Financial Intermediaries
1) financial institutions via which savers indirectly provide funds to borrowers
2) Banks + mutual funds
Banks roles
1) Place for people to deposit money (savings) + to withdraw loans (investment)
2) medium of exchange = use bank deposits to buy things via checks + debit cards
Mutual funds
1) institution that sells shares to the public and uses the proceeds to buy a selection, or portfolio, of various types of stocks, bonds, or both stocks and bonds
2) allow people to diversify savings
What does S = I mean?
1) It means that savings of economy should equal investment
2) Y = C + G + I + NX –> NX = 0 since closed
Y - C - G = I –> S = (Y-C-G)
S = I
Budget deficit vs surplus
1) If T > G –> surplus (collecting more taxes than you are spending)
2) If T < G –> deficit (spending more than collecting taxes)
Private Savings Equation
1) Private Savings = Income - Taxes - Consumption
2) Consumption = Income - Investment - G
Market for loanable funds
1) market for giving + taking loans
What is source of supply for loanable funds
1) Savings –> people with extra income they want to save + lend out
What is source of demand for loanable funds
1) Investment = people who want to take out mortgages to buy homes or businesses that need new equipment
What is interest for a loan
1) price of a loan
2) consider real interest rate which accounts for inflation
What is effect of changing tax laws to encourage savings
1) Supply curve (people who provide loans) shifts right –> equilibrium reduces –> lower interest rates
How would investment tax credit affect equilibrium
1) investment tax credit –> makes investment more attractive –> more people will want to take loans
2) demand shifts to the right –> increases interest rates
How does a govt budget deficit shift market for loanable funds
1) Deficit –> govt cannot give loans as easily –> supply shifts left –> interest rates rise
2) less loanable funds –> called crowding out since crowds out people who want to invest
3) Running budget deficit –> rise in interest rates + reduced investment
What does budget surplus do to market of loanable funds
1) opposite effect –> Supply curve shifts right –> increase in loanable funds supply + reduced interest rate + stimulates investment
