CGMA BA1 Fundamentals of Business Economics - The financial system: financial markets Flashcards
Why do financial intermediaries exist?
Financial intermediaries (e.g., banks/building societies) exist to connect those with surplus funds who want to invest with those who have a shortage of funds who want to borrow.
What is direct finance?
Direct finance involves no intermediary, meaning funds flow directly between investors and borrowers.
What is indirect finance?
Indirect finance involves an intermediary, such as a bank, facilitating the flow of funds between investors and borrowers.
What is the flow of funds?
The movement of money between savers, borrowers, and financial intermediaries in the economic system.
What is synchronisation in finance?
Synchronisation refers to balancing payments and receipts to maintain financial stability.
What are long-term loans, bonds, and debentures?
These are loans secured on the assets of a business, similar to a mortgage for individuals.
What is mezzanine finance?
Mezzanine finance combines debt and equity, allowing lenders to convert loans into shares if not repaid on time.
What is a budget surplus?
A budget surplus occurs when government revenues exceed expenditure.
What is a budget deficit?
A budget deficit occurs when government expenditure exceeds revenue, requiring financing.
What are clearing banks?
Also known as retail or high street banks (e.g., HSBC, LloydsTSB), they provide banking services by taking deposits and lending funds.
What are building societies?
Similar to clearing banks but traditionally mutual organisations, though many have converted to private companies.
What do pension funds do?
They use pension contributions to invest in financial assets such as equities and bonds.
What do venture capitalists do?
They finance high-risk ventures such as start-ups and management buyouts.
What are the advantages of using financial intermediaries?
Financial intermediaries provide risk management, aggregation, maturity transformation, and borrower-lender matching.
How do financial intermediaries help with risk management?
They shield individual borrowers and savers from bad debt risk by taking on the risk themselves.
What is aggregation in financial intermediation?
It allows intermediaries to pool small investments and lend in larger packages, removing the need for exact matches between lenders and borrowers.
What is maturity transformation?
Financial intermediaries match investors’ short-term needs with borrowers’ long-term financing requirements.
How do financial intermediaries help match borrowers and lenders?
They provide funds to borrowers even in unfavorable market conditions, ensuring access to finance.
What are cash instruments?
Cash instruments (e.g., shares and bonds) have values determined directly by the market.
What are derivative instruments?
Derivative instruments (e.g., options, futures) derive their value from an underlying asset, such as share options.
How are bills of exchange used in international trade?
A lender (supplier) issues a bill with a specified amount and repayment date (typically 90 days), which the borrower (customer) signs as acceptance.
What happens if a lender does not want to wait 90 days for repayment on a bill of exchange?
The lender can sell the bill on the secondary market for slightly less than its face value.
What is a Certificate of Deposit (CD)?
A CD is a time deposit that is insured and virtually risk-free, typically with a fixed term and interest rate.
What are negotiable CDs?
Some CDs are issued in a negotiable form, meaning they can be actively traded on the secondary market before maturity.
What are equities?
Equities are finance raised through the issue of shares, with ordinary shares being the most common type.
What are ordinary shares?
Ordinary shares represent business ownership, are irredeemable, and can be sold to a third party.
What are preference shares?
Preference shares have characteristics of both debt and equity and often do not grant voting rights.
What are cumulative preference shares?
If a dividend is not paid one year, it will be added to future dividends.
What are redeemable preference shares?
These shares may have rights to be bought back by the company at a later date.
What are participating preference shares?
These shares allow the holder to receive a share of excess profits above a certain amount.
What is a bond?
A bond is a long-term debt instrument issued by governments or companies with a written legal agreement stating its terms and conditions.
What are debentures and loan stock?
Debentures are secured bonds, while loan stock refers to unsecured bonds. Most UK corporate bonds are debentures.
What is the difference between redeemable and irredeemable bonds?
Redeemable bonds have a fixed repayment date, while irredeemable bonds (e.g., 3.5% War Loan) pay fixed interest indefinitely.
What are Eurobonds?
Eurobonds are bonds issued in the UK but not denominated in £, or bonds issued in £ but not in the UK. They pay interest annually.
What are UK government bonds called?
UK government bonds are called GILTS (Government Index Linked Treasury Stock).
What is the formula for Annual Percentage Rates (APR)?
R = (1 + r)^n - 1
Where R = APR
r = interest rate for the period
n = number of periods in a year
What is the annual rate of interest sometimes quoted as?
Nominal Rate
What is an annuity?
An annuity is an investment that generates a constant return (same amount received each period) for a number of periods.
How is the present value of an annuity calculated?
The present value of an annuity is calculated using a formula that assumes the first payment occurs in one year’s time unless stated otherwise.
What is an advanced annuity?
An advanced annuity is one where the first payment occurs immediately (at time T0).
How do you adjust for an advanced annuity?
Add one year’s amount (not discounted) to the normal annuity calculation or adjust the annuity factor by adding 1.
What is a delayed annuity?
A delayed annuity is one where the first payment occurs after time 1.
How do you adjust for a delayed annuity?
Discount the normal annuity calculation by the number of years of the delay or find the annuity factor for the exact period of cash flows.
What is a perpetuity?
A perpetuity is an annuity that lasts forever, providing constant cash flows indefinitely.
How do you calculate the present value of a perpetuity?
The present value (PV) of a perpetuity is calculated using the formula:
PV = S * (1/r), where S is the annual cash flow and r is the interest rate.
Can perpetuities be advanced or delayed?
Yes, perpetuities can be advanced (starting at T0) or delayed (starting after T1), and adjustments must be made accordingly.
