Ch. 1

Question 1

What is finance?

Define finance in terms of resource allocation and time.

Finance involves evaluating uncertain cash flows.

Answer 1

Finance is the study of how people allocate scarce resources over time.

Costs and benefits are distributed over time.

Question 2

What is the Financial System?

Define the Financial System in terms of its purpose and components.

The Financial System encompasses markets and institutions used for financial contracting and asset exchange.

Answer 2

The Financial System is defined as the set of markets and other institutions used for financial contracting and exchange of assets and risks.

It facilitates financial decisions and transactions.

Question 3

What does financial theory encompass?

Describe the components of financial theory.

Answer 3

Financial theory consists of two main elements:
* Concepts: These help organize thinking about resource allocation over time.
* Quantitative Models: These aid in evaluating alternatives, making decisions, and implementing strategies.

Question 4

What is the Financial System?

Describe the components that constitute the Financial System.

The Financial System facilitates financial decisions for households, businesses, and governments.

Answer 4

The Financial System comprises several key elements:
* Markets: Where financial assets are bought and sold.
* Intermediaries: Entities that connect borrowers and lenders.
* Service Firms: Organizations providing financial services.
* Other Institutions: Entities involved in financial transactions.

Question 5

How do funds flow between surplus and deficit units?

Describe the channels through which funds move from surplus to deficit units.

Answer 5

Funds may flow from surplus units (those with excess funds) to deficit units (those in need of funds) through two primary channels:
* Markets: Direct transactions where surplus units invest in financial assets held by deficit units.
* Intermediaries: Indirect channels where financial institutions facilitate the transfer of funds between surplus and deficit units.

Question 6

What are Financial Markets?

Describe the purpose and function of financial markets.

Answer 6

Financial markets are forums where participants engage in direct finance. In these markets:
* Buyers and sellers meet to exchange financial assets.
* Borrowers obtain funds directly from lenders by selling securities (also known as financial instruments).

Question 7

What are Financial Intermediaries?

Describe the role and function of financial intermediaries.

Answer 7

Financial intermediaries are institutions whose primary business is to provide financial services and products. They play a crucial role in indirect finance, where borrowers obtain funds indirectly from lenders through these intermediaries (such as banks).

Examples of financial intermediaries include banks (offering checking accounts, loans, and CDs), investment companies (such as mutual funds), and insurance companies (providing term life insurance).

Question 8

What is the primary function of financial markets?

Describe the fundamental role of financial markets.

Answer 8

The essential function of financial markets is to:
* Channel Funds: Transfer surplus funds from economic players (savers) to those in need of funds (borrowers).
* Promote Efficiency: Facilitate efficient allocation of capital, thereby supporting economic growth and benefiting society as a whole.

Question 9

what can financial markets be classified by?

Answer 9

1. The Type of Asset Traded
2. The Maturity of the Financial Asset
   * Money market
   * Capital market
3. The Owner of the Financial Asset
   * Primary market
   * Secondary market

Question 10

Financial Markets classified by Type of Assets

List the type of assets

Answer 10

• Debt
• Equities
• Derivatives

Question 11

Financial Markets classified by Maturity

How can financial markets be classified by maturity

Answer 11

1. Money Market
2. Capital Market

Question 12

Characterstics of Money Market

Answer 12

– Short-term securities.
– Mostly debt instruments issued by governments
and secure large corporations.
– Highly liquid: Quickly convertible to cash

Question 13

Characterstics of Capital Market

Answer 13

– Medium & long-term securities.
– Equities, and debt instruments with a life greater
than a year.

Question 14

T or F:

Bonds are Short term debt instruments

Answer 14

False

Question 15

I f you buy a government bond, You are considered the Lender or the borrower?

Answer 15

Lender

Question 16

Why are bonds called fixed-income securities?

Answer 16

Because the interest payments and the principal are typically specified at the time the bond is issued and fixed for the whole life time of the bond

Question 17

T or F:

Common stocks can be traded in Money Markets

Answer 17

Flase

Are traded only in Capital Markets

Question 18

What are preffered stocks?

Answer 18

Preferred stock is a hybrid of debt and
equity.

It is much like interest on a bond , where it specifies a fixed payment
called a dividend (that is estimated as a fixed percentage of the stock par value)

Question 19

What are the 3 types of derivatves

Answer 19

1. Futures and Forwards
2. Options
3. Swaps

Question 20

What are Futures and Forowards

Answer 20

Futures or forwards are contracts to buy or sell
an asset on or before a future date at a price
specified today

Question 21

How does future contracts differ from forowards

Answer 21

Futures contract is a standardized contract written by a clearing house that operates an exchange where the contract can be bought and sold. Whereas a forward contract is a nonstandardized contract written by the parties themselves

Question 22

What are Options?

Answer 22

Options are contracts that give the owner the right, but not the obligation, to buy or sell an asset. The price is specified at the time the parties enter into the option.

The option contract also specifies a maturity date.

Question 23

What are Swaps?

Answer 23

Swaps are contracts to exchange cash (flows) on or before a specified future date based on the underlying
value of currencies/exchange rates, bonds/interest rates, commodities, stocks or other assets