Chapter 1 Flashcards
Financial Market
A market in which securities can be purchased or sold.
Role of Financial Markets
Surplus units: participants who receive more money than they spend (investors).
Deficit units: participants who spend more money than they receive (borrowers).
Securities represent a claim on the issuers.
Primary Markets
Facilitate the issuance of new securities.
Secondary Markets
Facilitate the trading of existing securities.
Allows for a change in the ownership.
Liquidity
The degree to which securities can easily be sold without a loss of value.
Illiquid securities may have to be sold at a large discount to attract a buyer.
Money Market Securities
Facilitate the sale of short-term debt securities by deficit to surplus units.
Debt securities that have a maturity of one year or less.
Generally have a high degree of liquidity due to short maturity, high desirability, and common activity in secondary markets.
Tend to have a low expected return but also a low degree of default risk.
Capital Market Securities
Facilitate the sale of long-term securities by deficit to surplus units.
Bonds are issued by the Treasury, government agencies, and corporations to finance their operations.
Mortgages are created to finance the purchase of real estate.
Mortgage-backed securities represent claims on a package of mortgages.
Stocks represent partial ownership in the corporations that issued them.
Derivative Securities
Financial contracts whose values are derived from the values of underlying assets.
Speculation allows an investor to speculate on movements in the value of the underlying asset without having to purchase.
Risk management is used to adjust the risk of existing investments.
Impact of Information on Valuation
Estimate future cash flows by obtaining information that may influence a stock’s future cash flows.
Use economic or industry information to value a security.
Use published opinions about the firm’s management to value a security.
Impact of Behavioural Finance on Valuation
The application of psychology to make financial decisions.
Limited information leads to uncertainty in the valuation of securities.
Role of Depository Institutions
Accept deposits from surplus units and provide credit to deficit units through loans and purchases of securities.
Offer liquid deposit accounts to surplus units.
Provide loans of the size and maturity desired by deficit units.
Accept the risk of default on loans provided.
Have more expertise in evaluating creditworthiness.
Diversify their loans among numerous deficit units.
Commercial Banks
The most dominant type of depository institution.
Transfer deposit funds to deficit units through loans or purchase of debt securities.
Savings Institutions
Also called thrift institutions and include Savings and Loans (S&Ls) and savings banks.
Concentrate on residential mortgage loans.
Credit Unions
Nonprofit organizations.
Restrict business to CU members with a common bond.
Finance Companies
Obtain funds by issuing securities and lend the funds to individuals and small businesses.
Mutual Funds
Sell shares to surplus units and use the funds received to purchase a portfolio of securities.
Securities Firms
Provide a wide variety of functions in financial markets (broker, underwriter, dealer, advisory)
Insurance Companies
Provide insurance policies that reduce the financial burden associated with death, illness, and damage to property.
Charge premiums and invest in financial markets.
Pension Funds
Manage funds until they are withdrawn for retirement.
Systemic Risk
The spread of financial problems among financial institutions and across financial markets that could cause a collapse in the financial system.
