Chapter 1 Flashcards
Global financial crisis (GFC)
refers to the financial crisis of 2008 that has been traced to the collapse of the housing market in the United States and the consequences of that collapse for the market for mortgage-related securities
Short selling
- the sale of a financial product that the seller does not own
- the seller has a view to repurchasing the product at a lower price
Financial system
- comprises a range of financial institutions instruments and markets
- overseen by a central bank- supervised by prudential regulator
Financial instruments
issued by a party raising funds, acknowledging a financial commitment and entitling the holder to specified future cash flows
Flow of funds
movement of funds through a financial system
Surplus units
- savers or providers of funds- funds are available for lending or investment
Rate of return
- the financial benefit gained from investment of savings
- expressed in percentage terms
Return or yield
- the total financial benefit received (interest and capital gain) from an investment
- expressed as a percentage
Risk
the possibility or probability that an actual outcome will vary from the expected outcome
Liquidity
access to cash and other sources of funds to meet day-to-day expenses and commitments
Time-pattern of cash flows
the frequency of periodic cash flows (interest and principal) associated with a financial instrument
Asset portfolio
a combination of assets, each comprising attributes of return, risk, liquidity and timing of cash flows
Portfolio structuring
the buying and selling of assets and liabilities to best meet current savings, investment and funding needs
Monetary policy
- actions of a central bank that influence the level of interest rates in order to achieve economic outcomes- primary target is inflation
Inflation
- an increase in prices of goods and services over time- measured by the consumer price index (CPI)
Depository financial institutions
accept deposits and provide loans to customers (e.g. commercial banks, credit unions)
Investment banks and merchant banks
specialist providers of financial and advisory services to corporations, high-net-worth individuals and government
Contractual savings institutions
- offer financial contracts such as insurance and superannuation
- large investors
Finance companies and general financiers
borrow funds direct from markets to provide loans and lease finance to customers
Unit trusts
- investors buy units issued by the trust
- pooled funds invested (e.g. equity trusts and property trusts)
Securitisation
a process whereby an organisation, such as a bank, sells existing balance-sheet assets, for example, housing loans, thereby generating new cash flows
Equity
- the sum of the financial interest an investor has in an asset
- an ownership position
Ordinary share
- the principal form of equity issued by a corporation
- bestows certain rights to the shareholder
Dividend
that part of a corporation’s profit that is distributed to shareholders
Hybrid security
a financial instrument that incorporates the characteristics of both debt and equity (e.g. preference shares)
Liquidation
the legal process of winding up the affairs of a company in financial distress
Debt instruments
- represent a contractual claim against an issuer, and require the borrower to make specified payments, such as periodic interest payments and principal repayments over a defined period- entitle the holder to a claim (ahead of equity holders) to the income stream produced by the borrower and to the assets of the borrower if the borrower defaults on loan repayments
Secured debt
a debt instrument that provides the lender with a claim over specified assets if the borrower defaults
Negotiable debt instrument
a debt instrument that can be sold by the original lender through a financial market
Derivative instrument
- a synthetic security that derives its price from a physical commodity or security
- mainly used to manage risk exposures
Futures contract
an exchange-traded agreement to buy or sell a specific commodity or financial instrument at a specified price at a predetermined future date
Forward contract
an over-the-counter agreement that locks in a price (interest rate or exchange rate) that will apply at a future date
Option contract
- the right, but not the obligation, to buy or sell a commodity or security at a predetermined exercise price
- the buyer pays a premium to the writer
Swap contract
an agreement between two markets to swap future cash flows
Matching principal
the contention that short-term assets such as working capital and inventories should be funded with short-term liabilities, and longer-term assets should be funded with equity and long-term liabilities
Overdraft facility
a fluctuating credit facility provided by a bank which allows a business operating account to go into debt up to an agreed amount
Bonds
a long-term debt instrument issued directly into the capital markets that pays the bond-holder periodic interest coupons and the principal is repaid at maturity
Primary market transaction
- the issue of a new financial instrument into the money market and/or capital market
- funds are obtained by the issuer
Money
a commodity that is universally accepted as a medium of exchange
Secondary market transaction
- the buying and selling of existing financial securities
- represents a transfer of ownership and no new funds raised by the issuer
Securities
financial assets that are traded in a formal secondary market (e.g. stock exchange)
Direct finance
funding obtained direct from the money markets and capital markets
Broker
an agent who carries out the instructions of a client
Dealer
makes a market in a security by quoting both buy (bid) and sell (offer) prices
Credit rating
the assessment by a credit rating agency of the creditworthiness of an obligor to a financial obligation
Default risk
the risk that a borrower may not meet financial commitments such as loan repayments when they are due
Intermediated finance
- financial transaction conducted with a financial intermediary (e.g. bank deposits and bank loans)- separate contractual agreements
Asset transformation
the ability of financial intermediaries to provide a range of products that meet customers’ portfolio preferences
Maturity transformation
financial intermediaries offer products with a range of terms to maturity
Liability management
where banks actively manage their sources of funds (liabilities) in order to meet future loan demand (assets)
Credit risk transformation
- a savers’ credit risk exposure is limited to the intermediary
- the intermediary is exposed to the credit risk of the ultimate borrower
Liquidity transformation
measured by the ability of a saver to convert a financial instrument into cash
Economies of scale
financial and operational benefits gained from organisational size, expertise and volume of business
Wholesale market
direct financial flow transactions between institutional investors and borrowers
Retail market
financial transactions conducted with financial intermediaries mainly by individuals and small to medium-sized businesses
Money markets
wholesale markets in which short-term securities are issued and traded
Institutional investors
participants in the wholesale markets (e.g. funds managers, insurance offices, banks)
Inter-bank market
the lending and borrowing of very short-term funds by banks operating in the payments system
Discount securities
- short-term securities issued with a face value payable at maturity
- does not pay interest
- sold today at a discount to the face value
Bills market
an active money market for the issue and trading of bills of exchange (discount securities)
Commercial paper
promissory notes (discount securities) issued into the money market by corporations with a good credit rating
Negotiable certificate of deposit
a discount security issued by a bank
Capital markets
- markets for longer-term funding
- includes equity, corporate debt and government debt, and is supported by the foreign exchange and derivatives market
Equity markets
facilitate the issue of financial securities that represent an ownership interest in an asset (e.g. stock market)
Corporate debt markets
facilitate the issue and trading of debt securities issued by corporations (e.g. discount securities, bonds)
Euromarket instruments
financial transactions conducted in a foreign country in a currency other than the currency of that country
Government debt
government borrowing for short-term liquidity needs, or longer-term budget capital expenditures (T-notes, Treasury bonds)
Crowding out
government borrowing that reduces the net amount of funds available for other lending in the financial system
Foreign exchange markets
markets that facilitate the buying and selling of foreign currency
Derivatives markets
markets in synthetic risk management products (e.g. futures, forwards, options, swaps)
Deficit units
borrowers or users of funds
Sectorial flow of funds
- the flow of funds between surplus and deficit sectors in an economy
- the business, financial, government, household and rest-of-the-world sectors
Fiscal policy
the management of annual revenues and expenditures of a government
Compulsory superannuation
employers must contribute minimum specified amounts into retirement savings for employees
