Chapter 2 Flashcards
CAP Allocation Process
In a well-functioning economy, capital flows efficiently from those who supply capital to those who demand it
CAP Allocation Process: Suppliers of Capital
Individuals and institutions with “excess funds.” These groups are saving money and looking for a rate of return on their investment
CAP Allocation Process: Demanders or Users of Capital
Individuals and institutions who need to raise funds to finance their investment opportunities. These groups are willing to pay a rate of return on the capital they borrow
What is a Market?
- A venue where goods and services are exchanged
- A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds
Investment Bank
Underwrites and distributes new investment securities and helps business obtain financing
Commercial Bank
Traditional department store of finance serving a variety of savers and borrowers
Financial Services Corporation
A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking
Mutual Funds
Organizations that pool investor funds to purchase financial instruments and this reduce risks through diversification
Money Market Funds
Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts
Types of Financial Markets
- Physical assets vs. Financial assets
- Spot vs. Futures
- Money vs. Capital
- Primary vs. Secondary
- Public vs. Private
Physical Assets
- Tangible or real asset markets
- Ex. Wheat, Autos, Real Estate, Computers, and Machinery
Financial Assets
Stocks, bonds, notes, and mortgages
Spot Markets
Assets are bought or sold “on the spot” delivery
Future Markets
Participants agree today to buy or sell an asset at some future date
Money Markets
Funds are borrowed or loaned for short periods (less than one year)
Capital Markets
For stocks and for intermediate or long term debt (one year or longer)
Primary Markets
Corporations raise new capital by issuing new securities
Secondary Markets
Securities and other financial assets are traded among investors after they have been issued by corporations
Private Markets
Transactions are worked out directly between two or more parties
Public Markets
Standardized contracts are traded on organized exchanges
Importance of Financial Markets
Well-functioning financial markets facilitate the flow of capital from investors to the users of capital
- Markets provide savers with returns on their money saved/invested, which provide them money in the future
- Markets provide users of capital with the necessary funds to finance their investment projects.Well-functioning markets promote economic growth
- Economies with well-developed markets perform better than economies with poorly-functioning markets
Derivatives
- A derivative security’s value is “derived” from the price of another security (e.g., options and futures)
- Can be used to “hedge” or reduce risk. For example, an importer, whose profit fall
Types of Financial Institutions
- Investment banks
- Commercial banks
- Financial services corporations
- Pension funds
- Mutual funds
- Exchange traded funds
- Hedge funds
- Private equity funds
Initial Public Offering (IPO)
- Occurs when a company issues stock in the public market for the first time
- Enables a company’s owners to raise capital from a wide variety of outside investors. Once issued, the stock trades in the secondary market
- Public companies are subject to additional regulations and reporting requirements
What is meant by stock market efficiency?
- Securities are normally in equilibrium and are “fairly priced”
- Investors cannot “beat the market” except through good luck or better information
Behavioral Finance
Borrows insights from psychology to better understand how irrational behavior can be sustained over time
