Chapter 2 Flashcards
Adverse selection
is the problem created by asymmetric information before
the transaction occurs. Adverse selection in financial markets occurs when the
potential borrowers who are the most likely to produce an undesirable (adverse)
outcome—the bad credit risks—are the ones who most actively seek out a loan and
are thus most likely to be selected.
Asset transformation
risky assets are turned into safer assets for investors. Low transaction costs allow financial intermediaries to share risk
at low cost, enabling them to earn a profit on the spread between the returns they
earn on risky assets and the payments they make on the assets they have sold.
Assymetric information
when one party often does not know
enough about the other party to make accurate decisions
Brokers
are agents of investors who match buyers with sellers of securities; dealers
link buyers and sellers by buying and selling securities at stated prices.
Capital
(wealth, either financial or physical,
that is employed to produce more wealth),
Capital market
is the market in which longer-term debt
(generally with original maturity of one year or greater) and equity instruments are
traded.
Conflicts of interest
are a type of moral hazard problem that arises when a person
or institution has multiple objectives (interests) and, as a result, has conflicts
between those objectives.
Dealers
dealers
link buyers and sellers by buying and selling securities at stated prices.
Diversification
entails investing in a collection (portfolio) of assets whose returns
do not always move together, with the result that overall risk is lower than for individual assets. RISK MANAGEMENT
Dividends
periodic payments
Economies of scale
the reduction in transaction costs
per dollar of transactions as the size (scale) of transactions increases.
Economies of scope
lower the cost of information production for
each service by applying one information resource to many different services. Ex An
investment bank, for example, can evaluate how good a credit risk a corporation is when making a loan to the firm, which then helps the bank decide whether it would
be easy to sell the bonds of this corporation to the public.
Equities
common
stock, which are claims to share in the net income (income after expenses and
taxes) and the assets of a business.
Eurobond
a
bond denominated in a currency other than that of the country in which it is sold—for example, a bond denominated in U.S. dollars sold in London.
Eurocurrencies
e foreign currencies
deposited in banks outside the home country.
Eurodollars
which are U.S. dollars deposited in foreign banks
outside the United States or in foreign branches of U.S. banks.
Exchanges
where buyers and sellers of securities (or their agents or brokers) meet
in one central location to conduct trades.
Financial intermediation
is the primary route for moving funds from lenders to borrowers.
Financial panic
widespread collapse of financial intermediaries
Foreign bonds
sold in a foreign country and are denominated in that
country’s currency. For example, if the German automaker Porsche sells a bond in
the United States denominated in U.S. dollars, it is classified as a foreign bond.
Intermediate term
1-2 years
Investment bank
financial institution that assists in the initial sale of securities in the primary market
Liabilities
(IOUs or debts)
Liquid
raising cash
Liquidity services
services that make it easier for customers to conduct transactions.
Long term
several years
Maturity
the number of years (term) until that instrument’s expiration date.
Money market
a financial market in which
only short-term debt instruments (generally those with original maturity of less than
one year) are traded
Moral hazard
is the risk (hazard) that the
borrower might engage in activities that are undesirable (immoral) from the lender’s point of view because they make it less likely that the loan will be paid back.
OTC market
dealers at different locations who have an inventory of securities stand ready to buy and sell securities “over the counter” to anyone
who comes to them and is willing to accept their prices.
Portfolio
collection of assets
Primary market
is a financial market in which new issues of a security, such as
a bond or a stock, are sold to initial buyers by the corporation or government agency
borrowing the funds.
Risk
Risk sharing
create and sell assets with risk
characteristics that people are comfortable with, and the intermediaries then use
the funds they acquire by selling these assets to purchase other assets that may
have far more risk.
Secondary market
is a financial market in which securities
that have been previously issued can be resold.
Short term
short time period
Thrift institutions
savings and loan associations, mutual savings banks,
and credit unions
Transaction costs
