Chapter 2 Flashcards
Who are primary lender-savers?
Borrow funds to finance actives
Households
Also business, and govt (state and local) foreigners and their government
What is the purpose of a financial market?
Channel funds from households, firms, and governments that have saved surplus funds by spending less than their income to those who have a shortage of funds because they wish to spend more than their incomes
Who are primary borrower-spenders?
Businesses and governments
Borrow to spend
What is he direct route?
Borrowers borrow finds direct from lenders by selling securities (financial instruments) claims on borrowers future income or assets
What is a bond?
A debt security promising to make periodic payments for specified period in time
What is a stock?
A security that entitles the owner to a share of the company’s profits or assets
Why are financial markets important?
They promote financial efficiency and allow money to transfer from someone with no investment opportunities to someone with them
What is the order of lender-savers?
Household
Business firms
Government
Foreigners
What is the order of borrower-spenders?
Business firms
Government
Household
Foreigners
What is a debt instrument?
Bond/mortgage
Contractural agreement by borrower to pay holder of the instrument fixed dollar amounts at regular intervals until a specified date when final payment is made
What is the maturity of debt?
Number of years until instruments expiration date
When is a debt instrument short-Term?
Maturity less than a year
When is a debt instrument long-term?
If it’s maturity is 10 years or longer
What is an intermediate term?
Debt instruments with maturity between 1 and 10 years
What is an equity?
Common stock
Claims to share in net income and asset of a business
Pay dividends periodically
Right to vote etc
What is a residual claimant?
Disadvantage to owning corporation’s equities
Must pay debt holders before equity holders
Benefit more from any success of the business
What is a primary market?
Financial market which issues new securities
Bonds or stocks
What is a secondary market?
Financial market in which securities that have been previously issued can be resold.
Who is an important part of the primary market?
Investment banks
Underwriting securities
Guarantees a price then sells to public
What are examples of secondary markets?
New York a Stock Exchange NASDAQ Bonds market Futures markets Options markets
Who are brokers?
Agents of investors who match buyers won sellers of securities
Who are dealers?
Link buyers and sellers by buying and selling securities at a stated price
What are two functions of the secondary market?
Make it easier and quicker to sell financial instruments to raise cash
Make financial instruments more liquid
Make easier for firm to sell in primary market
What are two ways secondary markets can be organized?
Exchanges and over the counter market
What is exchanges?
Where buyers and sellers of securities meet in one central location to conduct trades
Ex) New York Stock Exchange
What is the over the counter market?
Dealers at different locations have an inventory of securities stand ready to buy and sell securities over the counter to anyone willing to accept their price
Computers make this very competitive
What is the money market?
Financial market in which only short-term debt instruments are traded
Generally less than 1 year
Traded more often and are more liquid
Smaller fluctuations, safer investment
What is the capital market?
The market in which long term debt and equity instruments are traded
Greater than 1 year
Usually held by intermediaries
What are money market instruments?
Short terms to maturity, least price fluctuations, less frisky investment
U.S. Treasury bills
Negotiable bank certificates of deposit
Commercial paper
Federal funds and security repurchase agreements
What are US treasury bills?
Short term debt instruments
1, 3, 6 month maturities to finance the federal government
No interest payments
Bought at a discount
What is prime rate?
Base interest rate on corporate bank loans
Indicator of the cost of business borrowing from banks
What is the federal funds rate?
Interest rate charged on overnight loans in the fed funds market
Sensitive indicator of the cost to banks of borrowing funds from other banks and the stance of monetary policy
What is treasury bill rate?
The interest rate on US treasury bills
Indicator of general interest rate movements
What is libor rate?
British bankers association avg of interbank rates for dollar deposits in the lord market
What is the most liquid of all money market instruments?
US treasury bills
Most actively traded
Also safest, no possibility of default
U.S. Gov can always pay because it can raise taxes or issue currency
Held by banksWhat is a negotiable bank certificate of deposits ?
CD, debt instrument sold by a bank to depositors that pays annual interest of a given amount and at maturity pays back original purchase price
Sold in secondary market
Funds for commercial banks
What is commercial paper?
Short term debt instrument issued by large banks and well known corporations
Growing fast
What are repurchase agreements?
Short term loans Less than 2 weeks Treasury bills serve as collateral Source of bank funds Most important lenders are large corporations
What are fed funds?
Overnight loans between banks of their deposit and the federal reserve
By banks to other banks
What is the federal firms rate?
Interest rate on fed funds
Closely related to credit market conditions in the banking system and stance of monetary policy
High, banks stopped for funds
Low, banks’ credit needs are low
What are capital market instruments?
Debt and equity instruments with maturities of greater than one year
Wider price fluctuations
Risky investments
Corporate stocks Residential mortgages Corporate bonds US government securities US government agency securities State and local government bonds Bank commercial loans Commercial and farm mortgages
What are stocks?
Equity claims on net income of a corporation
Largest in capital market
Individuals hold 1/2
What are mortgages and mortgage backed securities?
Loans to households or firms to purchase land, housing, or other real structures in which structure is the collateral
Largest debt market
Primarily residential
What is a mortgage back security?
Bond like debt instrument backed by a bundle of individual mortgages, who’s interest and rpm piles are paid to holders of securities
What are corporate bonds?
Long term bonds issued by corporations with strong credit ratings
Send holder interest payment twice a year to pay off face value when bond matures
What is a convertible bond?
Corporate bonds that can be converted to a specified number of shares of stock at maturity date
Reduce interest payments
Life insurance companies
What federal agencies are a part of mortgage market?
Federal national mortgage association Fannie Mae
Government national mortgage association ginnie Mae
Federal home loan mortgage corporation Freddie Mac
Sell bonds to buy mortgages
Not liquid
What are US government securities?
Long term debt instruments issued by Us treasury to finance deficit of fed government
Most widely traded bonds
Most liquid security traded in capital market
What are Us government agency securities?
Long term bonds issued by various government agencies (ginnie mae) to finance personal items like mortgages
What are state and local government bonds?
Municipal bonds
Long term debt instruments issued by state and local governments to finance schools, roads, and large programs
Inters payments exempt from federal income tax and state tax
Commercial banks, biggest buyer
What are consumer and bank commercial loans?
Loans to consumer and businesses made principally by banks or finance company’s
Why have international financial markets grown?
Increase in pool of savings
Deregualtion of finically markets
What are foreign bonds?
Traditional instruments in the international bond market
Sold in foreign country, denominated in that country’s currency
What is a Eurobond?
Bond denominated in a currency other than that of the country it is sold in
Larger than US corporate bonds
What are eurocurrencies?
Foreign currencies deposited in banks outside home country
What are Eurodollar?
Most important Eurocurrency
US dollars deposited in foreign banks outside US or foreign branches of US banks
What is true of world stock markets?
US not necessarily the largest anymore
Now mutual funds that concentrate on trading foreign markets
How does the secondary market work?
Borrow funds from lender savers and then use to make loans to borrower spenders
What is financial intermediation?
Primary route for moving funds from lenders to borrowers
What are transaction costs?
Time and money spent in carrying out Funchal transactions
Problem for people with excess funds
Why can finial intermediaries reduce transaction costs?
Expertise in lowering them and they can take advantage of scale
What are economies of scale?
Reduction in transition cost per dollar as the size of transitions increase
What is liquidity services?
Services that make it easier for costumers to conduct transactions
What is risk?
Uncertainty about returns investors will earn on assets
Low transaction cost reduce exposure to risks
What is risk sharing?
Done by intermediaries
Create and sell assets with risk characteristics that people are comfortable with
Asset transformation
Risky asset turned into safer ones
What is diversification?
Entails investing in a portfolio of assets whose return do not always move together, therefore lowering risk
What is asymmetric information?
One party does not know enough about the other to make accurate decisions
What is adverse selection?
Problem created by asymmetric information before transaction occurs
What is moral hazard?
Asymmetric information after transaction
What do financial intermediaries help with?
Provide liquidity services
Promote risk sharing
Solve information problems
What are economies of scope?
Lower cost of information production for each service by applying one information resource to many different services
What is conflict of interests?
Economies of scope
Too many objectives
May withhold some info
What are categories of financial intermediaries?
Depository institutions
Contractual savings institutions
Investment intermediaries
What are depository institutions?
Banks
Accept deposits from individuals and make loans
What is a thrift institution?
Saving and loan association, mutual savings bank, and credit union
What is a commercial bank?
Raise funds by issuing check able deposits, savings deposits, time deposits
Use funds to buy commercial, consumer, and mortgage loans
Largest intermediary, most diverse assets
What are savings and loan associations and mutual savings banks?
Depository institutions
Saving, time, and check able deposits
Used to use for residential housing loans
What is a credit union?
Money from shares, make consumer loans
What are contractual savings institutions?
Acquire funds on periodic intervals on a contractual basis
Long term securities
Life insurance companies
Annuities, annual income payments upon retirement
Acquire funds from premiums
What does government regulate financial markets?
Increase information available investors, ensure soundness of financial system
What is financial panic?
Widespread collapse of financial intermediaries
