Chapter 2-Financial Markets & Institutions

Question 1

3 primary ways that capital is transferred between savers and borrowers

Answer 1

Direct transfers
Investment banks
Financial intermediaries

Question 2

A market

Answer 2

A venue where goods and services are exchanged

Question 3

Financial market

Answer 3

A venue where money, capital, and risk is exchanged

Question 4

Prices…

Answer 4

equilibrate supply and demand in a market.

Question 5

Interest rates

Answer 5

The fundamental prices in financial markets

Question 6

Physical market

Answer 6

Buy & sell commodities like oil or corn.

Reallocate risk to those who want it.

Question 7

Financial market

Answer 7

Buy & sell a bond, stock, or option. Reallocate risk to those who want it.

Question 8

Spot market

Answer 8

Buy & sell assets at a price today for delivery today

Question 9

Futures

Answer 9

Buy & Sell assets at a price today for future delivery

Question 10

Money market

Answer 10

Buy & sell short term loans or investments

Question 11

Capital market

Answer 11

Buy & sell long-term capital (stocks & bonds)

Question 12

Primary

Answer 12

Capital market where buy & sell newly-issued securities

Question 13

Secondary

Answer 13

Capital market where buy & sell existing (seasoned) securities

Question 14

Why are capital markets essential to growth?

Answer 14

• Allocate capital to its highest & best use
• reconcile savers(supply capital) and capital users (businesses demand capital)
• use interest rates as the prices that reconcile supply & demand

Question 15

Derivatives

Answer 15

A security whose value is “derived” from the price of another security
Ex: An option may be written on the price of a share of stock

Question 16

How can derivatives be used to trade risk?

Answer 16

Transfer risk from those who don’t want it to those who do.

Question 17

8 financial intermediaries

Answer 17

Investment banks
 Commercial banks
Financial services 
Pension funds
Mutual funds 
ETFs
Hedge funds 
Private equity

Question 18

2 basic types of stock markets

Answer 18

Exchange market-physical location where buyers & sellers meet
Over the counter market -brokers & dealers connected electronically. A virtual market.

Question 19

Broker

Answer 19

Executes customer orders

Question 20

Dealer

Answer 20

Holds inventory. Takes a position in the trade itself.

Question 21

Dealer market

Answer 21

An OTC market primarily consisting of dealers. Brokers act as agents or match-makers.

Question 22

Market maker

Answer 22

Takes a position both to profit and to provide liquidity

Question 23

IPO

Answer 23

Initial public offering-when a new company issues stock in the public market for the first time “Going Public”

• enables company to raise capital from outside investors
• once issued, the stock trades in the secondary market
• public companies are subject to additional regulations & reporting requirements

Question 24

Stock market efficiency

Answer 24

Securities are normally in equilibrium (supply=demand at that price) at prices that reflect fundamentals.

Question 25

Possible reasons markets may not be efficient

Answer 25

-costly and/or risky for traders to take advantage of mispriced assets
-cognitive biases cause investors to make systematic mistakes that lead to inefficiencies
-behavioral finance-borrows insight from psychology to better understand how irrational behavior can be sustained over time
Ex: evaluating risks differently in up & down markets and overconfidence leads to self-attribution bias and hindsight bias