Chapter 2-Financial Markets & Institutions Flashcards
3 primary ways that capital is transferred between savers and borrowers
Direct transfers
Investment banks
Financial intermediaries
A market
A venue where goods and services are exchanged
Financial market
A venue where money, capital, and risk is exchanged
Prices…
equilibrate supply and demand in a market.
Interest rates
The fundamental prices in financial markets
Physical market
Buy & sell commodities like oil or corn.
Reallocate risk to those who want it.
Financial market
Buy & sell a bond, stock, or option. Reallocate risk to those who want it.
Spot market
Buy & sell assets at a price today for delivery today
Futures
Buy & Sell assets at a price today for future delivery
Money market
Buy & sell short term loans or investments
Capital market
Buy & sell long-term capital (stocks & bonds)
Primary
Capital market where buy & sell newly-issued securities
Secondary
Capital market where buy & sell existing (seasoned) securities
Why are capital markets essential to growth?
- 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
Derivatives
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
How can derivatives be used to trade risk?
Transfer risk from those who don’t want it to those who do.
8 financial intermediaries
Investment banks Commercial banks Financial services Pension funds Mutual funds ETFs Hedge funds Private equity
2 basic types of stock markets
Exchange market-physical location where buyers & sellers meet
Over the counter market -brokers & dealers connected electronically. A virtual market.
Broker
Executes customer orders
Dealer
Holds inventory. Takes a position in the trade itself.
Dealer market
An OTC market primarily consisting of dealers. Brokers act as agents or match-makers.
Market maker
Takes a position both to profit and to provide liquidity
IPO
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
Stock market efficiency
Securities are normally in equilibrium (supply=demand at that price) at prices that reflect fundamentals.
Possible reasons markets may not be efficient
-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
