Chapter 4 Flashcards by Ella Rice

What is a financial system?

Where Households, firms and governments can borrow/invest funds

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What are financial intermediaries

They connect those who want to invest with those who want to borrow

net savers and net borrowers (created by lack of synch can be connected here)

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What is direct/indirect finance?

Direct = no intermediary
Indirect = intermediary

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Aside from intermediaries, where else can you borrow from?

You can borrow/invest directly in financial markets
-> short term markets (money markets)
-> long term markets (capital markets)

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What do capital markets comprise of?

bond and equity markets

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What is syncronisation?

To maintain a stable financial position, there must be a syncronisation (balance or match) between payments and receipts

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When does lack of syncronisation happen?

-When payments or recipts aren’t consistent
-Can happen in short, medium and long term

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Synchronisation of payments: Businesses

Outgoings: salaries, purchase inventories and non-current assets

Ingoings: Sales of good, rental income

Business will have to make payments before cash is recieved before sale/use of their assets

-ensure length of credit = life of assets they are funding

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Short term finance sources

OC ABC

O Bank overdraft
C Credit card
A Credit Agreement
B Bills of exchange - IOU from one business to another
C Commercial papers - unsecured promissory notes (IOUs) issues by companies
-have a life of less than 270 days

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KEY TERM: Commercial papers

Unsecured promissory notes issued by companies that generally have a life of less than 270 days

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Long term finance sources

Share capital/equity - selling shares
Long term loans/bonds -secured on the assets of the business
Venture capital - finance risky ventures, require high return
Mezzanine finance - initially a loan, converted into shares in the company if loan is not paid back in time

SLUM SLVM

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Syncronisation in Gov

Many things to spend on
Income mainly through taxes
If expenditure /= income, budget surplus and budget deficit

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Eg’s of financial intermediarys

Clearing banks/investment banks/building societies
insurance companies/pension funds
Investment trusts/stock exchanges/VC’s

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What are the benefits of using financial intermediaries?

RAMM
Risk management - shielded from bad debt risk of other borrowers and lenders
Aggregations - intermediary can take small amounts from investors and lend in larger packages
Maturity transformation - match lenders and borrowers with correct timescales
Matching borrowers and lenders

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What is a financial instrument?

used to describe any funding medium

cash instrument - value directly determined by market
derivative instrument - value determined by underlying performance

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Financial instrument: what is a credit agreement

obtain G + S now and may repayments over a period of time

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Financial instruments: what is a mortage?

loan secured over a property - repayments are made

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Financial instruments: what is a bill of exchange?

IOU
-lender draws up a bill for an amount and a repayment date (typically 90 days) - borrower sign

active market - sells for slightly less than face value

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Financial instruments: what is a certificate of deposit?

essentially a savings account w a fixed term and fixed intrest rate
insured up to 90000
some can be traded

FInancial instruments: Equities

finance raised through the issue of shares

What is an ordinary share?

-holders are owners of the business
-ordinary equity cant be sold back to company (irredeemable)
-can be traded

What are preference shares?

-some characteristics of debt and equity

Cumulative - if a dividend not payid one year - it will be added to dividends paid in later years
Redeemable - may have rights to be bought back at a later date
Participating - right to a share in any excess profits over a certian amount

Financial instruments what is a bond

-long term debt instrument issued by gov or companies
-written legal agreement

UK issued bonds will pay owner interest, based on bonds coupon rate every 6 months

debenture = secured bonds - there is collatoral
loan stock = unsecured bonds

What is a redeemable/iredeemable bond?

Redeem = fixed repayment date
irredeemable = perpetual

3 types of bonds to know

eurobonds in $ or £ in another country - intrest annual and coupon rate = bill rate government bonds - GILTS corporate bonds - high risk - better yield

What is mezzanine finance?

for high risk lending situations unsecured - high interest rate initally a loan - can be converted into shares if unpaid

what is gearing

a company that uses a large proportion of debt finance relative to equity finance

Net present values

all future inflows minus the PV of outflows If NPY +ve PV inflows > PV outflows - project undertaken If NPV -ve project should not be undertaken discount rate = cost of capital = return req by investors

IRR

Discount rate that gives NPV = O -tells us the actual % return that the project generates as the discount rate increases, NPV reduces IRR>cost of capital - accept IRR< cost of capital - reject

What is a yield? what are the 4 types

the return to the investor running yield coupon rate gross redemption rate dividend yield

What is the running yield?

=interest yield annual interest/market price annual interest is based on the coupon rate

What is the coupon rate

=bill rate/nominal yield interest rate offered on a bond % value of the nominal value of the bond that is paid as interest each period

What is gross redemption yield?

yield to maturity overall av return to investor taking into accountt interest returns and capital gain or loss on redemption of the bond no calc

What is a dividend yield

annual dividend/market price (share price) current % dividend return in relation to the existing share price

What is TSR

total shareholder return overall return to an investor in any given period on equities (dividend in the year + change in share price)/share price at start of year = N %

What is a nominal rate?

nominal annual interest rate 24% - nominal monthly interest rate of % nominal monthly interest rate 2% 24% annual rate

what is a bond? simple

a loan a company buys a bond - company pay interest and then pays back eventually

why is equity the highest risk

-dividends might not be paid (directors determind this) -you might not be able to sell the shares

What is liquidity?

lack of liquidity - when investors have cash tied up for a long time -liquidity preference is when they are compensated for this lack of liquidity

what is the yield curve?

The yield curve represents the relationship between interest rates and term to maturity (for financial instruments

Longer term to maturity offer higher yields, why?

-low liquidity - compensated -additional risk of long term investment - uncertainty about future of economy/company -uncertainty about inflation

what is the real interest rate

1+ real interest rate = money rate (nominal rate)/inflation rate

Influence of central bank on interest bank

to set short term interest rates achieved in UK by open market operations - the buying and selling of short term instruments (treasuring bills and short term bonds) in primary market -direct impact on yields of other financial securities

how does central bank spoost spending in an economy that is lacking in consumer confidence

quantitative easing -by purchasing assets of the government or private sector -reducing interest rates by pushing up asset pirices and lowering yeilds so that spending is encouraged again

what is secured?

secured against collatoral