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IC101-Chapters 1-7 > Chapter 4 > Flashcards

Chapter 4 Flashcards

1
Q

What is maturity transformation?

A

Borrowing short term and lending long term

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2
Q

What has been at the root of numerous banking crises?

A

The fractional reserve system

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3
Q

What is direct financing

A

Financing without using a intermediary

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4
Q

What are the four limitations of direct financing?

A

It is limited by amount of gold that is available and how much people are willing to lend

Requires credit assessment and risk pricing

Ties up a lender’s money until final repayment of a loan

Lender has to apply to courts for redress if principal and interest are not paid. (Expensive and difficult)

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5
Q

What is settlement finality?

A

Transaction settlement that cannot be rescinded

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6
Q

Instead of exchangeability into gold what three things do we look for from a central bank?

A

That the currency of a country will be accepted by everyone in the country for the exchange of goods and services

That it’s value throughout time will not decline to an unacceptable rate

That it’s value in international trade will not decline

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7
Q

What are the two roles of currency?

A

Unit of account -to allow things to be priced relative to each other

Medium of exchange- to facilitate transactions

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8
Q

What do investment banks have?

A

A banking license which permits

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9
Q

What are the two main divisions of the investment bank?

A

Corporate finance- the investment banking side (arranges securities issues)

Investor facing -the brokers and dealers

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10
Q

What do principle activities involve?

A

Using their own capital for generating profit or loss directly without providing client services

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11
Q

Three product divisions in investment bank?

A

Corporate finance

Securities and trading sales

Asset management

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12
Q

What does ring fencing mean?

A

Retail banking on the on the one hand and investment banking on the other would have to be undertaken by separate companies with separate management and with separate capital and liquidity to support them.

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13
Q

What do the broker and dealer do?

A

The broker undertakes sales while the dealer makes markets

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14
Q

To minimise risk, what are the three offices trading and sales are divided into?

A

The front office- trading floor

Middle office- providing risk measurement and management

Back office- ensures trades are cleared and settled

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15
Q

What does the trading function provide?

A

The means for holders of financial assets to turn their securities into cash or vise versa (basically provision of liquidity)

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16
Q

What is financial risk?

A

The risk of loss in the value of financial instruments

17
Q

What is hedging ?

A

Hedging means reducing one’s exposure to financial risk by eliminating the risk of a downside price movement.

18
Q

What does a forward contract commit?

A

The buyer of the contract to buy a specified quantity of an asset on a specific date for a specific price

19
Q

What type of contracts are forward contracts?

A

Derivative contracts

20
Q

What is an example of a forward contract?

A

Natural hedge

21
Q

What are the two motives for entering a derivative contract?

A

A hedger

A speculator

22
Q

What is diversification?

A

A key means of reducing risk

23
Q

In medieval times, banks originally provided only what?

A

Safekeeping of funds

24
Q

A commercial bank is what?

A

A principle business

25
Q

On which side of the balance sheet do banks keep reserves in case of customer cash demands?

A

Asset side

26
Q

What do commercial banks use to settle outstanding balances between them?

A

Central bank money

27
Q

What are universal banks?

A

Financial institutions which offer both commercial and investment banking services

28
Q

Why were US banks not permitted to offer investment banking services prior to 1999?

A

Because they were not permitted under the Glass Steagall Act

29
Q

A typical investment bank today is involved in what?

A

Corporate finance

Securities sales and trading

Asset management and wealth management

30
Q

How does financial risk differ from pure risk?

A

Pure risk has no upside whereas financial risk does

31
Q

Derivative markets require both hedgers and speculators because of what?

A

It’s not possible for everyone to hedge on the same risk

32
Q

What does risk management by investors through diversification do?

A

Lower the cost of capital to issuers by reducing investor risk

33
Q

What is quasi money?

A

Assets that are not quite money but are close to it

34
Q

What are the two types of risk?

A

Central bank money

Credit money

35
Q

Credit money is typically divided into what?

A

Commercial bank money

Central bank money

IC101-Chapters 1-7 (7 decks)

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