Chapter 8 Flashcards
What is the function of financial markets?
The function of financial markets is to channel funds from economic players that have surplus funds to those that have a shortage
What kind of roles do players adopt within the economy
Efficient allocation of capital
Allows consumers to time their purchases
What is direct finance?
It is when one borrows funds directly from lenders
What does direct finance usually involve?
It involves selling a liability (an IOU or a debt)
What are bonds?
A bond is a contract between a borrower and a lender
What does a bond involve?
It involves regular payments until maturity
What is equity?
Equity is the value of shares within a corporation
What are equity holders?
They are residual claimants
What is a primary market?
It is a market where new security issues are sold to initial buyers
They are not well known to the public and includes the participation of investment banks who guarantee prices
What is a secondary market?
It is a market where previously issued securities are bought and sold
Who are the primary players in a secondary market?
Brokers and Dealers
What do Brokers do?
They match buyers and sellers in each other
What do Dealers do?
They offer to buy and sell securities at stated prices
What are the two main ways in which we can organize a primary market?
Through exchanges or by creating a over-the-counter market
What are the characteristics of an exchange market?
Buyers and sellers meet in one central location
What are the characteristics of an over-the-counter market?
Dealers have inventory, ready to buy/sell at stated prices
What do money and capital markets do?
They distinguish markets by maturity of the securities
What are money markets?
They are markets where only short-term debt instruments are traded
Why do banks and corporations use money markets?
They use money markets in order to reach interest on temporary surplus funds
What are capital markets?
They are markets for longer-term debts
Which market is more liquid; money markets or capital markets?
Money markets
List the 5 money market instruments
Government of Canada Treasury Bills
Certificates of Deposit
Commercial Paper
Repurchase Agreements
Overnight Funds
List the 8 capital market instruments
Stocks
Mortgages and mortgage-backed securities
Corporate bonds
Government of Canada bonds
Canada Savings bonds
Provincial and municipal government bonds
Government agency securities
Consumer and bank commercial loans
What are foreign bonds?
They are bonds sold in a foreign country denominated in that country’s currency
What is a eurobond?
They are bonds sold in a foreign country, denominated in that country’s currency, specifically in europe
What are eurocurrencies?
They are a variant of a eurobond where foreign currencies are deposited in banks outside the home country
What are eurodollars?
They are US dollars deposited in foreign banks outside the US or in foreign branches of US banks
What is financial intermediation?
It is indirect financing using financial intermediates
Primary route is to move funds from lenders to borrowers
What are the three main roles of financial intermediaries?
Lowers transaction costs
Improves risk sharing
Helps solve asymmetric information problems
How does financial intermediation lower transaction costs?
Through economies of scale and liquidity services
How does financial intermediation improve risk sharing?
Allows for asset transformation and diversification
How does financial intermediation help asymmetric information problems?
Adverse Selection: Potential borrows who are more likely to default will most actively seek out loans
Moral Hazard: Borrowers might engage in activities that are undesirable from a lender’s point of view
Financial intermediates can screen and monitor
What are the 3 types of financial intermediaries?
Depository Institutions
Contractual Savings Institutions
Investment Intermediaries
What are depository institutions?
Chartered Banks, Trusts and Mortgage Loan Companies, Credit Unions and Caisses Populaires
What are contractual savings institutions?
Life Insurance Companies, Property and Casual Insurance Companies, Pension Funds and Retirement Funds
What are investment intermediaries?
Finance Companies, Mutual Funds, Money Market Mutual Funds, Hedge Funds, Investment Banks
What are the primary reasons for regulation?
Increase information available to investors
Ensure soundness of financial intermediaries
How does an increase in information available to investors aid in regulation?
Reduces adverse selection and moral hazard problems
Increases efficiency of financial markets
How does the ensured soundness of financial intermediaries aid in regulation?
Restrictions on entry and competition, reporting requirements, and restrictions on assets and activities
Deposit insurance
