chapter 8 book: An Overview of the Financial System Flashcards
what do financial markets do?
perform the essential economic function of channelling funds from households, firms, and governments who have saved surplus funds by spending less than their income to those who have a shortage of funds because they wish to spend more than they earn
lends money from those with surplus to those who need it
The most important borrower- spenders
businesses
the government
households
foreigners
the two routes by which funds flow from lender-savers to borrower-spenders
direct finance
indirect finance
direct finance
borrowers borrow funds directly from lenders in financial markets by selling them securities
securities
also called financial instruments
claims on the borrower s future income or assets
assets for the person who buys them
liabilities (IOUs or debts) for the individual or firm that sells (issues) them
bonds
type of securities
debt securities that promise to make payments periodically for a specified period of time
stocks
securities that entitle the owners to a share of the com- pany s profits and assets
Why is this channelling of funds from savers to spenders so important to the economy?
the people who save are frequently not the same people who have profitable investment opportunities available to them, the entrepreneurs
Without financial markets, it is hard to transfer funds from a person who has no investment opportunities to one who has them
if one wants a house and waits by saving up on his own, hell be too old to enjoy the house once he can afford it
with financing, this individual can ask for a loan and enjoy the house while he’s still young, while the lender enjoys constant cash flow from interest
A firm or an individual can obtain funds in a financial market in which two ways?
debt instrument
raising funds is by issuing equities
which is the most common for a firm or an individual between debt instrument and issuing equities?
debt instrument
debt instrument
such as a bond or a mortgage
a contractual agreement by the borrower to pay the holder of the instru- ment fixed dollar amounts at regular intervals
interest and principal payments until a specified date (the maturity date)
The maturity of a debt instrument
the number of years (term) until that instrument s expiration date
short term debt instrument
less than a year
long term debt instrument
maturity is ten years or longer
intermediate term debt instrument
Debt instruments with a maturity between one and ten years
dividends
periodic payments by equities (for ex: stocks) to their holders
equities
stocks and shit
often pay dividends
a type of security
are considered long-term securities because they have no maturity date
true or false
owning stock means that you own a portion of the firm and thus have the right to vote on issues important to the firm and to elect its directors
true
The main disadvantage of owning a corporation s equities rather than its debt
an equity holder is a residual claimant
residual claimant
the corporation must pay all its debt holders before it pays its equity holders
they get the residuals
they have less seniority
advantage of owning a corporation s equities rather than its debt
equity holders benefit directly from any increases in the corporation s profitability or asset value because equities confer ownership rights on the equity holders
A primary market
a financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by the corporation or government agency borrowing the funds
A secondary market
a financial market in which securities that have been previously issued can be resold
why are primary markets not well known to the public?
because the selling of securities to initial buyers often takes place behind closed doors