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Market analysis- 220 > chapter 8 book: An Overview of the Financial System > Flashcards

chapter 8 book: An Overview of the Financial System Flashcards

1
Q

what do financial markets do?

A

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

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2
Q

The most important borrower- spenders

A

businesses

the government

households

foreigners

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3
Q

the two routes by which funds flow from lender-savers to borrower-spenders

A

direct finance

indirect finance

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4
Q

direct finance

A

borrowers borrow funds directly from lenders in financial markets by selling them securities

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5
Q

securities

A

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

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6
Q

bonds

A

type of securities

debt securities that promise to make payments periodically for a specified period of time

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7
Q

stocks

A

securities that entitle the owners to a share of the com- pany s profits and assets

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8
Q

Why is this channelling of funds from savers to spenders so important to the economy?

A

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

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9
Q

A firm or an individual can obtain funds in a financial market in which two ways?

A

debt instrument

raising funds is by issuing equities

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10
Q

which is the most common for a firm or an individual between debt instrument and issuing equities?

A

debt instrument

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11
Q

debt instrument

A

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)

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12
Q

The maturity of a debt instrument

A

the number of years (term) until that instrument s expiration date

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13
Q

short term debt instrument

A

less than a year

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14
Q

long term debt instrument

A

maturity is ten years or longer

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15
Q

intermediate term debt instrument

A

Debt instruments with a maturity between one and ten years

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16
Q

dividends

A

periodic payments by equities (for ex: stocks) to their holders

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17
Q

equities

A

stocks and shit

often pay dividends

a type of security

are considered long-term securities because they have no maturity date

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18
Q

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

A

true

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19
Q

The main disadvantage of owning a corporation s equities rather than its debt

A

an equity holder is a residual claimant

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20
Q

residual claimant

A

the corporation must pay all its debt holders before it pays its equity holders

they get the residuals

they have less seniority

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21
Q

advantage of owning a corporation s equities rather than its debt

A

equity holders benefit directly from any increases in the corporation s profitability or asset value because equities confer ownership rights on the equity holders

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22
Q

A primary market

A

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

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23
Q

A secondary market

A

a financial market in which securities that have been previously issued can be resold

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24
Q

why are primary markets not well known to the public?

A

because the selling of securities to initial buyers often takes place behind closed doors

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25
Q

investment bank

A

An important financial institution that assists in the initial sale of securities in the primary market

It does this by underwriting securities

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26
Q

underwriting securities

A

it guarantees a price for a corporation s securities and then sells them to the public

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27
Q

Brokers

A

agents of investors who match buyers with sellers of securities

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28
Q

dealers

A

link buyers and sellers by buying and selling securities at stated prices

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29
Q

does a corporation acquire new funds when shares are sold in the secondary market or primary market?

A

when they are sold on the primary market

When an individual buys a security in the secondary market, the person who has sold the security receives money in exchange for the security, but the corporation that issued the security acquires no new funds

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30
Q

two important functions of secondary markets

A

they make the financial instruments more liquid

they determine the price of the security that the issuing firm sells in the primary market

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31
Q

making a financial instrument more liquid

A

making it easier to sell the financial instrument to raise cash

makes them more desirable and thus easier for the issuing firm to sell in the primary market

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32
Q

two ways in which secondary markets can be organized

A

to organize exchanges

to have an over-the- counter (OTC) market

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33
Q

secondary market’s exchanges

A

buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades

ex: The Toronto Stock Exchange for stocks and the Winnipeg Commodity Exchange for commodities (wheat, oats, barley, and other agricultural commodities)

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34
Q

the secondary market’s over-the-counter (OTC) market

A

dealers at different locations who have an inventory of securities stand ready to buy and sell securities over the counter to anyone who comes to them and is willing to accept their prices

dealers are in computer contact and know the prices set by one another

market is very competitive and not very different from a market with an organized exchange

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35
Q

is the Canadian bond market a OTC market or part of the market exchanges?

A

OTC market

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36
Q

The money market

A

a financial market in which only short-term debt instruments are traded

generally those with original maturity of less than one year

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37
Q

the capital market

A

the market in which longer- term debt and equity instruments are traded

generally those with original maturity of one year or greater

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38
Q

which is more ideally traded, money market securities or capital market securities?

A

Money market securities are usually more widely traded than longer-term securities

this causes them to be more liquid

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39
Q

who has more fluctuations in prices, money market securities or capital market securities?

A

short-term securities have smaller fluctuations in prices than long-term securities

this makes them safer investments

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40
Q

who uses more the money markets? why?

A

corporations and banks

to earn interest on surplus funds that they expect to have only temporarily

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41
Q

who uses more the capital markets? why?

A

often held by financial intermediaries such as insurance companies and pension funds

they have more certainty about the amount of funds they will have available in the future

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42
Q

government of Canada treasury bills

A

short-term debt instruments of the Canadian government are issued in 1-, 3-, 6-, and 12-month maturities to finance the federal government

part of the money market

pay a set amount at maturity and have no interest payments

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43
Q

how do government of Canada treasury bills pay interest in the end?

A

pay interest by initially selling at a discount, that is, at a price lower than the set amount paid at maturity

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44
Q

Treasury bills

A

the most liquid of all the money market instruments because they are the most actively traded

safest of all money market instruments because there is almost no possibility of default

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45
Q

who mainly holds treasury bills?

A

banks

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46
Q

A certificate of deposit (CD)

A

a debt instrument sold by a bank to depositors

pays annual interest of a given amount

at maturity pays back the original purchase price

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47
Q

bearer deposit notes

A

traded (negotiated) certificates of deposit (CDs)

the buyer s name is neither recorded in the issuer s books nor on the security itself

issued in multiples of $100 000 and with maturities of 30 to 365 days

can be resold in a secondary market

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48
Q

term deposit receipts or term notes

A

non-negotiable CDs (they cannot be sold to someone else and cannot be redeemed from the bank before maturity)

issued in denominations ranging from $5000 to $100 000

with maturities of one day to five years

49
Q

Commercial paper

A

unsecured short-term debt instrument

part of money market

issued in either Canadian dollars or other currencies by large banks and well-known corporations, such as Microsoft and Bombardier

issued in minimum denomi- nations of $50 000 and in maturities of 1 to 365 day

50
Q

who can issue commercial paper?

A

only the largest and most creditworthy corporations issue commercial paper

51
Q

a commercial paper’s interest rate

A

reflects the firm s level of risk

low relative to those on other corporate fixed-income securities

slightly higher than rates on government of Canada treasury bills

52
Q

finance paper

A

issued by sales finance companies

short-term promissory notes

issued in minimum denomi- nations of $50 000 and in maturities of 30 to 365 day

53
Q

Repurchase agreements, or repos

A

short-term loans (usually with a maturity of less than two weeks)

treasury bills serve as collateral

54
Q

collateral

A

an asset that the lender receives if the borrower does not pay back the loan

55
Q

overnight funds

A

overnight loans by banks to other banks

56
Q

overnight interest rate

A

interest rate on overnight loans

57
Q

high overnight interest rate

A

indicates that the banks are strapped for funds

58
Q

low overnight interest rate

A

credit needs are low

59
Q

money market instruments

A

government of Canada treasury bills

A certificate of deposit (CD)

Commercial paper

Repurchase agreements, or repos

overnight funds

60
Q

capital market instruments

A

Stocks

Mortgages

corporate bonds

government bonds (Canada Savings Bonds (CSBs)

Provincial and municipal government bonds

government agency securities

consumer and bank commercial loans

61
Q

stocks

A

owning equity in a corporation

62
Q

mortgages

A

loans to households or firms to purchase housing, land, or other real structures

the structure or land serves as collateral for the loans

63
Q

the largest debt market in Canada

A

The mortgage market

64
Q

corporate bonds

A

long-term bonds issued by corporations with very strong credit ratings

send the holder an interest payment twice a year and pay off the face value when the bond matures

65
Q

convertible bonds

A

a type of corporate bond

allow the holder to convert them into a specified number of shares of stock at any time up to the maturity date

more desirable than normal bonds

66
Q

which is more liquid, Government of Canada bonds or corporate bonds? why?

A

Government of Canada bonds

Because the outstanding amount of both convertible and nonconvertible bonds for any given corporation is small

67
Q

Government of Canada bonds

A

Intermediate-term bonds and long-term bonds

issued by the federal government to finance its deficit

68
Q

registered bonds

A

the name of the owner appears on the bond certificate

recorded at the Bank of Canada

69
Q

call (or redemption) feature in bonds

A

allows them to be called on a specific notice

usually 30 to 60 days

70
Q

Canada Savings Bonds (CSBs)

A

offered exclusively to individuals, estates, and specified trusts

issued as registered bond

can be purchased from financial institutions or through payroll savings plans

they do not rise or fall in value

71
Q

provincial bonds or provincials

A

bonds used by provincial governments to finance expenditures on schools, roads, and other large programs

72
Q

municipal bonds or municipals

A

bonds used by municipalities governments to finance expenditures on schools, roads, and other large programs

73
Q

government agency securities

A

long-term bonds issued by var- ious government agencies such as the Ontario Municipal Improvement Corporation

74
Q

consumer and bank commercial loans

A

loans to consumers and businesses made principally by banks

75
Q

foreign bonds

A

Bond issued in a domestic market by a foreign entity in the domestic market’s currency

76
Q

Eurobond

A

a bond denominated in a currency other than that of the country in which it is sold

77
Q

true or false

over 80% of the new issues in the international bond market are Eurobonds

A

true fam

78
Q

Eurocurrencies

A

A variant of the Eurobond

foreign currencies deposited in banks outside the home country

79
Q

Eurodollars

A

most important of the Eurocurrencies

U.S. dollars deposited in foreign banks outside the United States or in foreign branches of U.S. banks

80
Q

indirect finance

A

funds moving from lenders to borrowers by a financial intermediary that stands between the lender-savers and the borrower-spenders

helps transfer funds from one to the other

81
Q

financial intermediation

A

The process of indirect finance using financial intermediaries

the primary route for moving funds from lenders to borrowers

82
Q

which is a more important source of financing for corporations: financial intermediaries or securities market?

A

financial intermediaries

83
Q

Transaction costs

A

the time and money spent in carrying out financial transactions

a major problem for people who have excess funds to lend

84
Q

how do financial intermediaries reduce transaction costs?

what does this mean in the end?

A

reduce transaction costs because they have developed expertise in lowering cost

reduce transaction costs because their large size allows them to take advantage of economies of scale

it can provide its customers with liquidity services

85
Q

liquidity services

A

services that make it easier for customers to conduct transactions

86
Q

how do low transaction costs reduce investors’ risks?

A

through risk sharing

87
Q

risk sharing with low transaction costs from financial intermediaries?

A

create and sell assets with risk characteristics that people are comfortable with

use the funds they acquire by selling these assets to purchase other assets that may have far more risk

sometimes referred to as asset transformation

risky assets are turned into safer assets for investors

88
Q

Diversification

A

investing in a portfolio whose returns do not always move together

overall risk is lower than for individual assets

89
Q

asymmetric information

A

in financial markets, one party often does not know enough about the other party to make accurate decisions

90
Q

Adverse selection

A

problem created by asymmetric information before the transaction occurs

occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcome are the ones who most actively seek out a loan

this causes that these are most likely to be selected

91
Q

Moral hazard

A

problem created by asymmetric information after the transaction occurs

the risk (hazard) that the borrower might engage in activities that are undesirable (immoral) from the lender s point of view

lowers the probability that the loan will be repaid

92
Q

problems created by asymmetric information

A

Adverse selection

Moral hazard

93
Q

types of financial intermediaries

A

depository institutions (banks and near banks)

contractual savings institutions

investment intermediaries

94
Q

Depository Institutions (Banks)

A

financial intermediaries that accept deposits from individuals and institu- tions and make loans

95
Q

types of banks

A

chartered banks

trust and mortgage loan companies

credit unions

caisses populaires

96
Q

chartered banks

A

raise funds primarily by issuing chequable deposits, savings deposits, and term deposits

use these funds to make commercial, consumer, and mortgage loans and to buy Canadian government securities and provincial and municipal bonds

97
Q

chequable deposits

A

deposits on which cheques can be written

98
Q

savings deposits

A

deposits that are payable on demand but do not allow their owner to write cheques

99
Q

term deposits

A

deposits with fixed terms to maturity

100
Q

trust and mortgage loan companies

A

obtain funds primarily through:

chequable and nonchequable savings deposits

term deposits

guaranteed investment certificates

debentures

101
Q

credit unions and causes populaires

A

small cooperative lending institutions organized around a particular group

ex: union members, employees of a particular firm, and so forth

they acquire funds from deposits

primarily make mortgage and consumer loans

102
Q

contractual savings institutions

A

financial intermediaries that acquire funds at periodic intervals on a contractual basis

they can predict with reasonable accuracy how much they will have to pay out in benefits in the coming years

do not have to worry as much as depository institutions about losing funds

103
Q

types of contractual savings institutions

A

Life insurance companies

property and casualty insurance companies

pensions funds and government retirement funds

104
Q

Life insurance companies

A

insure people against financial hazards following a death

sell annuities (annual income payments upon retirement)

acquire funds from the premiums that people pay to keep their policies in force

105
Q

property and casualty insurance companies

A

insure their policyholders against loss from theft, fire, and accidents

very much like life insurance companies, receiving funds through premiums for their policies

106
Q

who has a greater possibility of loss of funds between Life insurance companies and property and casualty insurance companies when a major disaster occurs?

A

property and casualty insurance companies

107
Q

pensions funds and government retirement funds

A

provide retirement income in the form of annuities to employees who are covered by a pension plan

Funds are acquired by contributions from employers and/or from employees

108
Q

the investment intermediaries

A

finance companies

mutual funds

money market mutual funds

109
Q

finance companies

A

raise funds by selling commercial paper and by issuing stocks and bonds

110
Q

mutual funds

A

acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds

allow shareholders to hold more diversified portfolios than they otherwise would

111
Q

money market mutual funds

A

have the characteristics of mutual funds

function to some extent as depository institutions because they offer deposit-type accounts

112
Q

why does the government regulate financial market?

A

to increase the information available to investors

to ensure the soundness of the financial system

to improve control of monetary policy

113
Q

financial panic

A

widespread collapse of financial intermediaries caused by ssymmetric information

114
Q

regulations to avoid financial panic

A

restriction one entry

disclosure

restrictions on assets and activities

deposit insurance

limits on competition

115
Q

restriction on entry

A

tight regulations gov- erning who is allowed to set up a financial intermediary

Individuals or groups that want to establish a financial intermediary, such as a bank or an insurance com- pany, must obtain a charter from the provincial or federal government

116
Q

disclosure

A

financial intermediaries’ bookkeeping must follow certain strict principles

117
Q

restrictions on assets and activities

A

There are restrictions on what financial intermediaries are allowed to do and what assets they can hold

118
Q

deposit insurance

A

The government can insure people s deposits so that they do not suffer any financial loss if the financial intermediary that holds these deposits fails

119
Q

limits on competition

A

Politicians have often declared that unbridled competi- tion among financial intermediaries promotes failures that will harm the public

Market analysis- 220 (41 decks)

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