Chapters 1-2 Flashcards
4 Main Functions of the Finance Industry
1) Provision of money and clearing and settlement of payment using money
2) Financing- Pooling resources and transferring them over time and space
3) Provision of liquidity
4) Risk Management
What is net worth/ equity
Difference between total assets & debits
What is an Autarkic economy
Self sufficient without trade (buying or selling)
Example of Autarkic economy
North Korea as there is no domestic trade
What is finance
Finance is about assessing RISK, PRICING it and then transferring it through credit and capital market
What is pooling
Gathering small sums and then when a large sum has been collected, using this to invest in large scale projects
What is the human economic lifecycle
The idea that individuals seek to smooth consumption over the course of their lifetime. Borrowing in times of low income and saving during periods of high income
What is gold?
An asset which does not generate any principle and income flows.
A speculative asset
Store of value
The ‘law of one price’ in relation to financial assets implies that in competitive markets…
If 2 financial assets are essentially the same, they will trade at the same market price.
If a single asset is traded in more than one market it will trade at the same price in each of them
When interests rates rise, the price of a bond will fall/rise?
Fall
Assets can be valued in different ways depending on what?
The intention of the asset owner with respect to its asset.
Why may bank shares trade below net asset value?
Asset values are overstated
The bank has little or no franchise value
What would real estate valeurs of residential property, in valuing a house consider?
1) Comparable houses
2) Realised sales prices from such houses
3) Any differences between the house being valued and comparables
Derivatives have little value because?
The statement may be considered to be untrue.
What does interest rate operate through?
The price of credit
What bank determines the demand for credit
The central bank
What three different types of markets does the price mechanism operate in?
1) Markets in goods and services
2) labour markets
3) financial markets
What is capital widening?
Greater investment to make use of existing technology and increase the amount of capital available. Spending more money on technology to increase productivity
What is capital deepening?
Increasing capital available to each employee, thereby hopefully increasing productivity
What is the general equilibrium theory?
Competitive markets are efficient and ensure that companies produce the things that people eat in the right quantities
What is no free lunch?
Investors cannot consistently expect returns on their financial assets because the risk is too high
What does allocative efficiency imply?
That the price of an asset accurately reflects the discounted stream of future earnings that expected to yield over its lifetime.
What are the three pillars of finance?
1) optimising over time
2) measuring and managing risks
3) valuing financial assets
What is pure time value?
Yield on government bonds for the period in question
What is risk? what is it measured by?
The possibility of unexpected outcomes. Usually measured as variability of return
What is risk aversion?
A measure of how willing someone is to pay to reduce their exposure to risk
What is franchise value?.
Amount of value their brand name reputation and skills add to the company value behind the cost of their assets
What are the two ways financial assets are valued?
1) Amortised cost- accounting rule based on the historical cost of acquiring the asset
2) market to market- uses fair value
What are the two classes the regulatory rules require banks to categorise their balance sheets into?
1) banking book
2) trading book
Risk Management could mean what?
1) avoiding risk by holding savings only in government guaranteed bank deposits
2) holding a wide range of assets with different characteristics
3) Never buying shares
A loan is?
A way of obtaining liquidity
A financial asset is?
A contract
A bubble results when?
Market prices exceed what a scientific valuation based on expected future cash flows would estimate as the value of an asset
An asset should be allocated to either the trading book or the banking book according to whether?
The intention is to trade it or hold it
A bank is insolvent if?
Its assets are worth less than its liabilities
A society is likely to become richer over time as a result of?
Capital widening
Capital deepening
Venture capital investment
What does pricing in credit and market capital involves?
The time value of money
An assessment of risk
If shares are always orderly priced, what does this mean?
In relation to the shares of similar companies
In relation to the expected cash flows and risk of the asset
Real investment means?
Investment in physical tangible assets such as real estate, research and development and other non-financial assets
What is an example of an opportunity cost?
Income forgone by taking a long holiday rather than taking a job
An opportunity to invest that absorbed a large proportion of current income.
What does Pari-passu mean?
Proportionally without reference
Companies are subject to only which type of risks?
Business and Financial risk
What is credit enhancement a result of?
Seniority/ priority ranking and subordination
How do companies benefit from a tax shield?
By employing debt in their capital structure
The optimum amount of debt is determined by?
The trade-off between the tax shield benefit and bankruptcy costs
A type of intermediary which generally has a capital structure with ‘undivided interest’ is?
A mutual fund
Principle and Income/Interest flows come from?
Employment
Tax revenue
Rental income
