class 1 Flashcards
what is a financial system?
the set of financial markets and institutions used for financial contracting and the exchange of assets and risks
what are the 3 things that make up financial systems?
financial markets
financial intermediaries
regulatory bodies
who are the 4 players in the financial system?
households
business firms
financial intermediaries
governments
what is the goal of the financial system?
to satisfy peoples consumption preferences
what are the 2 kinds of financing in the financial system?
direct finance (financial markets)
indirect finance (financial intermediaries)
what is direct financing?
when funding comes directly from lenders/ savers and borrowers/ spenders sell a new security, the security can be a debt instrument (bond) or a equity instrument (shares)
what is indirect financing?
when financial intermediaries borrow funds from lenders/savers and use those funds to make loans to borrower/spenders
what are financial markets?
places where financial transactions take place
what is the goal of financial markets?
to channel funds from economic players that have surplus funds to those that have a shortage
what are the 3 important roles financial markets play in the economy?
efficient allocation of capital/resources
allows consumers to time their purchases
allows for risk sharing between agents
what are the 4 ways financial markets can be categorized?
debt markets, equity markets and derivatives market (based on the type of financial assets)
primary and secondary markets
exchanges and over the counter markets
money and capital markets
what is an asset?
something that is owned by a business, institution, partnership or individual that has monetary value
what are the 2 types of assets?
physical assets (real assets)
financial assets (securities)
what is the key difference between physical assets and financial assets?
physical assets are income generating assets that produce goods or services (land or machines)
financial assets represent claims against the income generated by physical/real assets (securities, financial instruments or debt instruments)
what are the 4 assets sold on the debt market?
bonds
mortgages
consumer loans
commercial loans
what asset is sold on the equity market?
stocks, common and preferred
what 2 assets are sold on the derivatives market?
futures
options
what is a bond?
a debt security that promises to make payments periodically for a specified period of time
who issues a bond?
the borrower
what are the 3 periods until maturity of a bond?
short term, less than 1 year
intermediate term, 1-10 years
long term, more than 10 years
what happens when a bond reaches its maturity date?
at the maturity date the bond becomes due for payment and the face value is returned to the investor
what is face value of a bond?
the amount that is payed out when the bond reaches maturity
if the face value of a bond is 10,000, how much will the bond payout when it reaches its maturity date?
10,000
what are future coupons of a bond?
the periodic payments that the bond pays out
what is the coupon rate of a bond?
the amount of money that is payed out in the periodic payments
what is a stock?
a share of ownership in a corporation, this gives claim to the corporations earnings and assets
what is a common stock?
a stock that represents part-ownership in a corporation, this gives the holder residual benefit of dividends and/or capital gains after all other claims on the firm have been satisfied, common stocks do not have a maturity date
what is a preferred stock?
stocks that give you partial ownership but typically pay fixed dividends and have preference over payments to common share holders
what is the disadvantage to preferred stocks compared to common stocks?
their price gains are limited because the dividends are fixed, they also normally come with no voting rights
what does the value of a derivative security depend on?
the value of the security depends directly on the value of another asset
what are the 2 types of derivative securities?
forwards/futures
options
what are forwards/futures?
an agreement made today to deliver an asset (or its cash value) for an agreed-upon price at specified contract maturity date
what are the 2 kinds of options?
call options
put options
what is a call option?
the holder has the right to buy the underlying asset at the strike price, regardless of the current market price
what is a put option?
the holder has the right to sell the underlying asset at the strike price, regardless of the current market price
what are 4 characteristics of options?
you have the right but not obligation to buy or sell the asset
option is exercised only when it is profitable
to enter in to an options contract you must pay
the premium is the price of the options itself
what are 3 characteristics of futures/ forwards?
you are obliged to make or take delivery of the asset
long (short) position must buy (sell) at the futures price, regardless of it is profitable
futures/ forwards contracts are entered into without cost
what is the primary market?
the market where new securities are issued and sold to initial investors, this is where corporations and government entities can raise capital
what is the secondary market?
the market where previously issued securities are traded among other investors
what is an IPO?
when a companys shares are traded in the primary market for the first time
what are investment banks?
banks that usually handle issues in the primary market and act as underwriters of new issues of stocks
what are seasoned equity offerings?
when a company issues new stocks after their initial IPO
do investors have direct access to secondary markets?
generally not
what do investors normally do to gain access to the secondary market?
they normally employ financial institutions to act as intermediaries for them
what are the 2 types of intermediaries investors could use to gain access to the secondary market?
brokers
dealers
what are brokers?
intermediaries who match buyers and sellers with each other
what are dealers?
intermediaries who offer to buy and sell securities at stated prices
what are clearing and settlement processes?
processes that ensure that both sides to these financial transactions honour their commitment
what are the 3 kinds of brokers?
discount brokers
full service broker
online broker
what is a discount broker?
a broker who only executes trades that you tell them to
what is a full-service broker?
a broker who provides a wide range of services like financial advice and executing trades
what is an online broker?
a broker that executes trades electronically using the internet
what are the 2 ways the secondary market is organized?
exchanges
over-the-counter markets (OTC)