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)
what are exchanges?
places where buyers and sellers (or their brokers) meet in one central location to buy and sell
what are 2 examples of exchanges?
Toronto stock exchange
ICE futures Canada
what are over-the-counter markets?
dealers at different locations who have inventory stand ready to buy and sell at stated prices
what is an example of an over-the-counter market?
Canadian bond market
what is the key difference between money markets and capital markets?
the maturity of the securities
what are money markets?
a market where only short-term debt instruments are traded, the securities normally mature in less than a year on this market
who usually used money markets?
corporations and banks actively use money markets to earn interest on temporary surplus funds
what are capital markets?
markets where longer-term debt instruments and equity instruments are traded, normally the securities don’t mature until after at least a year
are money markets or capital markets more risky?
capital markets are more risky due to needing to be locked in to an investment much longer
are money markets or capital markets more liquid?
money markets, much easier to sell your securities
what are the 6 money market instruments?
government of canada treasury bills
certificates of deposit (US)
guaranteed investment certificate/GIC (CAD)
commercial paper
repurchase agreements
overnight funds
what are government of canada treasury bills?
similar to a bond but it has a fixed rate
what are guaranteed investment certificates?
purchase it with a fixed interest rate and you have your money locked in at the bank for a certain period
what is commercial paper?
short term unsecured loans issued by banks and well known companies that last from 1 week to 1 year with no assets as collateral
what are repurchase agreements?
mostly issued by banks, it is a contract in which the vendor of a security agrees to repurchase it from the buyer at an agreed price
what are overnight funds?
when commercial banks borrow money from other commercial banks, the borrower needs to pay the loan back the next day plus interest, typically around 4.5% interest
what are the 7 capital market instruments?
stocks
mortgages and mortgage backed securities
corporate bonds
government of cananda bonds
provincial and municipal government bonds
government agency bonds (issued by crown corps)
consumer and bank commercial loans
what are the 2 kinds of bonds sold in the international markets?
foreign bonds
eurobonds
what are foreign bonds?
when a bond is sold in another country and it is sold in the currency of the country it is being sold in
what is an example of foreign bonds?
a Canadian company selling bonds in the UK denominated in British pounds
what are eurobonds?
a bond sold in a foreign country denominated in another currency
what is an example of a eurobond?
a bond denominated in canadian dollars sold in the UK
are eurobonds or foreign bonds more widely used?
over 80% of new issued bonds are eurobonds
why are euro bonds much more popular than foreign bonds?
because the issuer of the bond does not have to deal with currency exchange
what are some examples of world wide stock markets?
NYSE
NASDAQ
what are the 3 reasons why financial intermediaries are so important in current economies?
lower transaction costs
improved risk sharing
helps solve asymmetric information problems
how do financial intermediaries help with lower transaction costs?
due to economies of scale, banks can reuse contracts instead of paying for new ones to be made with every new transaction
how do financial intermediaries help with improving risk share?
financial intermediaries mitigate risk through risk sharing and diversification, the amount of deposits and loans they take makes the return they can get much less risky
how can financial intermediaries help with asymmetric information problems?
the have adverse and strict selection before the transaction occurs and they monitor the behaviour after the transaction. they have the ability to screen and monitor peoples credit history in a way they we could not
what are the 3 types of financial intermediaries?
depository institutions
contractual savings institutions
investment intermediaries
what are depository institutions?
institutions that you can deposit your money at and they use that money
what are 4 depository institutions?
chartered banks
trusts and mortgage loan companies
credit union
caisses populaires
what are contractual savings institutions?
institutions where you can save your money but you sign a contract to have to leave it there for a certain amount of time
what are 4 contractual savings institutions?
life insurance companies
property and casual insurance companies
pension funds
retirement funds
what are 5 investment intermediaries?
finance companies
mutual funds
hedge funds
investment banks
information service firms
what are the 3 types of insurance?
life insurance
property-casualty insurance (non-life insurance)
re-insurance
what are the 2 types of life insurance?
term life insurance
permanent life insurance
what is term life insurance?
you pay monthly for a certain term, and only get a payout if that person dies within the term
what is permanent life insurance?
you pay much more of premium but it does not ever expire
what is property-casualty insurance?
insurance on anything else that isn’t a persons life
what is re-insurance?
a financial agreement between a reinsurance company and an insurance company to insure what the insurance company is insuring
what are pension funds?
an asset pool that accumulates over an employees working years and pays retirement benefits during the employees nonworking years
what are the 2 sets of distinctions for pensions funds?
pay-as-you-go system VS advanced-funded system
defined-benefit plan VS defined-contribution plan
what is the difference between the “pay-as-you-go system VS advanced funded system”?
pay-as-you-go system: you pay 5.95% of each paycheque, you can only pay 5.95% of up to 60,000 yearly. the money that you contribute go towards funding current retirees, while when you are retired the current workers will fund your retirement
advanced-funded system: money accumulates while you are working and then you get access to it after you retire
does the public system mostly use the “pay-as-you-go system” or the “advanced funded system”?
pay-as-you-go system
what is an example of a pay as you go pension?
Canadian pension plan
does the private system mostly use the “pay-as-you-go system or the advanced funded system”?
advanced funded system
what is the difference between “defined-benefit plan” VS the “Defined contribution plan”?
defined-benefit plan: you get a portion of the pension fund based on DB formula, it Is a non insured and the fund is managed for you
defined-contribution plan: your employer will contribute 6.2% of your income and you can contribute up to another 11.8% tax-free to max it out at 18%, this pension fund is completely managed by yourself, the more you contribute yearly the more you get when you retire
what is the DB formula?
DB= 2% X # number of years worked for company X salary of last 5 years
what is a mutual fund?
a portfolio purchased in the name of a group of investors and managed by a professional investment company or financial institution
what are the 2 types of mutual funds?
open-end funds
closed-end funds
what are open-end funds?
funds that stand ready to redeem (buy back) or issue (sell new) shares at their new asset value (NAV), the amount of shares that are available are not fixed
not traded on exchanges (can buy directly through the funds sponsoring company) uses very few leverage and the portfolio does not change much
what are 2 well known management companies?
fidelity
vanguard
what are the 7 investment policies (how these mutual funds invest)?
money market funds
bond funds
equity funds
sector funds
index funds
balanced funds (half stock, half bonds)
international funds
what are closed-end funds?
after the IPO, no new shares will be issued, existing shares are traded through brokers like other common stocks, and their prices can differ from net asset value (NAV). closed end funds are actively managed and changing their portfolio and use leverage
what is net asset value (NAV)?
the current market value of all securities held by the mutual fund minus any net liabilities divided by the total number of shares outstanding
what is the net asset value of a company who has, 290,000 in securities, 87,000 in net liabilities and 10,000 in outstanding shares?
20.3
what are exchange traded funds (ETFs)?
ETFs are offshoots of mutual funds and are traded on stock exchanges
are most ETFs index funds?
yes
what makes up most ETFs index funds?
they hold the same securities in the same proportions as a certain Stockmarket index or bond market index eg. (s&p 500, nasdaq 100)
what are hedge funds?
a private investment partnership, limited to institutions and high net worth individuals
how do hedge fund invest their money?
hedge funds are only lightly regulated, their managers can persue investment strategies involving heavy use if derivatives, short sales, and leverage. they can be very risky with their investing
what are the fees like for a hedge fund?
they charge a typical annual management fee of 2% plus a performance fee of 20% of the return on the year
what is an investment bank?
banks that handle the issuance of securities in the primary market, offer broker/ dealer operations, offer investment advice and facilitate corporate mergers and accusation. they do not operate like a normal bank
what are information service firms?
firms that provide information about the financial world, predominantly credit rating information on bonds on the ability of the issuer to pay back their debt and charge the issuer a service fee
what are 4 credit rating agencies?
S&P global ratings
Moodys investors service
Fitch group
DBRS morningstar
what is a information service firm that is not a credit rating agency?
bloomberg (provide real time financial news)
what are the 2 primary reasons for financial markets and financial intermediaries are highly regulated?
increase information available to investors
ensure soundness of financial intermediaries
why is it important that the highly regulated financial system provides increased information available to investors?
because It reduces adverse selection and moral hazard problems and increases efficiency of financial markets
why is it important that the highly regulated financial system provides ensure soundness of financial intermediaries?
restrictions on entry and competition, reporting requirements, and restrictions on assets and activities. this insures that all financial intermediaries are truthful and legit
that are the 8 agencies that regulate the Canadian financial system and make up the “financial institution supervisory committee”?
office of the superintendent of financial institution canada (OSFI)
canada deposit insurance corporation (CDIC)
bank of canada (BoC)
department of finance
financial consumer agency of Canada (FCAC)
Quebec deposit insurance board
Canadian life and health insurance compensation corporation (compcorp)
P&C insurance compensation corporation (PACIC)
who does the provincial securities and exchange commission regulate?
they regulate organized exchanges and financial markets by requiring them to disclose certain information and restrict insider trading
who does the bank of canada regulate?
they regulate chartered banks, TMLs and CUCPs by examining the books of the deposit taking institutions and coordinated with the federal agencies that are responsible for financial institution regulation
who does the office of the super intendant of financial institutions canada regulate (OSFI)?
they regulate all federally regulated chartered banks, TMls, CUCPs, life insurance companies, P&C insurance companies and pension plans by setting capital, accounting and board-of-directors responsibility standards, they also conduct bank audits with provincial securities commissions
who does the canada deposit insurance corporation (CDIC) regulate?
they regulate all chartered banks, TMLs, CUCPs by providing insurance of up to 100,000 for each depositor at a bank, examines the books of insured banks and imposes restrictions on assets they can hold
what does the Quebec deposit insurance board do?
the same as CDIC
what does the canadian life and health insurance compensation corporation do?
regulate life insurance companies by compensating the life insurance policy holders if their life insurance company goes bankrupt
what does the P&C insurance compensation corporation do?
regulate property and casualty insurance companies by compensating their P&C insurance policy holders if their P&C insurance company goes bankrupt
what are 2 regulatory bodies in the US?
securities and exchange commission (SEC)
federal reserve system
what are 2 regional and world regulatory bodies?
bank for international settlements
IMF
