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Investments > Econ ch 1-6 slides > Flashcards

Econ ch 1-6 slides Flashcards

1
Q

How do interest rates impact health of the economy?

A

they impact consumer’s willingness to save or spend as well as business’ investment decisions

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2
Q

Financial markets

A

markets in which funds are
directly transferred from people and firms who
have an excess funds to people and firms who
need funds

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3
Q

Why is stock market important?

A

It affects people wealth and their willingness to
spend

It affects businesses’ investment decisions, they can obtain more funds and invest more.

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4
Q

Financial intermediary

A

Institutions that borrow
funds from people who have saved and in turn
make loans to other people who want to inves

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5
Q

examples of financial institutions

A

insurance companies, finance
companies, pension funds, mutual funds and investment
companies

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6
Q

Why are financial intermerdiaries important?

A

Without them, financial markets would not be able to dorect funds from savers to investors efficiently

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7
Q

Quantity theory

A

There is a connection between the money supply and the price level

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8
Q

Why are financial systems important to the economy?

A

channels funds from savers to investors which
1. promotes investment
2. economic growth
3. promotes standard of living
4. increase economic efficency

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9
Q

Function of financial system

A

Channeling funds from economic players that have saved surplus funds (savers or lenders) to those
that have a shortage of funds (investors or borrowers)

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10
Q

How is the efficient flow of funds through the financial system, direct or indirect, important?

A

Promotes economic efficiency by producing an efficient allocation of capital, which increases production

Directly improve the well-being of
consumers by allowing them to time their purchases better

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11
Q

Prime rate

A

the base interest rate on corporate bank loan as indicator of the cost to the corporation of borrowing from the bank

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12
Q

Federal Funds Rate

A

the interest rate on over night loans in the federal funds market as indicator of the cost to the
banks of borrowing funds from other banks

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13
Q

Libor Rate

A

the British Banker’s Association average of interbank rates for dollar deposits in the London market (Benchmark)

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14
Q

Eurobond

A

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

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15
Q

Eurocurrencies

A

foreign currencies deposited in
banks outside the home country

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16
Q

Why is indirect finance so important?

A
  1. Lowers transaction costs because of economies of scale and liquidity services
  2. Reduces exposure of risk to investors through risk sharing and diversification
  3. deals with assymetric information problems
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17
Q

adverse selection

A

(before the transaction): try
to avoid selecting the risky borrower by gathering information about them

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18
Q

Moral hazard

A

(after the transaction): ensure
borrower will not engage in activities that will prevent him/her to repay the loan

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19
Q

Examples of depository institutions

A

commercial banks, savings/loan institutions, mutual savings banks, credit unions

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20
Q

contractual savings institutions examples

A

life insurance companies, fire and casualty insurance companies, pension funds, gov retirement funds

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21
Q

Investment intermediaries

A

finance companies, mutual funds, money market mutual funds, hedge funds

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22
Q

Why regulate financial system?

A

increase information available to public and investors, ensure soundness of intermediaries

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23
Q

Functions of money

A
  1. medium of exchange
  2. unit of account
  3. store of value
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24
Q

Medium of exchange, why and requirements

A

eliminates trouble of finding double coincidence in Barter economy
- be easily standardized
- be widely accepted
- be divisible
- be easy to carry
- not deteriorate quickly

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25
Q

Unit of account meaning

A

measures value in the economy, reduces transactions costs

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26
Q

store of value meaning

A

preserves purchasing power over time

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27
Q

commodity money

A

has intrinsic value, easily standardized

cigs, precious metals

28
Q

Fiat money

A

paper money decreed by goverment as legal tender

29
Q

Included in M1

A

currency
travelers checks
demand deposits
other check deposits

30
Q

Included in M2

A

M1
Small den deposits
savings and MM
MMF

31
Q

Why are interest rates watched in households?

A

consume or save?
buy house or not?
buy stocks and bonds or put into savings accounts?

32
Q

Simple loan

A

commercial loans to businesses

33
Q

fixed payment loans

A

mortgages (ordinary annuities)

34
Q

coupon bond

A

U.S. treasury and corporate bonds

35
Q

Discount bonds

A

U.S Treasury saving bonds and long- term zero-coupon bonds

36
Q

YTM

A

Yield to maturity: The interest rate that equates the present value of cash flow payments received from a debt instrument with its value today

37
Q

When is the YTM of a coupon bond the same as its coupon rate?

A

When it’s priced at its fave value

38
Q

formula for Return

A

Return = CY + Rate of capital gain

39
Q

When is the return equal to the YTM in a bond

A

when the holding period equals time to maturity

40
Q

How does the time until maturity impact changes in bond prices?

A

The more distant a bond maturity, the greater size price change it’ll have with changes in rates

LT bonds are more risky for this reason

41
Q

When is there no interest rate risk?

A

When holding period matches time to maturity

42
Q

Ex ante real interest rate

A

adjusted for expected changes in price levels

43
Q

ex post real interest rate

A

real interest rate is adjusted for actual
changes in the price level

44
Q

Fisher equation

A

Nominal int rate = real int rate + expected inflation

Real int rate = nominal int rate - exp inflation

45
Q

Determinants of Quantity demanded on an asset

A

wealth
expected return
risk
liquidity

46
Q

Two approaches to determine interest rates

A

supply and demand in bond market
supply and demand in money market

47
Q

Shifts in demand for bonds

A

wealth
expected returns
expected inflation
risk
liquidity

48
Q

How does an increase in the expected returns shift the demand for bonds

A

Higher int rates in the future lowers expected returns for LT bonds, shifting demand curve to the left

49
Q

How does expected inflation shift the demand for bonds

A

increase in expected inflation lowers expected return for bonds, causing demand curve to shift left

50
Q

Shifts in supply curve for bond

A

expected probabily of investment opportunities
expected inflation
gov budget

51
Q

How does government budget play a role in shift of supply for bonds?

A

An increased budget deficit shifts supply curve to the right

52
Q

What happens to int rates during a period of deflation?

A

Exp return on real assets decreases so bond return relatively increases, Bd shifts right

real int rates increase, increased real cost of borrowing, Bs shifts left

int rate falls

53
Q

What happens to int rates during a recession?

A

profitable investment opportuntiies fall, Bs shifts left

wealth decreases, Bd shifts left but less than Bs

interest rate falls

54
Q

Shifts in demand for money

A

Income effect
Price level effect
Exp inflation effect
Liquidity effect

55
Q

Risk structure of interest rates

A

Bonds with the same maturity (term) have
different interest rates due to:
– Default risk
– Liquidity
– Tax considerations

56
Q

risk premium

A

spread btn int rates on bonds with default risk and int rates on T bonds

How much additional interest people must earn to be willing to hold the risky bond

57
Q

Term structure of int rates

A

Bonds with identical risk, liquidity, and tax characteristics may have different interest rates because the time remaining to maturity is different

58
Q

Term structure of int rates must explain:

A
  • int rates of diff maturities move together over time
  • When ST yields are low, YC is upward
  • YC almost always slope upwards
59
Q

Expectations theory

A

The interest rate on a long-term bond will equal an
average of the short-term interest rates that people
expect to occur over the life of the long-term bond

Bond buyers will only hold bonds if expected return is higher

bonds w diff maturities are perfect substitutes

60
Q

How would expectations theory explain upward sloping yield curve?

A

average of future ST rates are expected to be higher than current

only occurs if ST rates are expected to rise

61
Q

How would expectations theory explain downward sloping yield curve?

A

average of future ST rates are lower than current

only occurs if ST rates are expected to fall

62
Q

Segmented markets theory

A

bonds of diff maturities are not substitutes at all

int rates are determined by supply and demand for that bond

investors hold bonds with shorter maturities, which is why upward sloping

63
Q

Liquidity premium theory

A

The interest rate on a long-term bond will equal an
average of short-term interest rates expected to
occur over the life of the long-term bond plus a
liquidity premium (term premium) that responds to
supply and demand conditions for that bond

Bonds of different maturities are partial (not perfect) substitutes

64
Q

Preferred Habitat Theory

A

Investors have a preference for bonds of one
maturity over another.

Investors are likely to prefer short-term bonds
over longer-term bonds.

65
Q

What does a steep upward yield curve project?

A

higher expected interest rates in the future, forecasting a future increase in economic expansions

66
Q

what does a flat or downward sloping YC represent?

A

forecasts a decrease in inflation or recession

Investments (14 decks)

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