Economics

Question 1

Market price

Answer 1

market price is the economic price for which a good or service is offered in the marketplace.

Question 2

Market Value

Answer 2

Market value or OMV (Open Market Valuation) is the price at which an asset would trade in a competitive auction setting.

International Valuation Standards defines market value as “the estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently, and without compulsion”.

Question 3

Fair Value

Answer 3

In accounting and in most Schools of economic thought, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset. It takes into account such objective factors as:

acquisition/production/distribution costs, replacement costs, or costs of close substitutes
actual utility at a given level of development of social productive capability
supply vs. demand
and subjective factors such as

risk characteristics
cost of and return on capital
individually perceived utility

There are two schools of thought about the relation between the market price and fair value in any kind of market, but especially with regard to tradable assets:

The efficient-market hypothesis asserts that, in a well organized, reasonably transparent market, the market price is generally equal to or close to the fair value, as investors react quickly to incorporate new information about relative scarcity, utility, or potential returns in their bids; see also Rational pricing.
Behavioral finance asserts that the market price often diverges from fair value because of various, common cognitive biases among buyers or sellers. However, even proponents of behavioral finance generally acknowledge that behavioral anomalies that may cause such a divergence often do so in ways that are unpredictable, chaotic, or otherwise difficult to capture in a sustainable profitable trading strategy, especially when accounting for transaction costs.

Question 4

Short Selling

Answer 4

In finance, a short sale (also known as a short, shorting, or going short) is the sale of an asset (securities or other financial instrument) that the seller does not own. The seller effects such a sale by borrowing the asset in order to deliver it to the buyer. Subsequently, the resulting short position is “covered” when the seller repurchases the asset in a market transaction and delivers the purchased asset to the lender to replace the quantity initially borrowed. In the event of an interim price decline, the short seller will profit, since the cost of (re)purchase will be less than the proceeds received upon the initial (short) sale.

Question 5

Margin (Finance)

Answer 5

In finance, margin is collateral that the holder of a financial instrument has to deposit with a counterparty (most often their broker or an exchange) to cover some or all of the credit risk the holder poses for the counterparty. This risk can arise if the holder has done any of the following:

Borrowed cash from the counterparty to buy financial instruments,
Borrowed financial instruments to sell them short,
Entered into a derivative contract.
The collateral for a margin account can be the cash deposited in the account or securities provided, and represents the funds available to the account holder for further share trading. On United States futures exchanges, margins were formerly called performance bonds. Most of the exchanges today use SPAN (“Standard Portfolio Analysis of Risk”) methodology, which was developed by the Chicago Mercantile Exchange in 1988, for calculating margins for options and futures.

Question 6

Performance Bond

Answer 6

A performance bond, also known as a contract bond, is a surety bond issued by an insurance company or a bank to guarantee satisfactory completion of a project by a contractor. The term is also used to denote a collateral deposit of good faith money, intended to secure a futures contract, commonly known as margin.

Performance bonds have been around since 2,750 BC. The Romans developed laws of surety around 150 AD,[1] the principles of which still exist.

A job requiring a payment and performance bond will usually require a bid bond, to bid the job.[2] When the job is awarded to the winning bid, a payment and performance bond will then be required as a security to the job completion.[3] For example, a contractor may cause a performance bond to be issued in favor of a client for whom the contractor is constructing a building. If the contractor fails to construct the building according to the specifications laid out by the contract (most often due to the bankruptcy of the contractor), the client is guaranteed compensation for any monetary loss up to the amount of the performance bond.

Another example of this use is in commodity contracts where the seller is asked to provide a Bond to reassure the buyer that if the commodity being sold is not in fact delivered (for whatever reason) the buyer will at least receive compensation for his lost costs.

Performance bonds are generally issued as part of a ‘Performance and Payment Bond’, where a payment bond guarantees that the contractor will pay the labour and material costs they are obliged to.

Question 7

Completion Bond

Answer 7

A completion guarantee (sometimes referred to as a completion bond) is a form of insurance offered by a completion guarantor company (in return for a percentage fee based on the budget) that is often used in independently financed films to guarantee that the producer will complete and deliver the film (based on an agreed script, cast and budget) to the distributor(s) thereby triggering the payment of minimum distribution guarantees to the producer (but received by the bank/investor who has cash flowed the guarantee (at a discount) to the producer to trigger production).

The producer will agree to deliver a film (based on an agreed script/cast/budget) to a distributor in respect of certain territories in consideration (inter alia) for payment of a “minimum distribution guarantee” payable at the point in time when the producer has delivered the completed film. The producer obviously requires such funds upfront to finance the film so the producer takes the signed distribution contract to a bank/financier and will effectively use it as collateral against a production loan. It is at this stage that the bank will require a completion bond to be executed to provide them with the required level of security against the risk of non-delivery by the producer. The parties to the completion bond agreement are typically the producer, the financier(s), the completion guarantor company and the distributor(s).

Key to the completion guarantor company’s risk assessment process will be a careful scrutiny of key persons on the production team to determine whether the film is “bondable”. Of particular interest will be the director, first assistant director, line producer, production manager, producer, cast and cinematographer, since these personnel will ultimately be responsible for keeping the production on budget and on schedule.

The completion guarantor will require a regular (usually daily) flow of production paperwork—for example, production reports, cashflow and cost reports etc. Under the bond agreement, the completion guarantor has the contractual right to “take over the film” (which will include wide “hire and fire” rights over any personnel including the director) since they are financially liable if the film goes over budget.

Question 8

Derivative (Finance)

Answer 8

In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the “underlying”.[1][2][3] Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation or getting access to otherwise hard-to-trade assets or markets.[4] Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps.

Question 9

over-the-counter (off-exchange)

Answer 9

Over-the-counter (OTC) or off-exchange trading is done directly between two parties, without the supervision of an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the benefit of facilitating liquidity, providing transparency, and maintaining the current market price. In an OTC trade, the price is not necessarily published for the public.

Question 10

Exchange (organized market)

Answer 10

Not to be confused with Stock exchange.
An exchange, or bourse /bʊərs/ also known as a trading exchange or trading venue, is an organized market where (especially) tradable securities, commodities, foreign exchange, futures, and options contracts are sold and bought.

The term bourse[note 1] is derived from the 13th-century inn named “Huis ter Beurze” owned by Van der Beurze (nl) family in Bruges, Belgium, where traders and foreign merchants from across Europe, especially the Italian Republics of Genoa, Florence and Venice, conducted business in the late medieval period. The building, which was established by Robert van der Buerze as a hostelry, had operated from 1285.
Its managers became famous for offering judicious financial advice to the traders and merchants who frequented the building. This service became known as the “Beurze Purse” which is the basis of bourse, meaning an organised place of exchange. Eventually the building became solely a place for trading in commodities.

In the thirteenth century, the Lombard bankers were the first to share state claims in Pisa, Genoa and Florence. In 1409, the phenomenon was institutionalized by the creation of the Exchange Bruges. It was quickly followed by others, in Flanders and neighboring countries (Ghent and Amsterdam). It is still in Belgium and the first building designed to house a scholarship was built in Antwerp. The first scholarship organized in France was born in Lyon in 1540.

In the seventeenth century, the Dutch were the first to use the stock market to finance companies.[4] The first company to issue stocks and bonds was the Dutch East India Company, introduced in 1602.

The London Stock Exchange started operating and listing shares and bonds in 1688.

In 1774, the Paris Stock Exchange (founded in 1724), say the courts, must now necessarily be shouted to improve the transparency of operations.

Since the computer revolution of the 1970s, we are witnessing the dematerialization of securities traded on the stock exchange.
In 1971, the NASDAQ became the primary market quotes computer. In France, the dematerialization was effective from November 5, 1984.

Question 11

Exchange (Settlement)

Answer 11

Exchanges bring together brokers and dealers who buy and sell these objects. These various financial instruments can typically be sold either through the exchange, typically with the benefit of a clearing house to reduce settlement risk.

Exchanges can be subdivided:

By objects sold:
Stock exchange or securities exchange[6]
Commodities exchange
Foreign exchange market – is rare today in the form of a specialized institution
By type of trade:
Classical exchange – for spot trades
Futures exchange or futures and options exchange – for derivatives.

Question 12

Clearing House (finance)

Answer 12

A clearing house is a financial institution formed to facilitate the exchange (i.e., clearance) of payments, securities, or derivatives transactions. The clearing house stands between two clearing firms (also known as member firms or participants). Its purpose is to reduce the risk of a member firm failing to honor its trade settlement obligations.

After legally-binding agreement (i.e. execution) of a trade between a buyer and a seller, the role of the clearing house is to centralize and standardize all of the steps leading up to the payment (i.e. settlement ) of the transaction. The purpose is to reduce the cost, settlement risk and operational risk of clearing and settling multiple transactions among multiple parties.

Question 13

Central counterparty clearing

Answer 13

Central counterparty clearing (CCP), also referred to as a central counterparty, is a financial institution that takes on counterparty credit risk between parties to a transaction and provides clearing and settlement services for trades in foreign exchange, securities, options, and derivative contracts. CCPs are highly regulated institutions that specialize in managing counterparty credit risk.

CCPs “mutualize” (share among their members) counterparty credit risk in the markets in which they operate.[1] A CCP reduces the settlement risks by netting offsetting transactions between multiple counterparties, by requiring collateral deposits (also called “margin deposits”), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the member firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting member’s collateral on deposit.

Question 14

Counter Party Risk

Answer 14

A counterparty risk, also known as a default risk, is a risk that a counterparty will not pay as obligated on a bond, derivative, insurance policy, or other contract.[18] Financial institutions or other transaction counterparties may hedge or take out credit insurance or, particularly in the context of derivatives, require the posting of collateral. Offsetting counterparty risk is not always possible, e.g. because of temporary liquidity issues or longer term systemic reasons.[19]

Counterparty risk increases due to positively correlated risk factors. Accounting for correlation between portfolio risk factors and counterparty default in risk management methodology is not trivial.[20]

Question 15

Risk Based Pricing

Answer 15

Risk-based pricing – Lenders may charge a higher interest rate to borrowers who are more likely to default, a practice called risk-based pricing. Lenders consider factors relating to the loan such as loan purpose, credit rating, and loan-to-value ratio and estimates the effect on yield (credit spread).

Question 16

Covenants

Answer 16

Covenants – Lenders may write stipulations on the borrower, called covenants, into loan agreements, such as:[21]
Periodically report its financial condition,
Refrain from paying dividends, repurchasing shares, borrowing further, or other specific, voluntary actions that negatively affect the company’s financial position, and
Repay the loan in full, at the lender’s request, in certain events such as changes in the borrower’s debt-to-equity ratio or interest coverage ratio.

Question 17

Credit Insurance Risk

Answer 17

Credit insurance and credit derivatives – Lenders and bond holders may hedge their credit risk by purchasing credit insurance or credit derivatives. These contracts transfer the risk from the lender to the seller (insurer) in exchange for payment. The most common credit derivative is the credit default swap.

Question 18

Tightening

Answer 18

Tightening – Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers. For example, a distributor selling its products to a troubled retailer may attempt to lessen credit risk by reducing payment terms from net 30 to net 15.

Question 19

Diversification

Answer 19

Diversification – Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk.[22] Lenders reduce this risk by diversifying the borrower pool.

Question 20

Deposit Insurance

Answer 20

Deposit insurance – Governments may establish deposit insurance to guarantee bank deposits in the event of insolvency and to encourage consumers to hold their savings in the banking system instead of in cash.

Prevents a run on the banks and defaults because of fractionalized lending.

Question 21

Credit Risk

Answer 21

A credit risk is the risk of default on a debt that may arise from a borrower failing to make required payments.[1] In the first resort, the risk is that of the lender and includes lost principal and interest, disruption to cash flows, and increased collection costs. The loss may be complete or partial. In an efficient market, higher levels of credit risk will be associated with higher borrowing costs.[2] Because of this, measures of borrowing costs such as yield spreads can be used to infer credit risk levels based on assessments by market participants.[3][4]

Losses can arise in a number of circumstances,[5] for example:

A consumer may fail to make a payment due on a mortgage loan, credit card, line of credit, or other loan.
A company is unable to repay asset-secured fixed or floating charge debt.
A business or consumer does not pay a trade invoice when due.
A business does not pay an employee’s earned wages when due.
A business or government bond issuer does not make a payment on a coupon or principal payment when due.
An insolvent insurance company does not pay a policy obligation.
An insolvent bank won’t return funds to a depositor.
A government grants bankruptcy protection to an insolvent consumer or business.
To reduce the lender’s credit risk, the lender may perform a credit check on the prospective borrower, may require the borrower to take out appropriate insurance, such as mortgage insurance, or seek security over some assets of the borrower or a guarantee from a third party. The lender can also take out insurance against the risk or on-sell the debt to another company. In general, the higher the risk, the higher will be the interest rate that the debtor will be asked to pay on the debt. Credit risk mainly arises when borrowers are unable to pay due willingly or unwillingly.

Question 22

Credit Default Risk

Answer 22

Credit default risk – The risk of loss arising from a debtor being unlikely to pay its loan obligations in full or the debtor is more than 90 days past due on any material credit obligation; default risk may impact all credit-sensitive transactions, including loans, securities and derivatives.

Question 23

Concentration Risk

Answer 23

Concentration risk – The risk associated with any single exposure or group of exposures with the potential to produce large enough losses to threaten a bank’s core operations. It may arise in the form of single name concentration or industry concentration.

Question 24

Country Risk

Answer 24

Country risk – The risk of loss arising from a sovereign state freezing foreign currency payments (transfer/conversion risk) or when it defaults on its obligations (sovereign risk); this type of risk is prominently associated with the country’s macroeconomic performance and its political stability.

Question 25

Sovereign Credit Risk

Answer 25

Sovereign credit risk is the risk of a government being unwilling or unable to meet its loan obligations, or reneging on loans it guarantees. Many countries have faced sovereign risk in the late-2000s global recession. The existence of such risk means that creditors should take a two-stage decision process when deciding to lend to a firm based in a foreign country. Firstly one should consider the sovereign risk quality of the country and then consider the firm’s credit quality.[15]

Question 26

Foreign Exchange (Forex)

Answer 26

foreign exchange (countable and uncountable, plural foreign exchanges)

The exchange of currency from one country for currency from another country.

“foreign exchange” means foreign currency and includes,- (i) deposits, credits and balances payable in any foreign currency, (ii) drafts, travelers cheques, letters of credit or bills of exchange, expressed or drawn in Indian currency but payable in any foreign currency, (iii) drafts, travelers cheques, letters of credit or bills of exchange drawn by banks, institutions or persons outside India, but payable in Indian currency;

Question 27

Foreign Exchange Market

Answer 27

A market for trading one currency for another.

Question 28

Settlement

Answer 28

Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against (in simultaneous exchange for) payment of money, to fulfill contractual obligations, such as those arising under securities trades.

In the United States, the settlement date for marketable stocks is usually 2 business days or T+2[1] after the trade is executed, and for listed options and government securities it is usually 1 day after the execution. In Europe, settlement date has also been adopted as 2 business days settlement cycles T+2.

Question 29

Settlement Interval

Answer 29

The time (grace period) between the due date and the actual payment date.

A number of risks arise for the parties during the settlement interval, which are managed by the process of clearing, which follows trading and precedes settlement. Clearing involves modifying those contractual obligations so as to facilitate settlement, often by netting and novation.

Question 30

Delivery versus payment

Answer 30

Delivery versus payment or DvP is a common form of settlement for securities. The process involves the simultaneous delivery of all documents necessary to give effect to a transfer of securities in exchange for the receipt of the stipulated payment amount. Alternatively, it may involve transfers of two securities in such a way as to ensure that delivery of one security occurs if and only if the corresponding delivery of the other security occurs.[1]

This is done to avoid settlement risk such as where one party fails to deliver the security when the other party has already delivered the cash when settling a securities trade.

Question 31

Settlement Risk

Answer 31

Settlement risk is the risk that a counterparty (or intermediary agent) fails to deliver a security or its value in cash as per agreement when the security was traded after the other counterparty or counterparties have already delivered security or cash value as per the trade agreement. The term covers factors incidental to the settlement process which may suspend or prevent a trade from completing, even though the parties themselves are in agreement, are acting in good faith, and otherwise competent to perform.

Question 32

Systemic Risk

Answer 32

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the entire system.[1][2] It can be defined as “financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries”.[3] It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire syst

Question 33

Bank Run

Answer 33

A bank run (also known as a run on the bank) occurs when a large number of people withdraw their money from a bank, because they believe the bank may cease to function in the near future. In other words, it is when, in a fractional-reserve banking system (where banks normally only keep a small proportion of their assets as cash), a large number of customers withdraw cash from deposit accounts with a financial institution at the same time because they believe that the financial institution is, or might become, insolvent; and keep the cash or transfer it into other assets, such as government bonds, precious metals or gemstones. When they transfer funds to another institution it may be characterised as a capital flight. As a bank run progresses, it generates its own momentum: as more people withdraw cash, the likelihood of default increases, triggering further withdrawals. This can destabilize the bank to the point where it runs out of cash and thus faces sudden bankruptcy.[1] To combat a bank run, a bank may limit how much cash each customer may withdraw, suspend withdrawals altogether, or promptly acquire more cash from other banks or from the central bank, besides other measures.

Question 34

Fractional Reserve Banking

Answer 34

Fractional-reserve banking is the practice whereby a bank accepts deposits, makes loans or investments, but is required to hold reserves equal to only a fraction of its deposit liabilities.[1] Reserves are held as currency in the bank, or as balances in the bank’s accounts at the central bank. Fractional-reserve banking is the current form of banking practiced in most countries worldwide.

Question 35

Bank Reserves

Answer 35

Bank reserves are a commercial banks’ holdings of deposits in accounts with a central bank (for instance the European Central Bank or the applicable branch bank of the Federal Reserve System, in the latter case including federal funds), plus currency that is physically held in the bank’s vault (“vault cash”).[1] Some central banks set minimum reserve requirements, which require banks to hold deposits at the central bank equivalent to at least a specified percentage of their liabilities such as customer deposits. Even when there are no reserve requirements, banks often opt to hold some reserves—called desired reserves—against unexpected events such as unusually large net withdrawals by customers or bank runs.

Question 36

Reserve Requirement

Answer 36

The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world’s central banks, that sets the minimum amount of reserves that must be held by a commercial bank. The minimum reserve is generally determined by the central bank to be no less than a specified percentage of the amount of deposit liabilities the commercial bank owes to its customers. The commercial bank’s reserves normally consist of cash owned by the bank and stored physically in the bank vault (vault cash), plus the amount of the commercial bank’s balance in that bank’s account with the central bank.

Question 37

Deposit Liability (account)

Answer 37

A deposit account is a savings account, current account or any other type of bank account that allows money to be deposited and withdrawn by the account holder. These transactions are recorded on the bank’s books, and the resulting balance is recorded as a liability for the bank and represents the amount owed by the bank to the customer. Some banks may charge a fee for this service, while others may pay the customer interest on the funds deposited.

Question 38

Bank Vault

Answer 38

A bank vault is a secure space where money, valuables, records, and documents are stored. It is intended to protect their contents from theft, unauthorized use, fire, natural disasters, and other threats, much like a safe. Unlike safes, vaults are an integral part of the building within which they are built, using armored walls and a tightly fashioned door closed with a complex lock.

Question 39

Bank Vault

Answer 39

Vault technology developed in a type of arms race with bank robbers. As burglars came up with new ways to break into vaults, vault makers found new ways to foil them. Modern vaults may be armed with a wide array of alarms and anti-theft devices. Some nineteenth- and early-twentieth-century vaults were built so well that today they are almost impossible to destroy.

Question 40

Open Market Operation

Answer 40

An open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds in the open market (this is where the name was historically derived from) or, in what is now mostly the preferred solution, enter into a repo or secured lending transaction with a commercial bank: the central bank gives the money as a deposit for a defined period and synchronously takes an eligible asset as collateral. A central bank uses OMO as the primary means of implementing monetary policy. The usual aim of open market operations is—aside from supplying commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks—to manipulate the short-term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation.[1][2]

Question 41

Monetary Base

Answer 41

In economics, the monetary base (also base money, money base, high-powered money, reserve money, outside money, central bank money or, in the UK, narrow money) in a country is defined as the portion of a commercial bank’s reserves that consist of the commercial bank’s accounts with its central bank[1] plus the total currency circulating in the public, plus the currency, also known as vault cash, that is physically held in the bank’s vault.[2]

The monetary base should not be confused with the money supply which consists of the total currency circulating in the public plus the non-bank deposits with commercial banks.

Question 42

Money Supply

Answer 42

In economics, the money supply (or money stock) is the total value of monetary assets available in an economy at a specific time.[1] There are several ways to define “money”, but standard measures usually include currency in circulation and demand deposits (depositors’ easily accessed assets on the books of financial institutions).[2][3]

Money supply data are recorded and published, usually by the government or the central bank of the country. Public and private sector analysts have long monitored changes in the money supply because of the belief that it affects the price level, inflation, the exchange rate and the business cycle.

Question 43

Business Cycle

Answer 43

The business cycle, also known as the economic cycle or trade cycle, is the downward and upward movement of gross domestic product (GDP) around its long-term growth trend.[1] The length of a business cycle is the period of time containing a single boom and contraction in sequence. These fluctuations typically involve shifts over time between periods of relatively rapid economic growth (expansions or booms), and periods of relative stagnation or decline (contractions or recessions).

Business cycles are usually measured by considering the growth rate of real gross domestic product. Despite the often-applied term cycles, these fluctuations in economic activity do not exhibit uniform or predictable periodicity.

The common or popular usage boom-and-bust cycle refers to fluctuations in which the expansion is rapid and the contraction severe.[citation needed]

Question 44

Economic Equalibrium

Answer 44

In economics, economic equilibrium is a state where economic forces such as supply and demand are balanced and in the absence of external influences the (equilibrium) values of economic variables will not change. For example, in the standard textbook model of perfect competition, equilibrium occurs at the point at which quantity demanded and quantity supplied are equal.[1] Market equilibrium in this case refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. This price is often called the competitive price or market clearing price and will tend not to change unless demand or supply changes, and the quantity is called “competitive quantity” or market clearing quantity. However, the concept of equilibrium in economics also applies to imperfectly competitive markets, where it takes the form of a Nash equilibrium.

Question 45

Market Clearing

Answer 45

In economics, market clearing is the process by which, in an economic market, the supply of whatever is traded is equated to the demand, so that there is no leftover supply or demand. The new classical economics assumes that, in any given market, assuming that all buyers and sellers have access to information and that there is not “friction” impeding price changes, prices always adjust up or down to ensure market clearing.

Question 46

Price

Answer 46

In ordinary usage, a price is the quantity of payment or compensation given by one party to another in return for one unit of goods or services.

In modern economies, prices are generally expressed in units of some form of currency. (For commodities, they are expressed as currency per unit weight of the commodity, e.g. euros per kilogram or Rands per KG.) Although prices could be quoted as quantities of other goods or services, this sort of barter exchange is rarely seen. Prices are sometimes quoted in terms of vouchers such as trading stamps and air miles. In some circumstances, cigarettes have been used as currency, for example in prisons, in times of hyperinflation, and in some places during World War II. In a black market economy, barter is also relatively common.

Question 47

Cost

Answer 47

In production, research, retail, and accounting, a cost is the value of money that has been used up to produce something or deliver a service, and hence is not available for use anymore. In business, the cost may be one of acquisition, in which case the amount of money expended to acquire it is counted as cost. In this case, money is the input that is gone in order to acquire the thing. This acquisition cost may be the sum of the cost of production as incurred by the original producer, and further costs of transaction as incurred by the acquirer over and above the price paid to the producer. Usually, the price also includes a mark-up for profit over the cost of production.

More generalized in the field of economics, cost is a metric that is totaling up as a result of a process or as a differential for the result of a decision.[1] Hence cost is the metric used in the standard modeling paradigm applied to economic processes.

In accounting, costs are the monetary value of expenditures for supplies, services, labor, products, equipment and other items purchased for use by a business or other accounting entity. It is the amount denoted on invoices as the price and recorded in bookkeeping records as an expense or asset cost basis.

Question 48

Opportunity Cost

Answer 48

In microeconomic theory, the opportunity cost, also known as alternative cost, is the value (not a benefit) of the choice of a best alternative cost while making a decision. A choice needs to be made between several mutually exclusive alternatives; assuming the best choice is made, it is the “cost” incurred by not enjoying the benefit that would have been had by taking the second best available choice.[1] The New Oxford American Dictionary defines it as “the loss of potential gain from other alternatives when one alternative is chosen.” Opportunity cost is a key concept in economics, and has been described as expressing “the basic relationship between scarcity and choice.

Question 49

Scarcity

Answer 49

Scarcity refers to the limited availability of a commodity, which may be in demand in the market. The concept of scarcity also includes an individual capacity to buy all or some of the commodities as per the available resources with that individual[1].

Scarcity refers to a gap between limited resources and theoretically limitless wants [2]. The notion of scarcity is that there is never enough (of something) to satisfy all conceivable human wants, even at advanced states of human technology. Scarcity involves making a sacrifice—giving something up, or making a tradeoff—in order to obtain more of the scarce resource that is wanted.[3]

The condition of scarcity in the real world necessitates competition for scarce resources, and competition occurs “when people strive to meet the criteria that are being used to determine who gets what.”[3]:p. 105 The price system, or market prices, are one way to allocate scarce resources. “If a society coordinates economic plans on the basis of willingness to pay money, members of that society will [strive to compete] to make money”[3]:p. 105 If other criteria are used, we would expect to see competition in terms of those other criteria.[3]

Question 50

Competition

Answer 50

In economics, “competition” is the rivalry among sellers trying to achieve such goals as increasing profits, market share, and sales volume by varying the elements of the marketing mix: price, product, promotion and place. Merriam-Webster defines competition in business as “the effort of two or more parties acting independently to secure the business of a third party by offering the most favorable terms”.

In his 1776 The Wealth of Nations, Adam Smith described it as the exercise of allocating productive resources to their most highly valued uses and encouraging efficiency.

Question 51

Perfect Competition

Answer 51

In a perfect market the sellers operate at zero economic surplus: sellers make a level of return on investment known as normal profits.

In economics, specifically general equilibrium theory, a perfect market is defined by several idealizing conditions, collectively called perfect competition. In theoretical models where conditions of perfect competition hold, it has been theoretically demonstrated that a market will reach an equilibrium in which the quantity supplied for every product or service, including labor, equals the quantity demanded at the current price. This equilibrium will be a Pareto optimum, meaning that nobody can be made better off by exchange without making someone else worse off.[1]

A large number of buyers and sellers – A large number of consumers with the willingness and ability to buy the product at a certain price, and a large number of producers with the willingness and ability to supply the product at a certain price.
Perfect information – All consumers and producers know all prices of products and utilities each person would get from owning each product.
Homogeneous products – The products are perfect substitutes for each other, (i.e., the qualities and characteristics of a market good or service do not vary between different suppliers).
Well defined property rights – These determine what may be sold, as well as what rights are conferred on the buyer.

No barriers to entry or exit.

Every participant is a price taker – No participant with market power to set prices.

Perfect factor mobility – In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions.
Profit maximization of sellers – Firms sell where the most profit is generated, where marginal costs meet marginal revenue.

Rational buyers: Buyers make all trades that increase their economic utility and make no trades that do not increase their utility.

No externalities – Costs or benefits of an activity do not affect third parties. This criteria also excludes any government intervention.

Zero transaction costs – Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market.

Non-increasing returns to scale and no network effects – The lack of economies of scale or network effects ensures that there will always be a sufficient number of firms in the industry.

Anti-competitive regulation - It is assumed that a market of perfect competition shall provide the regulations and protections implicit in the control of and elimination of anti-competitive activity in the market place.

Question 52

Profit

Answer 52

In economics, profit in the accounting sense of the excess of revenue over cost is the sum of two components: normal profit and economic profit. Normal profit is the profit that is necessary to just cover the opportunity costs of the owner-manager or of the firm’s investors. In the absence of this much profit, these parties would withdraw their time and funds from the firm and use them to better advantage elsewhere. In contrast, economic profit, sometimes called excess profit, is profit in excess of what is required to cover the opportunity costs.

Question 53

Factors of Production

Answer 53

The previously mentioned primary factors are land, labour (the ability to work), and capital goods.

In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, finished goods and services. The utilized amounts of the various inputs determine the quantity of output according to the relationship is called the production function. There are three basic resources or factors of production: land, labour and capital. The factors are also frequently labelled “producer goods or services” to distinguish them from the goods or services purchased by consumers, which are frequently labeled “consumer goods”. All three of these are required in combination at a time to produce a commodity.

Question 54

Output (economics)

Answer 54

Output in economics is the “quantity of goods or services produced in a given time period, by a firm, industry, or country”,[1] whether consumed or used for further production.[2] The concept of national output is essential in the field of macroeconomics. It is national output that makes a country rich, not large amounts of money. [3]

Question 55

Revenue

Answer 55

In accounting, revenue is the income that a business has from its normal business activities, usually from the sale of goods and services to customers. Revenue is also referred to as sales or turnover.

Question 56

Retail

Answer 56

Retail is the process of selling consumer goods or services to customers through multiple channels of distribution to earn a profit. Retailers satisfy demand identified through a supply chain. The term “retailer” is typically applied where a service provider fills the small orders of a large number of individuals, who are end-users, rather than large orders of a small number of wholesale, corporate or government clientele.

Question 57

Wholesale

Answer 57

Wholesaling, jobbing, or distributing is the sale of goods or merchandise to retailers; to industrial, commercial, institutional, or other professional business users; or to other wholesalers and related subordinated services.[1] In general, it is the sale of goods to anyone other than a standard consumer.

Question 58

Wholesale Banking

Answer 58

Wholesale banking is the provision of services by banks to larger customers or organizations such as mortgage brokers, large corporate clients, mid-sized companies, real estate developers and investors, international trade finance businesses, institutional customers (such as pension funds and government entities/agencies), and services offered to other banks or other financial institutions.[1][2]

Wholesale finance refers to financial services conducted between financial services companies and institutions such as banks, insurers, fund managers, and stockbrokers.

Modern wholesale banks engage in:

Finance wholesaling
Underwriting
Market making
Consultancy
Mergers and acquisitions
Fund management[3]

Question 59

Underwriting

Answer 59

Underwriting services are provided by some large specialist financial institutions, such as banks, insurance or investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liability arising from such guarantee. An underwriting arrangement may be created in a number of situations including insurance, issue of securities in primary markets, and in bank lending, among others.

Question 60

Lloyd’s of London

Answer 60

Lloyd’s of London, generally known simply as Lloyd’s, is an insurance market located in London, United Kingdom. Unlike most of its competitors in the industry, it is not an insurance company. Rather, Lloyd’s is a corporate body governed by the Lloyd’s Act 1871 and subsequent Acts of Parliament and operates as a partially-mutualised marketplace within which multiple financial backers, grouped in syndicates, come together to pool and spread risk. These underwriters, or “members”, are a collection of both corporations and private individuals, the latter being traditionally known as “Names”.

Question 61

Insurance

Answer 61

Insurance is a means of protection from financial loss. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss.

Question 62

Reinsurance

Answer 62

Reinsurance is insurance that is purchased by an insurance company. In the classic case, reinsurance allows insurance companies to remain solvent after major claims events, such as major disasters like hurricanes and wildfires. In addition to its basic role in risk management, reinsurance is sometimes used for tax mitigation and other reasons. The company that purchases the reinsurance policy is called a “ceding company” or “cedent” or “cedant” under most arrangements. The company issuing the reinsurance policy is referred simply as the “reinsurer”.

Question 63

Hedge (finance)

Answer 63

A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. In simple language, a hedge is a risk management technique used to reduce any substantial losses or gains suffered by an individual or an organization.

Hedging is the practice of taking a position in one market to offset and balance against the risk adopted by assuming a position in a contrary or opposing market or investment. The word hedge is from Old English hecg, originally any fence, living or artificial. The use of the word as a verb in the sense of “dodge, evade” is first recorded in the 1590s; that of insure oneself against loss, as in a bet, is from the 1670s.[3]

Question 64

Risk (management) history

Answer 64

Methods for transferring or distributing risk were practiced by Chinese and Babylonian traders as long ago as the 3rd and 2nd millennia BC, respectively.[1] Chinese merchants travelling treacherous river rapids would redistribute their wares across many vessels to limit the loss due to any single vessel’s capsizing. The Babylonians developed a system which was recorded in the famous Code of Hammurabi, c. 1750 BC, and practiced by early Mediterranean sailing merchants. If a merchant received a loan to fund his shipment, he would pay the lender an additional sum in exchange for the lender’s guarantee to cancel the loan should the shipment be stolen, or lost at sea.

Circa 800 BC, the inhabitants of Rhodes created the ‘general average’. This allowed groups of merchants to pay to insure their goods being shipped together. The collected premiums would be used to reimburse any merchant whose goods were jettisoned during transport, whether to storm or sinkage.[2]

Separate insurance contracts (i.e., insurance policies not bundled with loans or other kinds of contracts) were invented in Genoa in the 14th century, as were insurance pools backed by pledges of landed estates. The first known insurance contract dates from Genoa in 1347, and in the next century maritime insurance developed widely and premiums were intuitively varied with risks.[3] These new insurance contracts allowed insurance to be separated from investment, a separation of roles that first proved useful in marine insurance.

Lloyd’s Coffee House was a significant meeting place in London in the 17th and 18th centuries.

It was opened by Edward Lloyd (c. 1648–15 February 1713) on Tower Street in 1686.[1][2] The establishment was a popular place for sailors, merchants and shipowners, and Lloyd catered to them with reliable shipping news. The shipping industry community frequented the place to discuss maritime insurance, shipbroking and foreign trade.[2] The dealing that took place led to the establishment of the insurance market Lloyd’s of London, Lloyd’s Register and several related shipping and insurance businesses.[3]
The coffee shop relocated to Lombard Street in December 1691. Lloyd had a pulpit installed in the new premises, from which maritime auction prices and shipping news were announced.[2] From 1697–1698 Lloyd also experimented with publishing a newspaper, Lloyd’s News, reporting on shipping schedules and insurance agreements reached in the coffee house. Merchants continued to discuss insurance matters here until 1774 when the participating members of the insurance arrangement formed a committee and moved to the Royal Exchange on Cornhill as the Society of Lloyd’s.

Question 65

Currency

Answer 65

A currency (from Middle English: curraunt, “in circulation”, from Latin: currens, -entis), in the most specific use of the word, refers to money in any form when in actual use or circulation as a medium of exchange, especially circulating banknotes and coins.[1][2] A more general definition is that a currency is a system of money (monetary units) in common use, especially in a nation.

Question 66

Federal Funds

Answer 66

In the United States, federal funds are overnight borrowings between banks and other entities to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions. Transactions in the federal funds market enable depository institutions with reserve balances in excess of reserve requirements to lend reserves to institutions with reserve deficiencies. These loans are usually made for one day only, that is, “overnight”. The interest rate at which these deals are done is called the federal funds rate. Federal funds are not collateralized; like eurodollars, they are an unsecured interbank loan.

Question 67

Flight to Quality

Answer 67

A flight-to-quality is a financial market phenomenon occurring when investors sell what they perceive to be higher-risk investments and purchase safer investments, such as US Treasuries or gold. This is considered a sign of fear in the marketplace, as investors seek less risk in exchange for lower profits.

Flight-to-quality is usually accompanied by an increase in demand for assets that are government-backed and a decline in demand for assets backed by private agents.

Question 68

Flight to Liquidity

Answer 68

A flight-to-liquidity is a financial market phenomenon occurring when investors sell what they perceive to be less liquid or higher risk investments, and purchase more liquid investments instead, such as US Treasuries. Usually, flight-to-liquidity quickly results in panic leading to a crisis.

Question 69

Liquidity Crisis

Answer 69

In financial economics, a liquidity crisis refers to an acute shortage (or “drying up”) of liquidity.[1] Liquidity may refer to market liquidity (the ease with which an asset can be converted into a liquid medium, e.g. cash), funding liquidity (the ease with which borrowers can obtain external funding), or accounting liquidity (the health of an institution’s balance sheet measured in terms of its cash-like assets). Additionally, some economists define a market to be liquid if it can absorb “liquidity trades” (sale of securities by investors to meet sudden needs for cash) without large changes in price. This shortage of liquidity could reflect a fall in asset prices below their long run fundamental price, deterioration in external financing conditions, reduction in the number of market participants, or simply difficulty in trading assets.[2]

Question 70

Security (finance)

Answer 70

A security is a tradable financial asset.

Question 71

Debt Security

Answer 71

Debt securities may be called debentures, bonds, deposits, notes or commercial paper depending on their maturity, collateral and other characteristics. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually “senior” to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is “subordinated”.

Question 72

Debenture

Answer 72

In corporate finance, a debenture is a medium to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term “debenture” originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital.[1] Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

Question 73

Share Capital

Answer 73

A corporation’s share capital[1] (or capital stock in US English) is the portion of a corporation’s equity that has been obtained by the issue of shares in the corporation to a shareholder, usually for cash.

Question 74

Share (finance)

Answer 74

In financial markets, a share is a unit used as mutual funds, limited partnerships, and real estate investment trusts.[1]

Corporations issue shares which are offered for sale to raise share capital. The owner of shares in the corporation is a shareholder (or stockholder) of the corporation.[2] A share is an indivisible unit of capital, expressing the ownership relationship between the company and the shareholder. The denominated value of a share is its face value, and the total of the face value of issued shares represent the capital of a company,[3] which may not reflect the market value of those shares.

Question 75

Share Holder

Answer 75

A shareholder or stockholder is an individual or institution (including a corporation) that legally owns one or more shares of stock in a public or private corporation. Shareholders may be referred to as members of a corporation. Legally, a person is not a shareholder in a corporation until his or her name and other details are entered in the register of shareholders.[1]

Shareholders of a corporation are legally separate from the corporation itself. They are generally not liable for the debts of the corporation; and the shareholders’ liability for company debts are said to be limited to the unpaid share price, unless if a shareholder has offered guarantees.

Question 76

Share Holder Rights

Answer 76

Shareholders are granted special privileges depending on the class of stock. The board of directors of a corporation generally governs a corporation for the benefit of shareholders.

Subject to the applicable laws and rules of the corporation, other rights of shareholders may include:

The right to sell their shares.[2]
The right to vote on the directors nominated by the board of directors.[2]
The right to nominate directors (although this is very difficult in practice because of minority protections) and propose shareholder resolutions.[2]
The right to vote on mergers and changes to the corporate charter.[2]
The right to dividends if they are declared.[2]
The right to access certain information; for publicly-traded companies, this information is normally publicly available.[2]
The right to sue the company for violation of fiduciary duty.[2]
The right to purchase new shares issued by the company.
The right to what assets remain after a liquidation.
Shareholders are considered by some to be a subset of stakeholders, which may include anyone who has a direct or indirect interest in the business entity. For example, employees, suppliers, customers, the community, etc., are typically considered stakeholders because they contribute value and/or are impacted by the corporation.

Shareholders may have acquired their shares in the primary market by subscribing to the IPOs and thus provided capital to corporations. However, the vast majority of shareholders acquired their shares in the secondary market and provided no capital directly to the corporation.

Question 77

Initial public offering (IPO)

Answer 77

Initial public offering (IPO) or stock market launch is a type of public offering in which shares of a company are sold to institutional investors[1] and usually also retail (individual) investors; an IPO is underwritten by one or more investment banks, who also arrange for the shares to be listed on one or more stock exchange. Through this process, colloquially known as floating, or going public, a privately held company is transformed into a public company. Initial public offerings can be used: to raise new equity capital for the company concerned; to monetize the investments of private shareholders such as company founders or private equity investors; and to enable easy trading of existing holdings or future capital raising by becoming publicly traded enterprises.

Question 78

Prospectus (finance)

Answer 78

A prospectus, in finance, is a disclosure document that describes a financial security for potential buyers. It commonly provides investors with material information about mutual funds, stocks, bonds and other investments, such as a description of the company’s business, financial statements, biographies of officers and directors, detailed information about their compensation, any litigation that is taking place, a list of material properties and any other material information. In the context of an individual securities offering, such as an initial public offering, a prospectus is distributed by underwriters or brokerages to potential investors. Today, prospectuses are most widely distributed through websites such as EDGAR and its equivalents in other countries.

Question 79

Capital Market

Answer 79

A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold.[6] Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments.

Question 80

Equity (finance)

Answer 80

In accounting, equity (or owner’s equity) is the difference between the value of the assets and the value of the liabilities of something owned. It is governed by the following equation:

Equity=Assets-Liabilities

Question 81

Stock

Answer 81

The stock (also capital stock) of a corporation is constituted of the equity stock of its owners. A single share of the stock represents fractional ownership of the corporation in proportion to the total number of shares. In liquidation, the stock represents the residual assets of the company that would be due to stockholders after discharge of all senior claims such as secured and unsecured debt. Stockholders’ equity cannot be withdrawn from the company in a way that is intended to be detrimental to the company’s creditors.

Question 82

Par Value

Answer 82

Par value, in finance and accounting, means stated value or face value. From this come the expressions at par (at the par value), over par (over par value) and under par (under par value).

A bond selling at par is priced at 100% of face value. Par can also refer to a bond’s original issue value or its value upon redemption at maturity.

The par value of stock has no relation to market value and, as a concept, is somewhat archaic. The par value of a share is the value stated in the corporate charter below which shares of that class cannot be sold upon initial offering; the issuing company promises not to issue further shares below par value, so investors can be confident that no one else will receive a more favorable issue price. Thus, par value is the nominal value of a security which is determined by the issuing company to be its minimum price.

Question 83

Term Repurchase Agreement

Answer 83

REPO MARKET (Pawn Broker of Asset Backed Securities)

DEFINITION of Term Repurchase Agreement
Under a term repurchase agreement, a bank will agree to buy securities from a dealer and then resell them a short time later at a specified price. The difference between the purchase and sale prices represents the interest paid for the agreement. Term repurchase agreements are used as a short-term cash-investment alternative.

BREAKING DOWN Term Repurchase Agreement
The repurchase, or repo, market is where fixed income securities are bought and sold. Borrowers and lenders enter into repurchase agreements in the repo market where cash is exchanged for debt issues to raise short-term capital. A repurchase agreement is a sale of securities for cash with a commitment to buy back the securities on a future date for a predetermined price - this is the view of the borrowing party. A lender, such as a bank, will enter a repo agreement to buy the fixed income securities from a borrowing counterparty, such as a dealer, with a promise to sell the securities back within a short period of time. At the end of the agreement term, the borrower repays the money plus interest at a repo rate to the lender and takes back the securities.

A repo can be either overnight or a term repo. An overnight repo is an agreement in which the duration of the loan is one day. Term repurchase agreements, on the other hand, can be as long as one year with a majority of term repos having a duration of 3 months or less. However, it is not unusual to see term repos with a maturity as long as two years. The financial institution that purchases the security cannot sell them to another party, unless the seller defaults on its obligation to repurchase the security. The security involved in the transaction acts as collateral for the buyer until the seller can pay the buyer back. In effect, the sale of a security is not considered a real sale, but a collateralized loan which is secured by an asset.

The repo rate is the cost of buying back the securities from the seller or lender. The rate is a simple interest rate that uses an actual/360 calendar, and represents the cost of borrowing in the repo market. For instance, a seller or borrower may have to pay a 10 percent higher price at repurchase time.

Banks and other savings institutions that are holding excess cash quite often employ these instruments, because they have shorter maturities than certificates of deposit (CDs). Term repurchase agreements also tend to pay higher interest than overnight repurchase agreements because they carry greater interest-rate risk, since their maturity is greater than one day. Furthermore, the collateral risk is higher for term repos than overnight repos since the value of the assets used as collateral have a higher chance of declining in value over a longer period of time.

Central banks and banks enter into term repurchase agreements to enable banks boost their capital reserves. At a later time, the central bank would sell back the Treasury bill or government paper back to the commercial bank. By buying these securities, the central bank helps to boost the supply of money in the economy, thereby, encouraging spending and reducing the cost of borrowing. When the central bank wants the growth of the economy to contract, it sells the government securities first, and then buys them back at an agreed upon date. In this case, the agreement is referred to as a reverse term repurchase agreement.