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Financial Markets & Institutions > Exam 1 > Flashcards

Exam 1 Flashcards

1
Q

ch1. explain the meaning of surplus units and deficit units (provide example of each)

A

surplus units: people who receive more money than they spend (investors)

deficit units: people who spend more money than they receive (college students)

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2
Q

ch1. distinguish between primary and secondary markets

A

primary market: facilitate the issuance of new securities (allows corporation to obtain new funds and offer a means of investment

secondary market: facilitate the trading of existing securities, which allows investors to change their investments by selling securities that they own and buying other securities.

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3
Q

ch1. distinguish between money and capital markets

A

money market: facilitate the sale of short-term debt securities by deficit units to surplus units (sells money market securities) (high liquidity)

capital market security: facilitate the sale of long-term securities by deficit units to surplus units. commonly issued to finance the purchase of capital assets, such as buildings, equipment, or machinery

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4
Q

ch1. distinguish between perfect and imperfect security markets

A

perfect security market: characterized by perfect competition, market equilibrium, and an unlimited number of buyers and sellers

imperfect security market: individual buyers and sellers can influence prices and production. there is no full disclosure of information about products and prices, and there are high barriers to entry or exit in the market

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5
Q

ch1. why does the existence of imperfect markets create a need for Finacial intermediaries?

A

because if there are none, then many people will try to get away with non-disclosure of all information, and could hurt people and their investments

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6
Q

ch1. what is efficient markets

A

those who current prices reflect all available, relevant information about the actual value of underlying assets (updated extremely frequently, due to changing environment. does not allow competition to get ahead

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7
Q

ch1. what was the purpose of the securities act of 1933

A

it was intended to ensure compete disclose of relevant financial information on publicly offered securities and to prevent fraud practices in selling securities

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8
Q

ch1. what was the purpose of the securities exchange act of 1934

A

extended the disclosure requirements from the 1933 act to secondary markets. also declared illegal to lie about financial information.

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9
Q

ch1. why do many financial institutions expand internationally

A

because it allows governments and corporations easier access to funding from creditors or investors in other countries to support growth

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10
Q

ch1. what advantages can be obtained through an international merger of financial institutions

A

diversity in investors, more people to invest, currency changes could be in favor

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11
Q

ch1. what type of information do investors rely on when determining the proper value of stocks

A

information on financial statements, past stock movement, market indicators, industry trends

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12
Q

ch1. what are the functions of securities firms

A

they provide a wide variety of functions in financial markets, such as a broker, dealers, underwriting and advising services..

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13
Q

ch1. distinguish between the functions of a broker and those of a dealer (how are they paid)

A

broker: someone who executes security transactions for a commission (% of transaction amount)

dealer: making a market in specific securities by maintaining an inventory of securities. income is based on the performance of security portfolio

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14
Q

ch1. why are the securities more marketable than the loans in the secondary market

A

securities are more standardized than loans and therefore can be more easily sold in the secondary market.

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15
Q

ch1. explain the primary use of funds by commercial banks vs savings institutions

A

commercial banks: purchases of government and corporate securities; loans to business and households

savings institutions: purchases of government and corporate securities; mortgages and other loans to households, some loans to businesses

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16
Q

ch1. with regard to the profit motive, how are credit unions different from other financial institutions

A

credit unions are non-profit

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17
Q

ch1. compare the main sources and uses of funds for finance companies, insurance companies, and pension funds

A

Finance Companies:
-Source: securities sold to households and businesses
-Use: loans to household and businesses

Insurance Companies:
-source: insurance premiums and earnings from investments
-use: purchases of long term government and corporate securities

pensions funds:
-source: employer/employee contributions
-use: purchases of long term government and corporate securities

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18
Q

ch1. what is the function of a mutual fund

A

they give investors access to diversified professionally managed portfolios

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19
Q

ch1. why are mutual funds popular among investors

A

they are relatively safe and provide a variety of different stocks to an individual

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20
Q

ch1. how does a money market mutual fund differ from a stock or bond mutual fund

A

a money market mutual fund only invests money in ultra safe investments, such as treasury securities that are guaranteed.

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21
Q

ch1. why is it important for long term debt securities to have an active secondary market

A

because they provide liquidity to investors

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22
Q

ch2. explain why interest rates changed as they did over the past year

A

inflation, people spending less, trends (also supply and demand (loanable funds theory)

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23
Q

ch2. explain what is meant by interest elasticity

A

a measure of the responsiveness of the demand for money or savings to change in interest rates. (Change in quantity over the change in price

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24
Q

ch2. explain why interest rates tend to decrease during recessionary periods

A

because loan demand declines, investors seek safety, and consumers reduce their spending.

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25
Q

ch2. how does expected interest rate in one year and economic growth and inflation impact each other

A

they have a direct relationship so as the one goes up, so does the other

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26
Q

ch2. would increasing the money supply growth place upward or downward pressure on interest rates?

A

they have an inverse relationship, so it would lower interest rates

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27
Q

ch2. could expectations of a strong dollar affect the supply of loanable funds

A

yes, and it could increase the supply of funds because households will be encouraged to save their money.

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28
Q

ch2. what is the difference between the nominal interest rate and the real interest rate?

A

Nominal interest rate: the total of the real interest rate plus a projected inflation

real interest rate: the difference between the nominal interest rate and the projected inflation

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29
Q

ch2. why is there a positive relationship between expected inflation and nominal interest rates

A

because according to the fisher effect, the nominal rate will adjust to reflect the changes in inflation in order for products and lending avenues to remain competitive

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30
Q

ch2. why do forecasts of interest rates made by experts differ

A

because everyone might have different interpretation of economic trends and where our economy is going also everything is just unexpected

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31
Q

ch2. how might expectations of a strong dollar affect the demand for loanable funds in the united states and US interest rates

A

it can reduce the demand for loanable funds, and therefore reduce interest rates. The expectations of a strong dollar could also increase the supply of funds because it may encourage saving (there is less concern to purchase goods before prices rise when inflationary expectations are reduced).

32
Q

ch3. identify the relevant characteristics of any security that can affect its yield

A

-credit (default) risk
-liquidity
-tax status
-term to maturity

33
Q

ch3. how does high credit risk affect the yield offered securities

A

securities with a higher credit risk must offer credit risk premium (a higher yield above the bond yield)

34
Q

ch3. what is the relationship between the yield and the liquidity of securities

A

other things being equal, the greater the liquidity, the lower the yield, vice versa

35
Q

ch3. explain how a yield curve would shift in response to a sudden expectation of rising interest rates, according to the pure expectations theory

A

The demand for short-term securities would increase, placing upward (downward) pressure on their prices (yields). The demand for long-term securities would decrease, placing downward (upward) pressure on their prices (yields). If the yield curve was originally upward sloped, it would now have a steeper slope as a result of the expectation. If it was originally downward sloped, it would now be more horizontal (less steep), or may have even become upward sloping

36
Q

ch3. what is the meaning of the forward rate in context of the term structure of interest rates

A

it is the expected interest rate at a future point in time

37
Q

ch3. why might future forward rates consistently overestimate future interest rates?

A

because they could be estimated without considering the liquidity premium

38
Q

ch3. what would be the effect on the shape of the yield curve if there is an expectation of lower interest rates rising quite suddenly

A

The demand for short-term securities would decrease, placing downward (upward) pressure on their prices (yields). The demand for long-term securities would increase, placing upward (downward) pressure on their prices (yields). If the yield curve was originally upward sloped, it would now be more horizontal (less steep). If it was downward sloped, it would now be more steep.

39
Q

ch3. explain the liquidity premium theory

A

If investors believe that securities with larger maturities are less liquid, they will require a premium when investing in such securities to compensate.

40
Q

ch3. how does the consideration of a liquidity premium affect the estimate of a forward interest rate

A

When considering a liquidity premium, the estimate of a forward interest rate will be reduced.

41
Q

ch3. if a downward sloping yield curve is mainly attributed to segmented markets theory, what does that suggest about the demand for and supply of funds in the short term and long term maturity markets

A

A downward-sloped yield curve suggests that the demand for short-term funds is high relative to the supply of short-term funds, causing a high yield. In addition, the demand for long-term funds is low relative to the supply of long-term funds, causing a low yield.

42
Q

ch3. if the segmented markets theory causes an upward sloping yield curve what does this imply

A

An upward-sloped yield curve caused by segmented markets implies that the demand for short-term funds is low relative to the supply of short-term funds.

43
Q

ch3. explained the preferred habitat theory

A

The preferred habitat theory suggests that while investors and borrowers may prefer a natural maturity, they may wander from that maturity under conditions where they can benefit from selecting a different maturity.

44
Q

ch3. which factors influence the shape of the yield curve

A

The yield curve’s shape is affected by the demand and supply conditions for securities in various maturity markets. Expectations of interest rates, the desire for liquidity, and the desire by investors or borrowers for a specific maturity will influence the demand and supply conditions.

45
Q

ch3. describe how financial market participants use the yield curve

A

The yield curve can be used to determine the market’s expectations of future interest rates. Market participants can compare their own expectations to the market’s expectations in order to determine their borrowing or investing decisions.

46
Q

ch4. describe the functions of the fed district bank

A

-conducts the monetary policy
-promotes stability
-promotes the safety and soundness of financial institutions
-fosters payment and settlement systems
-promotes consumer protection and community

47
Q

ch4. what are the main goals of the federal open market committee? how does it attempt to achieve these goals

A

The main goals of the FOMC are to promote high employment, economic growth, and price stability (by adjusting the monetary policy accordingly)

48
Q

ch4. explain how the fed increases the money supply through open market operations

A

by lowering interest rates and purchasing securities in the secondary market

49
Q

ch4. what is the policy directive, and who carries it out

A

policy directive is established by the Fed and submitted to the Trading Desk. The manager of the Trading Desk must ensure that the directive is achieved.

50
Q

ch4. what is the beige book and why is it important to the FOMC

A

The Beige book is a consolidated report of regional economic conditions in each of the 12 districts. This book is sent to FOMC members before their meeting so that they are updated on regional conditions before they decide on monetary policy.

51
Q

ch4. how is the money supply growth affected by an increase in the reserve requirement ratio

A

An increase in the reserve requirement ratio reduces the proportion of deposited funds that a financial institution can lend out. Consequently, it reduces the rate by which money can multiply.

52
Q

ch4. describe the characteristics that is a measure of money should have if it is to be manipulated by the fed

A

A desirable measure of money is one that can be precisely controlled by the Fed and has a predictable impact on economic variables.

53
Q

ch4. explain how the fed can use open market operations to reduce the money supply

A

the Fed can sell holdings of its existing Treasury securities to various depository institutions, which will cause a reduction in the account balances of these institutions.

54
Q

ch4. why do the feds open market operations have a different effect on the money supply than do transactions between two depository institutions

A

When the Fed engages in a purchase of Treasury securities from a depository institution, money is transferred to the depository institution without any offset at another institution. However, a similar transaction between depository institutions would increase the account balance at one institution and decrease the account balance at the other institution

55
Q

ch4. how does the feds monetary policy affect the unemployment level

A

The Fed’s monetary policy affects interest rates, which affect the cost of borrowing by households and businesses, and therefore affect their level of spending for products and services. The aggregate demand for products and services affects the number of people employed by businesses and therefore affects the unemployment level.

56
Q

ch4. explain how the fed influences the monthly mortgage payments on homes

A

The Fed influences interest rates, which affect the rate paid by homeowners on mortgages. When the Fed reduces interest rates, it reduces the monthly payment to be made on new mortgages. Thus, it may increase the demand for homes by consumers. If it increases interest rates, it may reduce the demand for homes.

57
Q

ch4. explain how the feds monetary policy may indirectly effect the prices of equity securities

A

The Fed’s monetary policy influences the aggregate demand for products and services, and therefore affects the cash flows generated by publicly-traded businesses. The value of the stock of a business is influenced by expectations of its future cash flows

58
Q

ch4. how might the FOMC statement stabilize financial markets more than if no statement were provided

A

If a statement was not provided, investors would have to guess at the conclusion of the FOMC meeting, and there would be more uncertainty regarding the Fed’s future monetary policy. The statement makes the Fed’s plans more transparent.

59
Q

ch4. explain how the feds facility programs improved liquidity in some debt markets

A

The Fed established facilities that provided loans to financial institutions that were willing to invest in some types of debt securities, such as bonds that were backed by consumer loans. In this way, the Fed increased the liquidity of these markets, which allowed easier access for consumers who wanted to borrow funds. The Fed also used some of its own funds to purchase commercial paper, which restored the liquidity of the commercial paper market.

60
Q

ch4. what is the role of the consumer financial protection bureau

A

The bureau is responsible for regulating financial products and services, including online banking, certificates of deposit, and mortgages. The existence of a bureau can act more quickly to protect consumers from deceptive practices than waiting for Congress to pass new laws.

61
Q

ch4. explain why participating in the eurozone causes a country to give up its independent monetary policy and control over its domestic interest rates

A

When a country adopts the euro as its currency, it is subject to the monetary policy of the European Central Bank (ECB), which controls the supply of euros in the banking system. The ECB influences the interest rate on euros regardless of the country. If the interest rate on euros was higher in one eurozone country, funds would flow to that country until the supply and demand conditions caused the interest rate there to be the same as in other euro countries.

62
Q

ch5. how does the feds monetary policy affect economic conditions

A

The Fed’s monetary policy can affect the supply of loanable funds available in financial markets and therefore may affect interest rates. it may also affect inflation (with a lag) and therefore the demand for loanable funds by influencing inflationary expectations.

63
Q

ch5. describe the economic trade off faced by the fed in achieving its economic goals

A

-A stimulative monetary policy can increase economic growth and reduce unemployment, but may increase inflation.

-A restrictive monetary policy can keep inflation low, but may cause low economic growth and higher unemployment.

64
Q

ch5. when does the fed use a stimulative monetary policy, and when do they use a restrictive monetary policy

A

A stimulative monetary policy may be used to stimulate the economy, especially if inflation is not a concern. A restrictive monetary policy may be used to slow economic growth in order to reduce inflationary fears.

65
Q

ch5. what is a criticism of a stimulative monetary policy

A

A stimulative-monetary policy may result in higher inflation.

66
Q

ch5. what is the risk of using a monetary policy that is too restrictive

A

The risk of a restrictive monetary policy is a potential slowdown in the economy. A restrictive monetary policy may result in higher interest rates, reduced borrowing, and reduced spending to an excessive degree.

67
Q

ch5. describe an active monetary policy

A

An active monetary policy is when a central bank, such as the Federal Reserve Board in the United States, uses its discretion to set monetary policy in response to changing economic conditions. This means that the central bank can act, or choose not to act, based on its assessment of the nation’s economy. Central banks use monetary policy to manage the supply of money in a country’s economy, and to keep inflation, growth and employment on track.

68
Q

ch5. describe a passive monetary policy

A

Passive monetary policy is a system where macroeconomic policy is conducted according to a preset series of rules. It involves a set of rules that dictate monetary policy actions. The Fed can be mandated to be a “passive” policy institution designed to supply enough revenue via the inflation tax or its excess earnings to preserve budget balance while Congress would be free to pursue its own fiscal objectives.

69
Q

ch5. why might the fed have difficulty controlling the economy in the manner desired

A

because the economy is every changing

70
Q

ch5. compare the recognition lag and the implementation lag

A

recognition lag: the delay between the time a problem arises and the time it is recognized

implementation lag: the difference between the time a serious problem is recognized and the time the fed implements a policy to resolve that problem

71
Q

ch5. how can the fed use an open market operation to reduce inflation. what is the adverse effect

A

Open market operations also signal when the Fed believes inflationary pressure has gotten too high and the economy needs to contract. By selling securities, the Fed attempts to raise rates, slow economic growth, and stem inflation. Unfortunately, contractionary economic periods like this also traditionally cause increases in unemployment.

72
Q

ch5. why do financial market participants closely monitor money supply movements

A

Investors in the financial markets pay special attention to changes in the money supply because these changes give them crucial data regarding the economy’s short-term trajectory and influence long-term price levels and inflation.

73
Q

ch5. describe the feds monetary policy response to the credit crisis that began in 2008

A

Toward the end of 2008, the recession deepened with the prospect of a substantial monetary policy funds rate shortfall. In response, the Fed expanded its balance sheet policies in order to lower the cost and improve the availability of credit to households and businesses.

74
Q

ch5. explain why an increase in the money supply can affect interest rates in different ways

A

Money supply and interest rates have an inverse relationship. A larger money supply lowers market interest rates, making it less expensive for consumers to borrow. Conversely, smaller money supplies tend to raise market interest rates, making it pricier for consumers to take out a loan.

75
Q

ch5. which factors might be considered by financial market participants who are assessing whether an increase in money supply growth will affect inflation

A

Any factors that could offset or magnify the impact should be considered, such as expected oil prices, the strength or weakness of the dollar, and the strength of the economy.

76
Q

ch5. explain how the feds monetary policy could depend on the fiscal policy that is implemented

A

A fiscal policy that involves much government borrowing could place upward pressure on interest rates. If the Fed wants to keep interest rates low in order to stimulate the economy, it may need to use a loose monetary policy to offset the fiscal policy effect on interest rates.

Financial Markets & Institutions (2 decks)

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