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Money and Banking > Exam 1 > Flashcards

Exam 1 Flashcards

0
Q

What does capital mean in accounting and finance terms?

A

Money

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1
Q

Who are the four major players in the economy?

A

Households, Firms, Government, Foreign Sector

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2
Q

What does capital mean in economics terms?

A

Goods used as inputs to produceother goods and services.

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3
Q

What is the formula to determine total output in an economy and what does each part represent?

A

Z = C + I + G + (x-m)

Where Z means total output
C means consumer spending
I means investment (firms investment)
G means government spending
X means exports
M means imports

x-m represents trade surplus or deficit

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4
Q

What is a market?

A

Any MECHANISM which brings BUYERS and SELLERS together with a purpose to transact in agreementa

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5
Q

Buyer

A

Economic agent willing and able to buy

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6
Q

Seller

A

Economic agent willing and able to sell

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7
Q

Market price

A

Price at which market clears (transaction occurs)

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8
Q

Financial market

A

Any mechanism which facilitates issuing (origination) and/or trading (repurchasing and reselling) of financial securities with a purpose of TRANSFERRING FUNDS

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9
Q

Financial security

A

A transferable claim on the future income or on the assets of the economic agent who issued that financial security

  • Financial security is an asset to the security holder (buyer) and a liability to the security issuer (who is not always the seller)
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10
Q

What essential function do the financial markets perform?

A

Channel funds (not money) from economic agents with surplus funds but do not have productive use or desire to consume to economic agents who have a shortage of funds but have productive use or desire to consume

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11
Q

Other functions of financial markets

A

Promote economic growth by stimulating increase in production due to efficient allocation of funds.

Improve consumer well-being by allowing time preference of consumption

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12
Q

8 classifications of financial markets

A 
Debt vs. Equity
Money vs. Capital Markets
Primary vs. Secondary
-Secondary markets are classified as
-Centralized Exchanges vs. Over the Counter
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13
Q

Debt contracts

A

Buyer of debt instrument = creditor
issuer of debt instument = borrower
has a maturity day
principal and interest must be repaid

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14
Q

Equity contracts

A

ownership stake in enterprise
no maturity day
proportionate claims on future income
residual claims on assets… means that in dissolution or insolvency of business, debt contracts are paid first, and if there is any leftover, it goes to equity holders

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15
Q

Primary market

A

Company issues securities and funds flow to issuers.

Public offering

  • Registered with SEC
  • Initial Public Offering (IPO) - first time securities issued
  • Seasoned - subsequent issue
  • -Investment bank via Firm Commitment or Best Efforts
  • -Auction - issue acquired by dealer
Private Placement (not registered with SEC)
-Investment bank assists in locating buyers and negotiating for a fee (broker)
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16
Q

Secondary market

A 
Investors trade (repurchase and resell) securities 
Funds flow to sellers not original issuers
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17
Q

Exchanges

A

Centralized trading floor (like New York Stock Exchange NYSE)
Buyers and sellers submit orders to a central location and orders are matched by a specialist

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18
Q

Over the Counter (OTC)

A

Decentralized computer and phone network of dealers
Individual dealers provide liquidity for investors by buying and selling securities out of their own inventory
Example: NASDAQ, National Association of Securities Dealers Automated Quotation System

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19
Q

Money market

A 
Only short term - 1 year or less
Only debt instruments
Generally highly liquid
Have nearly non-existent price fluctuations, guaranteed rate of return
Maturity dates
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20
Q

Capital markets

A 
Longer term debt (above 1 year)
Equity instruments (No maturity)
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21
Q

Money Market Instrument examples

A

US Treasury Bills
Certificates of Deposit (CDs)
Commercial paper
Federal funds and security repurchase agreements

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22
Q

Capital Market Instruments

A 
Corporate stocks
Residential mortgages
Corporate bonds
US government securities (long term)
US govt. agency securities
State and local government bonds
Bank commercial loans
Consumer loans
Commercial and farm mortgages
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23
Q

Direct finance

A

Funds are transferred directly from the fund suppliers to the fund users
-a fund provider receives a financial security (claim) and a fund user receives funds

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24
Q

Indirect finance

A

Funds move from suppliers to users indirectly via financial intermediaries (banks, mutual funds, investment banks, pension funds, etc.)

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25
Q

Where do financial intermediaries operate in terms of direct vs. indirect finance

A

Indirect

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26
Q

Financial intermediaries

A

Financial institutions which CHANNEL FUNDS from those who have a surplus and no productive use to those who have a shortage but also a productive use

Depository institutions (banks): accept deposits and make loans
Mutual funds: transform assets and offer diversification
Pension funds: offer savings plans for retirement
Insurance companies: protect from adverse events
Finance companies: make loans but do not accept deposits

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27
Q

Functions of financial intermediaries

A

Lower transaction costs
Provide liquidity services
Reduce risk exposure

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28
Q

How to financial intermediaries lower transaction costs?

A

Their expertise in locating and evaluating investments

Economies of scale: reduction in transaction cost per unit as number of transactions increase

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29
Q

How do financial intermediaries reduce risk?

A

Asset transformation: combine risky assets with less risky assets to offer risk-return combinations acceptable to small investors
Offer investment diversification (portfolio instead of individual assets)

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30
Q

Asymmetric Information

A

Unevenly distributed knowledge between counterparts in a transaction

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31
Q

Adverse selection

A

Before transaction

Financial intermediaries reduce risk of selecting most risky borrowers by gathering information about potential borrower

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32
Q

Moral hazard

A

After transaction

Ensure borrower won’t engage in activities preventing him/her to repay the loan

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33
Q

Why regulate the financial system

A

To increase information available to investors:

  • reduce adverse selection and moral hazard problems
  • reduce insider trading (SEC)

To ensure the soundness of financial intermediaries

  • Restrictions on entry (chartering)
  • Disclosure of information
  • Restrictions on Assets and Activities (control holding of risky assets)
  • Deposit Insurance (avoid bank runs)
34
Q

What can be described as direct finance?

A

You borrow $2,500 from a friend

35
Q

Are debt and equity contracts both short term? Why or why not?

A

No because although debt contracts can be short term, equity is a perpetual claim against future income. It never expires

36
Q

Liquid financial security

A

Short notice
Predictable price
Low transaction cost

37
Q

U.S. Treasury bills pay no interest but are sold at a ______. That is, you pay a lower purchase price at the time of the purchase than the amount you receive at maturity.

A

Discount

38
Q

Income

A

the flow of earnings per unit of time

39
Q

Wealth

A

total collection of the property owned.
in addition to money, wealth includes:

Value storing or income producing REAL assets
Income producing Financial Assets
Income Producing Intangible Assets

40
Q

Value Storing or Income Producing Real Assets

A 
Art (paintings, sculptures, antiques, precious metals, jewelry)
Real estate (land, houses, offices, apartments, storage space)
Means of production (factories, equipment, tools, warehouse, trucks)
41
Q

Income producing Financial Assets

A

Stocks - paying cash dividends

Bonds and notes - paying fixed or floating interest income

42
Q

Income Producing Intangible Assets

A

Copyrights

Patents

43
Q

Money

A

Anything universally accepted as a payment for goods and services and in repayment of debts.

Defined as stock
Expressed as quantity at a point in time

44
Q

Functions of money

A

Medium of exchange
Store of value
Unit of account

45
Q

Benefit of money as a medium of exchange

A

Money promotes economic efficiency by reducing transaction costs associated with double coincidence of wants

46
Q

Double coincidence of wants

A

Like in barter: example:

I have diamonds willing to trade and I want chocolate. I must find someone who wants diamonds but has chocolate.

47
Q

Barter

A

Exchanging goods and services for other goods and services without using money

48
Q

What can function as money

A

Any commodity can as long as it is:

Universally accepted as payment
Easily standardized
Divisible "to make change"
Easy to carry
Not deteriorate too quickly
49
Q

How does money store value?

A

It is used to save purchasing power over time. Value storing refers to the time period from when we received money in exchange for goods or services to the time period we want to use it to pay for other goods and services.

  • Money is not unique value-storing asset
  • Money isn’t a perfect store of value. Inflation slowly erodes purchasing power.
  • Gold, real estate, art, jewelry and art store value better.
50
Q

How is money a unit of account

A

the value of all of the goods and services can be expressed in a singular term… the quantity of money it takes to purchase something.

instead of

in the barter system, there would be several terms.

Ex. 1 gallon of milk = $5 instead of 1 gal of milk = 1/3 haircut, or 4 pounds of salt, or 1/25 of a chair.

51
Q

Payments system

A

Method of conducting transactions in the economy. System of payments has been evolving over centuries and so has the form of money

52
Q

Commodity money

A

Valuable, easily standardized and divisible commodities

Precious metals, tobacco or cigarettes

53
Q

Fiat money

A

Paper money, which used to carry a guarantee that it would be converted to precious metal on demand. Lighter than commodity but still heavy in large amounts

54
Q

Checks

A

An instruction to your bank to transfer money from your account to someone else’s account when he or she deposited your check

55
Q

Electronic payment

A

Ex. online bill pay. Saves costs on stamps and envelopes. Payment is faster and recurring payments make life easier

56
Q

E-money

A

Debit card - enables consumer to pay for goods and services by electronic transfer or funds from own account to merchant’s account

Stored value card - prepaid card

Smart card - rechargeable card

E-cash

57
Q

Bitcoin

A

World’s first decentralized digital currency

58
Q

M1 (most liquid assets)

A

Currency (paper money and coins held in the hands of nonbank public)
Traveler’s checks
Demand deposits
Other checkable deposits

59
Q

M2

A 
M1
small denomination time deposits
savings deposits
money market deposit accounts
money market mutual fund shares
60
Q

Does it matter which measure of money is considered?

A

Yes because M1 and M2 can move in different directions in the short run

61
Q

What is investment in terms of finance?

A

What we do with our savings to make them grow over time.

Commitment of your savings for a period of time in order to derive future payments, which will compensate you for:

  • The time your funds were committed
  • Inflation or lost purchasing power
  • Any sources of uncertainty of collecting what is promies
62
Q

Calculate savings

A

Income (Y) - Tax (T) - Consumption (C) = Savings (S)

Also referred to as

Income - Tax = Disposable income

So then, Disposable Income - Consumption = Savings, or
Disposable Income = Savings + Consumption

63
Q

Two things that can be done with disposable income

A

Consumed or saved

64
Q

Why is it true that the only way to persuade people to defer their consumption and let others use their savings is to promise them a higher payback in the future than the original loan they make today?

A

Most people are rational and act in their own self-interest

65
Q

What is the source of interest rates?

A

Time Value of Money (Savings)

66
Q

Interest rate

A

Rate that a creditor charges a borrower for using creditor’s savings.

Typically expressed as a fee amount of dollars divided by the original loan amount

67
Q

Time Value Analysis formula

A

Future Value at maturity = Present Value x (1+ interest rate) ^number of periods

or

FV at n = PV x (1 + i)^n

68
Q

Time Value Analysis

A

Process of converting dollar values over time

69
Q

Compounding

A

Process of finding future values

70
Q

Discounting

A

Process of finding present values

71
Q

Four types of credit market instuments

A

Simple Loan (Commercial loans, CDs)
Fully Amortized Loan (installment loan)
Coupon Bonds (T-notes, T-bonds, Corp-bonds)
- finite maturity (most common)
-Infinite maturity (perpetuities or consoles)
Discount bond (Zero coupon bonds like T-Bills)

72
Q

Coupon rate

A

“Promised” rate of interest paid in form of coupon. *Constant and printed on the bond contract.

*except for floating rate bonds.

73
Q

Coupon payment

A

Expressed at a percentage of the instrument’s face value (AKA Future Value)

74
Q

Yield to Maturity (YTM)

A

Prevailing market interest rate, which investors expect to earn when buying bonds with certain risk characteristics. Fluctuates continuously.

75
Q

Relationship between coupon rate, YTM, and price of bond

A

when coupon rate = YTM, then PV = FV
coupon rate < YTM, then PV < FV
coupon rate > YTM, then PV >FV

76
Q

Perpetuity formula

A

Yield to maturity = Yearly Interest Payment / Price
or
i at c = C / P at c

77
Q

One year discount bond formula

A

i = (F-P) / P

78
Q

Nominal interest rate

A

Makes no allowance for inflation

79
Q

Real interest rate

A

adjusted for changes in price level so it more accurately reflects the cost of borrowing

ex ante: real interest rate is adjusted for expected changes
ex post: adjusted for actual changes

80
Q

Fisher equation

A

Nominal interest rate = real interest rate + expected inflation rate

When real interest rate is low, better to borrow than to lend

81
Q

How to calculate interest rate

A

(FV/PV)^(1/n) - 1 = i

82
Q

Calculate the number of time periods

A

ln(FV/PV) / ln (1 + i) = N

83
Q

Calculate coupon bonds

A

Calculate coupon payments which = i or YTM x FV

The use

Payment / (1 + i)^N for each period and add all periods together.

Money and Banking (1 decks)

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