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m&B > Final > Flashcards

Final Flashcards

1
Q

ch1: financial market 9s () finance

what does it do

A
  1. suppliers and demanders of funds interact

2. set prices for financial assets

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2
Q

4 financial organizations in financial market

A

financial market
savers (assets)
borrower’s IOU
intermediaries

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3
Q

4 functions of the financial system

A
  1. matches savers with borrowers
  2. liquidity (allow people to hold financial claims + increases liquidity by providing trading systems)
  3. information cost
  4. risk-sharing (diversity portfolios)
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4
Q

primary markets

  1. what does it trade
  2. enhance/create liquidity
A
  1. newly issued claims
  2. creates
  3. does not provide other services
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5
Q

secondary markets

1. enhance/create liquidity

A
  1. enhance liquidity; risk sharing, promoting liquidity and information
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6
Q

capital markets include () and ()

short-term instrument w/ m<1 is traded in ()

A
  1. auction market (competitive bidding)
  2. OTC (computerized & NASDAQ)
  3. MONEY MARKET
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7
Q

fin institutions

  1. how does it make money
  2. how does it enhance liquidity
A
  1. interest rate spread

2. checking accounts

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8
Q

fin. institutions
1. how does it make money
2. how does it enhance liquidity

A
  1. interest rate spread

2. checking accounts

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9
Q 
ch2: 
what 5 criteria define money 
1. common medium of exchange (4 criteria)
2. unit of account
3. store of value 
4. the standard of deferred payment

what does money enable (specialization)

A
  1. acceptable + standard quality + durable + valuable relative to weight + divisible
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10
Q

what determines acceptability

A
  1. universal faith (fulfilling expectations)
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11
Q

what is inflation? (hyperinflation –> Zimb)

deflation?

A
  1. decrease in the purchasing power of money

2. increase in the purchasing power of money

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12
Q

payment system
1. definitive $
(physical goods + system)

  1. fiat money vs. legal tender
  2. checks
  3. setting and clearing transactions (electronic funds)
A
  1. money that does not have to be converted to a more basic medium of exchange
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13
Q

measuring the money supply
1. M1

  1. M2(best measure of money supply + increases more rapidly than M1)
  2. M3
A
  1. liquid assets (checkable deposits + cash + traveler’s checks)
  2. M1 + short-term investment account
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14
Q

CH3

IR must cover oppor.cost

A
  1. inflation
  2. default risk
  3. opportunity cost
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15
Q

yld (def)

A
  1. yield = PV of return == PV today
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16
Q

when YTM < Coupon

A

premium

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17
Q

when YTM = couplon

A

par

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18
Q

YTM > coupon

A

discount

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19
Q

capital gain/ loss formula

A

FV - P

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20
Q

current yld

  1. C/P move in the same direction as YLD
A

C/P

increase in P, decrease in CY

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21
Q

F = P –> capital gain/ loss = () –> coupon rate = () –> current yld =()

A
  1. 0, current yld, ytm
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22
Q

F<p> capital () –> coupon rate () current yild )_ ytm</p>

A

loss, >, >

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23
Q

F>P –> capital() –> coupon rate () current yld () YTM

A

gain,

24
Q

the longer the time until a bond matures, the () the potential price change caused by a change in YTM

A

GREATER

25
Q

the negative impact of a () in i on P increases with n

A

rise

26
Q

TIPS

pays () a year at a fixed rate

A

offers low return

27
Q

TIPS

pays () a year at a fixed rate

A

offers a low return

28
Q

Jeremy Siegal

  1. why are TIPS bad investment
  2. when are TIPS an awful investment
A
  1. when inflation is high
  2. according to the Fisher equation, inflation can be a sign of economic growth –> increase in real rate –> decrease in PV of TIPS
29
Q

how does the treasury benefit from issuing TIPS

A
  1. avoid having to pay inflation risk premium

2. provide useful reading of interest rates

30
Q

drawbacks of tips

A
  1. difficulty adjusting to a new asset class
  2. low liquidity
  3. supply trends
31
Q

drawbacks of tips

A
  1. difficulty adjusting to a new asset class
  2. low liquidity
  3. supply trends
32
Q

pros of strips

A
  1. no periodic cost

2. match information

33
Q

5 determinants of portfolio choice

A
  1. wealth
  2. exp. return
  3. liquidity
  4. risk
  5. cost to acquire information
34
Q

for every p that clears the () market, there is an equivalent () that clears the () market

  1. demand in B == () in LF
  2. Supply in B == () in LF
A
  1. bond, i, loanable funds
35
Q

5 factors that affect D in Bond mkt and S in LF mkt

A
  1. wealth (w increases, Db & Slf shifts out)
  2. expected return & exp. inflation (increase in expected inflation and return cause Db and Slf to shift in
  3. risk
  4. liquidity
  5. information cost
36
Q

4 factors that affect the supply of bonds and demands of loanable funds

A
  1. exp profitability (increase in prof. increase in supply of bonds / demand of lf)
  2. business taxes (same as profitability)
  3. expected inflation (high expected inflation means low real interest rate in borrowing –> supply of bonds and demand of lf shifts out)
  4. government borrowing (increased deficit –> more savings –> shifts supply of bonds out
37
Q

why are interest rates low during recession

  1. in the beginning of a recession –> the demand of bonds shifts () because economic activities are reduced.
  2. meanwhile, the supply of the bonds also fall because shrinking business activities
  3. ultimately the second effect would be > the first effect, causing interest rate to fall
A
  1. in

2. snow ball effect

38
Q

what happens to the loanable funds and bond mkts when expected inflation is high

A
  1. demand of bonds falls
  2. supply of bonds increases
  3. interest rate increases
39
Q

pros of strips

people who buy strips are (receive certain amount at a specific date, not concerned about receiving current income, do not want to worry about finding an appropriate reinvestment opportunity)

A
  1. a promise at a certain date with reduced purchase price

2. provide safety of principal

40
Q

cons of securities

A
  1. interest rate risk (only gains and losses if strips are sold before maturity)
    2 .less liquid
  2. inflation risk
41
Q

the negative impact of a rise in i on p increases with n, because()

A
  1. the change in present value is larger and further out into the future
42
Q

explain why increased liquidity premium would precede a recession

A
  1. before recession –> economic activities slow down (less investment etc) –> higher default risk -> less demand for bonds –> lower Pbonds & higher i
  2. people demand treasury bonds –> increase Dt-bills –> higher Pbills & lower i
  3. premium = bondi - t-bill i > than before
43
Q 
risk structure 
() maturity with differences in () factors
A
  1. same

2. liquidity, risk, info cost, tax

44
Q 
term structure (only for government bonds) 
()maturity with () factors
A
  1. different

2. same

45
Q

interest carry trade strategy and difficulty

  • expectation theory suggests that interest carry trade is not an ordinary road to riches
    1. institutional investors can do this (i.e borrow at 1% and invest at 3%; however if expectation theory is applied, the short-term interest rate would rise. By the time the bond is matured, all profits are wiped out + interest rate risk )
A
  1. the gap between the interest rate and the rate you can borrow can be small or negative
46
Q

reasons why yield curve is a good forecasting tool

A
  1. predictive ability + supplement models
  2. quick and simple
  3. takes future and current monetary policy into account
47
Q

the required return on equity (Re)

A
  1. expected return necessary to compensate for the risk of investing in stocks
48
Q

assumptions of GGM

A
  1. receive dividend during the same period
  2. dividend is constant
  3. Re > g
49
Q

adaptive expectations vs. rational

A
  1. make expectations based on past events
50
Q

under rational expectation, the expectation of an asset’s future price = optimal price forecast, Pf

A

the random error still exists

51
Q

EMH
1. Under EMH, how does a price forecast translate into prices

  1. equilibrium price of an asset = optimal forecast of its fundamental value
A
  1. Self-interests drive the price to reach its fundamental value (Microsoft & 50 per share)
52
Q

adverse selection

  1. in bond market
  2. in stock market
A
  1. higher interest rate attract high default risk borrowers –> credit rationings
  2. lemon problem ( the cost of equity financing is higher)
53
Q

moral hazard

  1. in bond market
  2. in stock market
A
  1. high-risk investments by managers because they can keep the additional profit (restrictive covenants = solution)
  2. principal agent problem (publication of financial statements = solution)
54
Q

moral hazard

  1. in bond market
  2. in stock market
A
  1. high-risk investments by managers because they can keep the additional profit (restrictive covenants = solution)
  2. principal agent problem (publication of financial statements = solution)
55
Q

securitization

  1. higher liquidity
  2. spreading risk
  3. specialization
A
  1. involves the process of a sale of loans by the lender to a new agency who later sell the securities to investors. Putting smaller loans into standard debt and sell them to investors

m&B (2 decks)

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