Finance Flashcards
What do higher expected future returns result in?
Lowers the expected return for long term bonds, decreases their demand, shifts the demand curve to the left.
What does an increase in expected return on alternative assets result in?
lowers the demand for bonds, shifts the demand curve to the left.
What does an increase in the expected rate of inflation result in?
lowers expected return on bonds causing their demand to decline and shifts the demand curve to the left
What is risk premium?
the spread between the interest rate on bonds with default risk and interest rates on default free bonds, both with the same maturity. Indicates how much additional interest people must earn to be willing to hold the risky bond.
What is default risk
It is an attribute of a bond which influences interest rate. Occurs when issuer is unwilling/unable to make interest payments when promised or pay off face value when the bond matures
What is segmented market theory?
it sees the market for different maturity bonds as completely separate and segmented. Assumption is that bonds of different maturities are not substitutes at all
What happens to the demand for money due to the price level effect?
a rise in price level caused demand for money at each interest rate to increase and the demand curve shifts to the right. Vice versa when price level falls.
What happens to the demand for money due to the income effect?
A higher level of income causes the demand for money at each interest rate to increase and the demand curve shifts to the right
Define income and state its variable time
flow of earnings per unit time. Flow variable
Define wealth and state what type of variable it is?
Total collection of pieces of property that serve to store value. Stock variable
What is included in M2?
M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares (retail)
What is a money market?
A financial market in which only short-term debt instruments are traded
What is included in M1?
currency + traveller’s checks + demand deposits + other checkable deposits
What is perpetuity/consol?
a special case of a coupon bond. It Is a perpetual bond with no maturity date and no repayment of principal that makes fixed coupon payments of $C forever
What does expected inflation do to the bond price and demand curve when there is an increase in change in variable
Decreases the bond price
Shifts the demand curve to the left.
What is the fisher effect?
When expected inflation rises, interest rates will rise
What are the functions of financial intermediaries?
Lower transaction costs
Reduce risk
Reduces information costs of screening and monitoring borrowers
What are reasons to regulate the financial system?
To increase info available to investors.
To ensure soundness of financial intermediaries.
Stockholders are?
those who hold stock in a corporation - own an interest in the corporation equal to the percentage of outstanding shares they own. they are residual claimants
What is Dividends?
payments made periodically, usually every quarter, to stockholders
The theory of rational expectations
Expectations will be identical to optimal forecasts (best guess of the future) using all available informations
What are implications of Ration Expectations
- if there is a change in the way a variable moves, the way in which expectations of this variable are formed will change as well
- The forecast errors of expectations will, on average, be zero and cannot be predicted ahead of time
Efficient Market Hypothesis?
Based on the assumption that prices of securities in financial markets fully reflect all available information.
What is behavioural finance?
Applies concepts from other social sciences, such as anthropology, sociology and particularly psychology to explain behaviour of securities prices.
What are debt contracts?
extremely complicated legal documents that place substantial restrictions on the behaviour of the borrower.
True or False: Indirect finance is more important than direct finance and stocks
True
How do financial intermediaries reduce transaction costs?
Economies of scale
Expertise
What are Economies of scales and give an example?
Investors funds may be bundled together to reduce transaction costs for each individual investor. An example is a mutual fund, which is a financial intermediary that sells shares to individuals and then invests the proceeds in bonds or stocks. Because it buys large blocks of bonds or stocks, a mutual fund can take advantage of lower transaction costs.
What is asymmetric information?
A situation where one party’s insufficient knowledge about the other party involved in a transaction makes it impossible for the first party to make accurate decisions when conducting a transaction.
What is adverse selection?
An asymmetric information problem that occurs before a transaction
What is Moral Hazard?
arises after a transaction occurs. ‘The likeliness of repayment of a loan by the borrower is uncertain’
Why are stocks not the primary sources of financing for businesses in any country in the world?
only bad firms will want to sell stocks at average market price, while good firms will not want to sell stocks at average market price. This means few stocks will sell in this market and not be a good source of financing.
What are tools to help solve adverse selection problems?
Private production and sale of information
Government regulation to increase information
Financial intermediation
Collateral and Net Worth
what is the principal-agent problem?
Equity contracts, like common stocks, are subject to a particular type of moral hazard. Stockholders who most of the firm’s equity have more incentives to maximize profits for the firm than managers, who own a small fraction. By owning a small fraction, they may act in their own interest
What are tools to help solve the principal agent problem?
Production of information: Monitoring
Government Regulation to Increase Info
Financial Intermediation - Venture Capital Firms
Debt Contracts
What are the four restictive covenants to reduce moral hazard
- Covenants to discourage undesirable behaviour
- Covenants to encourage desirable behaviour
- Covenants to keep collateral valuable
- Covenants to provide information
What are drawbacks of the government safety net?
Moral hazard
Adverse selection
“too big to fail”
Financial consolidation
What are the 6 types of financial regulation?
Restrictions on asset holdings
Capital Requirements
Financial supervision: Chartering and Examination
Disclosure Requirements
Consumer Protection
Restrictions on competition
Describe capital requirements as a type of financial regulation
By forcing a financial institution to hold a large amount of equity capital, the institution has more to lose if it fails and thus more likely to pursue less risky activities
What is Chartering?
a method to prevent adverse selection. through chartering, proposals for new institutions are screened to prevent undesirable people from controlling them. Once a bank has been chartered, it is required to file periodic call reports, revealing assets, liabilities, income etc …
What are disclosure requirements
to ensure that better information is available in the marketplace, regulators can require that financial institutions adhere to certain standard accounting principles and disclose a wide range of info that helps the market assess the quality of an institution’s portfolio and the amount of its exposure to risk.
