Finance tentaplugg

Question 1

Lemons’ problem

Answer 1

It refers to the problem of the value of an investment or product due to asymmetric information possessed by the buyer and the seller. Using a used car for example we can assume that the seller has more knowledge of the car’s condition and thus is more aware of its valuation. This can lead to the buyer paying more for a car than what he would’ve done had he known the knowledge of the seller.

Question 2

Too big to fail

Answer 2

Is a theory in banking and finance that asserts that certain financial institutions are so large and interconnected that their failure would be disastrous to the economic system.

Question 3

Quantitative easing (QE)

Answer 3

Is a monetary policy central banks use to stimulate economic activity. It means that the central bank purchases securities in an attempt to reduce interest rates or increase the money supply to increase lending to consumers and corporations.

Question 4

Real interest rate

Answer 4

The real interest rate is the interest rate that has been adjusted for the effects of inflation. It reflects the real costs of funds to a borrower and the real yield to a lender or investor.

Question 5

Expectations theory

Answer 5

It tries to predict where short-term interest rates will be in the future based on current long-term interest rates. The theory suggests that an investor buying 2 one-year bonds will make the same return as if he had bought 1 two-year bond.

Question 6

Asset price Bubble

Answer 6

This exists when the market price is far higher then what the fundamentals would suggest. It can be extremely devastating for individuals and corporations that invest too late.

Question 7

Net interest margin

Answer 7

Is the difference between interest paid and interest received, adjusted for the total interest generating assets held by the bank. It can be an indicator of a bank’s profitability, seeing how much they make on loans and pay for deposits.

Question 8

Federal Open Market Committee (FOMC)

Answer 8

Consists of 12 members , the seven board of governors, the president of New York reserve bank and 4 of the eleven reserve bank presidents. It controls the open market operations, The discount rate and reserve requirements.

Question 9

Order driven trading

Answer 9

An order driven market is a financial market where all buyers and sellers display the prices at which they would like to buy and sell a particular security as well as the amount they are willing to buy or sell.

Question 10

Adverse selection

Answer 10

Adverse selection is when a seller has more knowledge about the product’s quality then a buyer or vice versa. It is therefore that adverse selection is that people seek to exploit their knowledge advantage over the other party. Can be for a person living a risky life buying insurance to be able to finance his risky lifestyle with insurance covering his costs. The company in this case doesn’t know this condition.

Question 11

Open market operations

Answer 11

Open market operation refers to the purchase or sale of securities in the open market performed by a central bank to regulate the supply of money in the market.

Question 12

Reserve requirement

Answer 12

Is the amount of funds a bank needs to hold in its reserve to meet its liabilities in case of sudden withdrawals, it is set by the central bank to regulate the amount of money supply in the economy and also influence interest rates.

Question 13

Nominal anchor

Answer 13

Is a way of making promises credible, 1 method this occurs in is using commodities such as gold or silver as money, or adopting a fixed exchange rate with a currency that has a reputation of stability such as the US dollar.

Question 14

Taylor’s rule

Answer 14

Is an equation linking the federal reserve’s benchmark interest rate to levels of inflation and economic growth. It assumes an equilibrium federal funds rate 2% above the annual inflation rate.

Question 15

Transparency

Answer 15

Is the extent to which investors have steady access to required financial information about a company, for example, price levels, market depth and audited financial reports.

Question 16

Asymmetry of information

Answer 16

Occurs when one party to an economic transaction possesses greater knowledge than the other party. It can work both ways with the seller or buyer holding better knowledge over the other. For example buying a used car, the seller can know all the flaws with the vehicle and not disclose it and in the other way the seller might sit on a rare expensive car and not know its true value and the buyer can get a better deal than it should.

Question 17

Moral hazard

Answer 17

Is the risk that a party has not entered the deal in good faith or has provided misleading information about for example, it’s assets, liabilities or credit capacity. Can also be that a party has incentive to take unusual risks in an attempt to earn a profit before the contract ends.

Question 18

Shadow banking

Answer 18

Financial intermediaries that participate in creating credit but are not subject to regulatory oversight. Examples of these can be hedge funds, private equity funds, mortgage lenders and some large investment banks.

Question 19

Deposits

Answer 19

Generally money held on a bank account or other financial institution but can also refer to the amount of money used as a security or collateral for delivery of goods and services.

Question 20

TIER 1

Answer 20

Refers to the core capital held in a bank’s reserves and is used to fund business activities for the bank’s clients, Can include common stock as well as disclosed reserves and certain other assets. Under the Basel III accord, the minimum amount required is set to 6% of a bank’s risk-weighted assets.

Question 21

Deposit taking institution

Answer 21

Refers to the receipt of funds from the general public, for example via deposits or the issuance of bonds. Examples for these institutions can be banks, trust companies and credit unions.

Question 22

Risk-free rate

Answer 22

Is the theoretical rate of return on zero-risk assets. The rate should reflect the yield of return on default-free governmental bonds.

Question 23

Maintenance margin

Answer 23

Is the minimal amount of equity an investor must hold in the margin account after a purchase has been made. The current amount FINRA has set is 25% of the total value in securities from the account. A margin account is an account with a brokerage that allows an investor to borrow money from the brokerage to invest in stocks, bonds and options. It exists to mitigate losses for both investors and brokerages.

Question 24

Basel III Accord

Answer 24

It is an internationally agreed set of measures developed by the Basel Committee and the Banking Supervision in response to the 07-08 crisis. It consists of minimum requirements that apply to international active banks and exist to regulate and protect the financial systems that exist in our world.

Question 25

Underwriting

Answer 25

Is the process of evaluating risks to protect investors, banks, insurance agencies and other financial institutions. Usually an underwriter performs risk analysis and then makes recommendations for loans, investments and insurance policies for their organization.

Question 26

Market maker

Answer 26

A Market maker is an individual participant or member firm of an exchange that buys and sells securities for its own account. They provide liquidity in the market and depth while still profiting from the difference in the bid-ask spread. The most common type of market makers are brokerage houses, providing purchase and sale solutions for investors.

Question 27

Over-the-Counter (OTC) market

Answer 27

Is a market that is not centralized and occurs between two parties. An example of this occurring is a trade of stocks between two parties that is not listed on an exchange. These trades can exist of any type of security such as equities, commodities and derivatives.

Question 28

Efficient Market Hypothesis

Answer 28

Is a thesis that states that if a share price reflects all the available information. According to the thesis it is impossible for investors to purchase undervalued stocks or sell stocks for over priced. It says that the only way an investor can obtain higher returns is by taking riskier investments.

Question 29

Intermediation

Answer 29

Intermediation is the act of coming inbetween. In Finance this refers to the “matching” of lenders who have savings in a (bank) and borrowers who are in need of financing. Borrowers can be people, companies or other third parties.

Question 30

Money multiplier

Answer 30

Is defined as the maximum amount of new money created by banks for every dollar of reserves. It’s calculated as the reciprocal of the reserve requirement ratio set by the central bank. It represents how a single dollar deposited in a bank can “multiply” into a greater amount in the economy.

Question 31

Reserve ratio

Answer 31

Is the percentage of deposits a financial institution must hold in reserve as cash.

Question 32

Precautionary motive

Answer 32

A desire to hold cash in order to be able to deal effectively with unexpected events that would require cash outlay.

Question 33

Margin call

Answer 33

Occurs when the percentage of an investors equity in a margin account falls below the broker’s required amount, and then requires the investor to deposit more funds into the account so that the value of equity rises to the minimum amount.

Question 34

Large caps

Answer 34

Refers to a company with a market capitalization with a value of more than $10 billion. The companies value is determined by the amount of shares times the share price.

Question 35

Value style portfolio management

Answer 35

Is focused on investing in strong companies at a good price, these are often older and more mature companies that usually pay out dividends, for example the financial sector.

Question 36

Monetary base

Answer 36

Refers to the amount of cash circulating in the economy. Consists of two parts, currency in circulation and bank reserves. it differs from money supply which includes non-cash assets like demand deposits, time deposits and checks.

Question 37

Technical analysis

Answer 37

Is a trading principle that is used to evaluate investments and identify trading opportunities in price trends and patterns. It believes that trading activity and price changes of a security can be valuable indicators of the securities future price movement.