Financial Markets and Institutions Flashcards
What is the main role of financial markets?
Channeling funds from those with excess funds (savers) to those needing funds for productive investments (borrowers).
Facilitates economic growth.
What are the key types of financial markets?
- Bond market: Where debt securities (bonds) are issued and traded.
- Stock market: Where ownership shares (stocks) of corporations are bought and sold.
What is a bond?
A debt security that represents a loan made by an investor to a borrower.
The borrower promises to make periodic interest payments (coupons) and repay the principal (face value) at maturity.
What are Treasury Bills (T-bills)?
Short-term federal government bonds sold at a discount from their face value. They do not pay interest but provide a return through the difference between the purchase price and the face value at maturity.
What are the different types of bonds based on maturity?
- Short-term bonds: Maturity less than one year.
- Intermediate-term bonds: Maturity between one and ten years.
- Long-term bonds: Maturity greater than ten years
What is a stock?
A share of ownership in a corporation, giving the holder a claim on the corporation’s earnings and assets.
What is the stock market?
A marketplace where stocks are traded, reflecting the current value of companies and expectations of future earnings growth.
What are financial intermediaries?
Institutions acting as middlemen between savers and borrowers, facilitating the flow of funds in the financial system.
Like banks, insurance companies, and pension funds.
How do financial intermediaries reduce transaction costs?
- Economies of scale: They can spread the cost of operations over a larger volume of transactions.
- Economies of scope: They can offer a wider range of financial services using the same infrastructure.
- Liquidity services: They provide easy access to funds for depositors and borrowers.
How do financial intermediaries improve risk sharing?
They pool funds from multiple savers, diversify investments across different assets, and transform risky assets into less risky ones, reducing the risk for individual investors.
How do financial intermediaries address information asymmetry?
They screen borrowers to reduce adverse selection (the risk of lending to high-risk individuals) and monitor borrowers to mitigate moral hazard (in this case, the risk of borrowers engaging in undesirable activities after receiving loans).
What are some examples of financial intermediaries?
Depository institutions: Chartered banks, trust and mortgage loan companies, credit unions, and caisses populaires.
Contractual savings institutions: Life insurance companies, property and casualty insurance companies, and pension funds.
Investment intermediaries: Finance companies, mutual funds, money market mutual funds, hedge funds, and investment banks.
What is yield to maturity (YTM)?
The total return anticipated on a bond if it is held until maturity. It represents the annual rate of return an investor can expect to receive if they purchase the bond at its current market price and hold it until the maturity date.
How is YTM calculated for a simple loan?
YTM is calculated as the difference between the cash flow received at maturity and the amount borrowed, divided by the amount borrowed.
How do you calculate the YTM for a fixed-payment loan or a coupon bond?
Calculating YTM for fixed-payment loans and coupon bonds involves complex formulas that require a computer or financial calculator.
