Financial System Definitions

Question 1

Adverse Selection

Answer 1

Problem created by asymmetric information before the transaction.
e.g. not knowing how risky a debtor is.

Question 2

Asset Transformation

Answer 2

Process that turns risky assets into safer assets by creating and selling assets with risk characteristics that people are comfortable with (using the funds from those sales to buy risky assets) AKA RISK SHARING.

Question 3

Brokers

Answer 3

Agents of investors who match buyers with sellers.

Question 4

Capital

Answer 4

Wealth that is employed to produce more wealth.

Question 5

Capital Market

Answer 5

Market where longer-term debt and equity instruments are traded.

Question 6

Dealers

Answer 6

People who link buyers to sellers by buying and re-selling securities at stated prices.

Question 7

Default

Answer 7

When the party issuing the debt instrument is unable to make interest payments or pay off the amount owed at maturity.

Question 8

Diversification

Answer 8

Investing in a collection of assets which returns’ do not always move together to reduce default risk.

Question 9

Dividends

Answer 9

Periodic payments made by equities to shareholders.

Question 10

Economies of Scale

Answer 10

Reduction in transaction costs of the transaction per dollar as the size of transaction increases.

Question 11

Equity

Answer 11

Claims to share in the net income and assets of a corporation.

Question 12

Eurobond

Answer 12

Bonds denominated in a currency different to that of the country in which it is sold.

Question 13

Eurocurrency

Answer 13

Foreign currencies deposited in banks outside the home country.

Question 14

Eurodollars

Answer 14

US dollars deposited in foreign banks outside the US or in the foreign branches of US banks.

Question 15

Centralized Exchanges

Answer 15

Secondary markets in which buyers and sellers of securities meet in one central location to conduct trades.

Question 16

Federal Funds Rates

Answer 16

The interest rate on overnight loans of deposits at the Fed.

Question 17

Financial Intermediation

Answer 17

Process of indirect finance whereby financial intermediaries link lender-savers with borrowers spenders.

Question 18

Financial Panic

Answer 18

Widespread collapse of financial markets and intermediaries in an economy.

Question 19

Foreign Bonds

Answer 19

Bonds sold in a foreign country and denominated in that country’s currency.

Question 20

Investment Bank

Answer 20

Firms that assist in the initial sale of securities in the primary market.

Question 21

Liabilities

Answer 21

IOUs (written acknowledgement of debt) or debts.

Question 22

Liquidity Services

Answer 22

Services that financial intermediaries provide to their customers to ease transactions.

Question 23

Maturity

Answer 23

The time to the expiration date of a debt instrument.

Question 24

Money Market

Answer 24

A financial market in which only short-term debt instruments are traded.

Question 25

Moral Hazard

Answer 25

The risk that one party to a transaction will engage in behavior that is undesirable from the other party’s point of view.

Question 26

Mortgage-backed Securities

Answer 26

Securities that cheaply bundle and quantify the default risk of the underlying high-risk mortgages.

Question 27

Mortgages

Answer 27

Loans to households or firms that wish to purchase housing, land, or the real structures; the structure or land itself serves as collateral for the loan.

Question 28

Over-the-counter Market

Answer 28

Secondary market in which dealers at different locations who have an inventory of securities to any individual willing and able to pay.

Question 29

Portfolio

Answer 29

A collection or group of assets.

Question 30

Primary Market

Answer 30

Financial market in which new issues of a security are sold to initial buyers.

Question 31

Risk

Answer 31

The degree of uncertainty associated with the return on an asset.

Question 32

Thrift Institutions

Answer 32

Savings and loan associations, mutual savings banks, and credit unions.

Question 33

Transaction Costs

Answer 33

The time and money spent trying to exchange financial assets, goods, or services.

Question 34

Underwrite

Answer 34

To purchase securities from a corporation at a predetermined price and then resell them in the market.

Question 35

Underwriting

Answer 35

Guaranteeing the price of a corporation’s securities and then selling them to the public.