Financial System Quiz Flashcards
How can funds be obtained in the financial market?
1) Issuance of debt instruments
2) Issuance of equities
How are secondary markets organized?
1) Centralized exchange
2) OTC market
What is the difference between the Money and Capital market?
Short-term instruments are exchanged in the money market, and long-term instruments in the capital market.
List the money market instruments
1) US Treasury bills
2) Certificates of deposit
3) Commercial paper
4) Repos
5) Federal Funds
US Treasury Bills
Issued by the US government to finance government expenditure + sold at discount prices.
Certificates of Deposit
Sold by banks and pays annual interest of a given amount and at maturity pays back face value + must remain untouched for whole period.
Commercial Paper
Issued by large banks and well known big corporations (e.g. Microsoft) used by firms to repay short-term liabilities.
Repos
Short-term loans for which Treasury bills serve as collateral (firm purchases t-bills from bank, and bank repurchases some time later).
Federal Funds
Overnight loans between banks at the Federal Reserve.
What is the name of the rate of borrowing costs?
Prime rate
List the capital market instruments
1) Stocks
2) Mortgages
3) Corporate bonds
4) Government securities
5) State and local government bonds
6) Consumer & bank commercial loans
Stocks
Equity claims on the net income and assets of a corporation.
Mortgages
Loans used to purchase structure which becomes collateral for loans.
What are mortgage-backed securities?
Debt instruments backed by a bundle of individual mortgages whose interest and payments are paid to the holder of the security.
Corporate bonds
Long-term bonds that sends the holder an interest payment twice per year and pays off the face value when the bond matures.
What are convertible bonds?
Corporate bonds that are allowed to be converted into a specified number of shares of stock at any time up to the maturity date.
What is an attractive characteristic of state and local government bonds?
Interest payments are exempt from federal income tax and state taxes.
Foreign bonds
Bonds sold in a foreign country and denominated in that country’s currency.
Eurobond
A bond denominated in a currency other than that of the country in which it is sold.
Eurocurrency
Foreign currencies deposited in banks outside the home country (e.g. Eurodollars).
What is Financial Intermediation?
The process of indirect financing using financial intermediaries.
How do Financial Intermediaries reduce transaction costs?
Economies of scale (reduced cost as size of transaction increases) and liquidity services
What is risk-sharing?
Process of creating and selling assets with lower risk and using the funds acquired to purchase other assets that have more risk.
What processes involve risk-sharing?
Asset transformation + diversification.
Moral Hazard
Occurs after the transaction when the lenders have no control on the behavior of the borrower after having received the loan.
Asymmetric Information
The unequal knowledge that each party to a transaction has about the other party.
How is asymmetric information reduced in the market?
Screening (credit ratings) + monitoring.
List the types of depository institutions
1) Commercial banks
2) Savings and loans associations
3) Credit unions
List the types of contractual savings institutions
1) Life insurance companies
2) Fire & casualty insurance companies
3) Pension and retirement funds
List the types of investment intermediaries
1) Finance companies
2) Mutual funds
3) Hedge funds
4) Investment banks
What regulations are used to prevent financial panic?
- Restriction of entry
- Disclosure of books
- Restriction on assets + activities
- Deposit insurance
- Limits on competition
- Restriction on interest rates
What are the key principles of money and banking?
1) Time
2) Risk
3) Information
4) Markets
What is the difference between an asset and liability?
An asset is something that is owned; a liability is something that is owed.
What is the difference between brokers and dealers?
Brokers match buyers with sellers; dealers buy/sell from buyers and sellers.
What are the advantages of Financial Intermediaries?
1) Lower transaction costs
2) Reduce risk
3) Reduce information asymmetry
