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FM > FM W1 > Flashcards

FM W1 Flashcards

1
Q

5 core principles of the financial system

A
  1. time has value
  2. risk requires compensation
  3. information is the basis for decisions
    4.market determines prices and allocates resources
  4. stability improves welfare
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2
Q

what is direct finance

A

lenders sell securities directly to borrowers in the financial market

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3
Q

what is indirect finance

A

an institution stands between a lender and a borrower

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4
Q

what is an asset

A

something of value you own

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5
Q

what is a liability

A

something you owe

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6
Q

what are ultimate lenders

A

Agents whose excess of income over expenditure creates a
financial surplus which they are willing to lend

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7
Q

what are ultimate borrowers

A

Agents whose excess of expenditure over income creates
a financial deficit which they wish to meet by borrowing

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8
Q

what are the functions of money

A
  1. Means of payment
  2. unit of account
  3. store of value
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9
Q

what is liquidity

A

the ease at which an asset can be turned into a means of payment

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10
Q

what are the types of money

A

M1 - Narrow money (sum of currency in circulation)
M2 - Intermediate money (M1 + short-term time deposits + deposits redeemable of up to 3 months)
M3 - Broad money (M2 + long-term time deposits)

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11
Q

how to work out CPI

A

CPI = cost of current basket/cost of base year basket x100

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12
Q

what are financial instruments

A

The written legal obligation of one party to transfer something of value,
usually money, to another party at some future date, under certain
conditions

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13
Q

3 principal economic functions of financial assets

A
  1. Acts as a means of payment
  2. Act as a store of value (stocks)
  3. Allow for the transfer of risk (insurance)
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14
Q

3 economic functions of financial markets

A
  1. Market liquidity - ensures owners of financial instruments can buy and sell easily
  2. Information - communicate info about the seller
  3. Risk sharing - allows individuals to buy and sell risk
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15
Q

classification of financial markets

A
  1. By nature of claims
  2. By maturity of claims
  3. By seasoning of claims
  4. By delivery time
  5. By organisational structure
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16
Q

what are the 5 roles of financial intermediaries

A
  1. Pooling the resources of small savers
  2. Providing safekeeping and accounting services
  3. Supplying liquidity
  4. Providing ways to diversify risk
  5. Collecting and processing information
17
Q

Pooling the resources of small savers

A

By accepting many small deposits, banks empower themselves to make large loans

18
Q

Providing safekeeping and accounting services

A

Provides a reliable and inexpensive payment system. Helps us to manage our finances, bookkeeping and take advantage of economies of scale

19
Q

Supplying liquidity

A

Eg: ATMs. They offer both individuals and businesses lines of credit, which
provides customers with access to liquidity

20
Q

Diversifying risk

A

Banks take deposits from thousands of individuals and make thousands of
loans with them. Thus, each depositor has a very small stake in each one of the loans. Diversifying investments

21
Q

Collecting and processing info

A

The fact that the borrower knows whether he or she is trustworthy, while the lender faces substantial costs to obtain that information, results in an information asymmetry.
Borrowers have information that lenders do not have.
By collecting and processing standardized information, financial
intermediaries reduce the problems that information asymmetries create

22
Q

what is adverse selection

A

Occurs before the transaction. Unable to distinguish between good and bad companies/bonds.

23
Q

what is moral hazard

A

Occurs after the transaction. Arises when we cannot observe people’s actions. Equity finance. Debt finance

24
Q

solutions to adverse selection

A
  1. government-required information disclosure
  2. private collection of info
25
Q

solutions to moral hazard

A
  1. requiring managers to report to owners
  2. requiring managers to invest significant amount themselves
26
Q

What is Future Value

A

FV is the value on some future date of an investment made today.
FV = PV x (1 + i)
Use compound interest for > 1 year

27
Q

what is Present Value

A

PV is the value today of a payment planned for the future.
PV = FV / (1+i)^n

28
Q

what is a bond

A

a promise to make a series of payments on specific future dates

29
Q

the price of a bond depends on what characteristics

A
  1. Zero-coupon or discount bonds
  2. Fixed-payment loans
  3. Coupon bonds
  4. Consol or perpetuity
30
Q

zero-coupon bonds

A

Pay a certain amount on a fixed future date.
= Face Value / (1+i)^n, where n=years

31
Q

fixed-payment loans

A

Sequence of fixed payments like a mortgage. Sum of present values.
= Fixed payment / (1+i) + … Fixed payment / (1+i)^n

32
Q

coupon bonds

A

Periodic interest payments + principal repayment at maturity.
= Coupon payment / (1+i) + …. Coupon payment / (1+i)^n + …. Face Value / (1+i)^n

33
Q

perpetuity or consol bonds

A

The owner promises to make series of periodic investment payments forever.
= Yearly Coupon Payment / i

34
Q

explain the 3 types of bond yields

A
  1. Nominal yield = the stated rate of the bond
  2. Yield to maturity = the yield bondholders receive if they hold the bond to its maturity when the final principal payment is made.
  3. Current yield = interest rate of the bond given its current price = Yearly Coupon Rate / Price Paid
35
Q

explain price-yield relationship

A

the price of the bond changes in the opposite direction to the change in the required yield.
As bond price increases, the yield to maturity decreases.

36
Q

what is a par bond

A

Bond Price = Face value (par value): Coupon rate = Current yield =
Yield to maturity

37
Q

what is a discount bond

A

Bond price < Face value (par value): Coupon rate < Current yield<
Yield to maturity

38
Q

what is a premium bond

A

Bond price > Face value (par value): Coupon rate > Current yield >
Yield to maturity

39
Q

what is the fisher equation

A

nominal interest rate = real interest rate + expected inflation

FM (25 decks)

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