Intro Flashcards
What does the financial system do
It enables investors to buy and to sell financial securities
Why is there a need for a financial system
Because some have a cash surplus and others have opportunities so both win on transferring the liquidity where it is needed the most
What are tue firms role in the financial system
They issue securities to gain liquidity for acquiring capital
What are the individuals role in the financial system
They supply capital through investment in securities
What position has the government in the financial system
They to can act as a firm and issue treasury bills to finance their activities
What are se securities
Claims on the borrowers future earnings or assets
What are direct finance
When borrowers aka firms borrow direct from lenders aka bond buyers on the financial markets
Why are financial markets important
They allow capital to be allocated where most productive and so making the economy as a whole better off
What are debt markets
A place where people can obtain funds by issuing a debt instrument like a bond or a mortgage
What are debt instruments
A contract to pay a fixed amount until the maturity date where the final payment is made
When is a debt instrument short intermediate or long term
Short if maturity is less than one. Long if maturity is more than ten. Intermediate in between
What is a stock
A claim to a share in a firms assets and net income
How does one earn money on stocks
Through capital gains and dividends
What are dividends
Periodic payments of equities
Why is the status of residual claimant negative for equity holders
Because they are payed last and may get the scraps
What does it mean that debt is senior to equity
That lenders raid first in the case of a bancrupcy
Is the stock market a primary or secondary security market
Secondary as you never buy directly from the issuer
What do investment banks do
They assist in a companies initial public offering the IPO
What does it mean that investment banks underwrite equity issues
They buy issued securities at a guaranteed price and sell them to the public
What does it mean that an IB forms a syndicate
That it asks other banks to share the risk of the IPO by assisting in underwriting
Why does secondary markets excist
Because they provide liquidity’s to the buyers in the primary market which makes the stocks easier to sell even there
What are stock exchanges
A centralized market where a clearing house makes sure that the buyers have cash and the sellers get their money. It validates the transaction and makes sure that people follow their contractual obligations
What are OTC markets
Over the counter markets have no central authority in contrast to exchanges and thus contain risk
Who are financial intermediaries
Banks, brokers, hedge funds and market makers
How can financial intermediaries reduce transaction costs
By leveraging economics of scale
“at least in the past”
Explain asset transformation conducted by financial intermediaries
They issue an asset with a fixed low risk and use the proceeds from the issue to buy a riskier asset in bulk. Thus providing risk sharing
Can financial intermediaries reduce information costs
Yes they are usually more in the know when it comes to information asymmetry
What is adverse selection
When an inability to discriminate when it comes to price forces prices to rise.
What comes first adverse selection or moral hazzard
Adverse selection takes place before a transaction while moral hazard takes place after
What is moral hazard in financial markets
The borrowers who incentive to engage in other uncondoned activities once they have the money
Bow do FIs reduce information asymmetry problems
By screening borrowers to prevent adverse selection and monitoring their activities against moral hazard
What are depository institutions
Commercial banks, savings and loan associations as well as mutual savings banks that specialize in mortgages plus credit unions that specialize in consumer loans
What are contractual savings institutions
Life insurance companies, fire and casualty insurance companies and pension/ government retiremental funds where people are bound to save by contract and that hold assets in stocks and bonds
What are some financial intermediaries
Finance companies, mutual funds and money market mutual funds.
What is the purpose of financial regulation
To prevent panic and crashes by regulating reports and propping up those at the risk of a bank run or something similar as well as limiting certain assets and forcing some to buy ensurance
