Introduction Flashcards
What is the purpose of financial markets?
- Purpose: Matchmakers
- Remove economic inefficiencies: lack of matchmaking
What is a security and who are the involved parties?
- A claim on the issuer’s future income or assets
- Holder of security
- Supplier of funds
- Issuer of security
- Demander of funds
What types of securities are there?
- Bonds
- Debt finance
- Equities/Stocks
- Equity finance
What is the first asymmetric information encountered?
- (before the transaction) Adverse Selection: try to avoid selecting the risky borower
- Need to screen
- Gather information about potential borrower
What is the second asymmetric information encountered?
- (after the transaction) Moral Hazard: ensure borrower will not engage in activities that will prevent them from repaying
- Need to monitor
- Sign a contract with restrictive covenants
What is a bond?
A debt security that promises to make payments periodically for a specified period of time
What are interest rates and what accounts for the differences between them?
- The cost of borrowing or the price paid for the rental of funds
- Differences in rates
- Different maturities
- Different risk associated
What kinds of stocks are there?
- Common stock
- Represents a share of ownership in a corporation
- A share of stock
- A claim on the residual earnings and assets of the corporation
- All debts must be paid before paid out
- A claim on the residual earnings and assets of the corporation
What describes financial crises?
Major disruptions to financial markets that are characterised by sharp declines in asset price and the failures of many financial and non-financial firms
What is the relationship between money and the business cycle?
Money has a role in generating business cycles
What is indirect finance?
Through intermediaries
What is maturity?
Maturity: number of years until the expiration date
What comprises and what are the differences between primary and secondary markets?
- Investment banks underwrite securities in primary markets
- New issues of securities
- Brokers and dealers work in secondary markets
- Sale of existing securities
- Exchanges and OTC markets
- Exchanges: NYSE
- OTC Markets (e.g. Federal Funds Market)_
What are money and capital markets?
- Money markets deal in short term debt instruments
- Capital markets deal in longer term debt and equity instruments
What are the differences between the international assets?
- Foreign Bonds: Sold in a foreign country and denominated in that country’s currency
- Eurobond: Bond denominated in a currency other than that of the country in which it is sold
- Eurocurrencies: foreign currencies deposited in banks outside the home country
Why/How regulate?
- T0 increase information available to ivnestors
- Reduce adverse selection and moral hazard problems
- Reduce insider trading
- To ensure the soundness of financial intermediaries
- Restrictions on entry (chartering process)
- Disclosure of information
- Restrictions on Assets and Activities (control holding of risky assets)
- Deposit Insurance (avoid bank runs)
What is money and what is it not?
- Anything that is generally accepted in payment for goods or services or in the repayment of debts
- Money (a stock concept) is different from:
- Wealth
- The total collection of pieces of property that serve to store value
- Income
- Flow of earnings per unit of time
- Flow concept
- Wealth
What are the characteristics of money?
- Medium of Exchange
- Unit of account
- Store of value
What is M1?
M1 (most liquid assets) = currency + traveler’s checks + demand deposits + other checkable deposits
What is M2?
M2 = M1 + small denomination time deposits + saving deposits and money market deposit accounts + money market mutual fund shares.
Components grow faster than M1
What is true about the metric of money measurement?
M1 & M2 can move in different direction in short run
What is return?
Revenue (principal) + Profit, NOT JUST PROFIT
What is rate of change?
(New - old)/old
What effect do stock prices have on firms?
Changes in stock prices affect a firm’s ability to raise funds, and thus their investment.
Why is the bond market important?
The bond market supports economic activity by enabling the government and corporations to borrow to undertake their projects
What is the money growth/business cycle relationship?
Prior to almost every recession in the U.S. the money growth rate has declined; however, not every decline is followed by a recession.
Why are most US dollars outside the US?
Concern about high inflation eroding the value of their own currency causes many people in foreign countries to hold U.S. dollars as a hedge against inflation risk
What is the most important fact about return?
It’s a %
