Lecture 1

Question 1

What do common stocks represent?

Answer 1

Share of ownership in corporation

Question 2

What is a share of stock?

Answer 2

A claim on residual earnings and assets of the firm

Question 3

What is the FOREX?

Answer 3

Foreign exchange market where funds converted from one currency into another

Question 4

Functions of financial markets

Answer 4

• Channeling funds from economic players with surplus fund to those with shortage
• Direct finance : borrow fund direct from lenders in market by selling them securities
• Promotes economic efficiency
• Directly improve well-being of consumers by allowing them to time purchases better

Question 5

Debt and equity markets

Answer 5

• Debt instruments (maturity)

- Equities (dividends)

Question 6

Primary and secondary markets

Answer 6

• Investment banks underwrite securities in primary markets.

- Brokers and dealers work in secondary markets.

Question 7

Money and capital markets

Answer 7

» Money markets deal in short-term debt instrument.

» Capital markets deal in longer-term debt and equity instruments

Question 8

Money market instruments

Answer 8

• Treasury bills
• Negotiable bank certificates of deposit (large denominations)
• Commercial paper
• Repurchase agreements

Question 9

Capital market instruments

Answer 9

• Corporate stocks (market value)
• Residential mortgages
• Commercial and farm mortgages
• Gilts or government securities
• Corporate bonds
• Bank commercial loans
• Consumer loans

Question 10

What are Financial intermediaries?

Examples?

Answer 10

institutions that borrow funds from people who have saved and in turn make loans to people who need funds.

• Banks: accept deposits and make loans
• Other financial institutions: insurance companies, finance companies, pension funds, mutual funds and investment companies

Question 11

Function of Financial Intermediaries

Answer 11

Lower transaction costs (time and money spent in carrying out financial transactions):
» Economies of scale.
» Liquidity services.

Reduce the exposure of investors to risk:
» Risk sharing (asset transformation).
» Diversification

Deal with asymmetric information problems:
» Adverse selection (before the transaction): try to avoid selecting the risky borrower by gathering information about them.
» Moral hazard (after the transaction): ensure borrower will not engage in activities that will prevent him or her to repay the loan. Sign a contract with restrictive covenants.