Lecture 1 - introduction

Question 1

what are financial markets and institutions?

Answer 1

Markets and institutions are primary
channels to allocate capital in our society.

Question 2

what are 5 things proper capital allocation leads to growth in?

Answer 2

1) societal wealth
2) income
3) economic opportunity
4) economic efficiency and opportunity
5) wealth and income

Question 3

what are financial markets?

Answer 3

Financial markets are one type of structure through
which funds flow

Question 4

Financial markets can be distinguished along two
dimensions:

Answer 4

1) primary versus secondary markets.
2) money versus capital markets.

Question 5

what are the 3 elements of financial system?

Answer 5

1) financial markets
2) financial institutions
3) financial instruments

Question 6

Financial markets and institutions are the
primary channels of allocating what in our society?

Answer 6

capital

Question 7

what is direct finance?

Answer 7

no intermediary

Question 8

what are primary markets?

Answer 8

Markets where users of funds (e.g., IBM, corporations)
raise funds by issuing new financial instruments (e.g.,
stocks and bonds).
 Securities can be sold only once in a primary market.

Question 9

what are secondary markets

Answer 9

Markets where all subsequent transactions take place
with existing financial instruments traded among
investors (e.g., Toronto Stock Exchange, NASDAQ)

Question 10

Secondary markets add value to society by supporting
primary markets in the following ways

Answer 10

1) They offer primary market purchasers liquidity for their
holdings.
2) They update the price/value of the primary market
claims.
3) They reduce the cost of trading the primary market
claims.
4) They help investors diversify portfolios to encourage
investment in the primary market.

Question 11

what are money markets?

Answer 11

markets that trade debt securities with maturities of
one year or less (e.g., certificates of deposit and
Treasury bills).
 little or no risk of capital loss, but low return

Question 12

what are capital markets?

Answer 12

Markets that trade debt (bonds) and equity (stock)
instruments with maturities of more than one year.
 substantial risk of capital loss, but higher promised
return

Question 13

what are spot markets?

Answer 13

the immediate (i.e., one or two business days)
exchange of asset at current price agreed. “Cash and Carry.

Question 14

what are forward markets?

Answer 14

the exchange of asset in the future on a
specific date and at a pre-specified price. “Future Delivery.

Question 15

what is a derivative security

Answer 15

A financial security whose payoff is linked to (i.e.,
“derived” from) a previously issued security, such as a
security traded in capital or foreign exchange markets.
 Generally an agreement to exchange a standard
quantity of assets at a set price on a specific date in
the future.
 The main purpose of the derivatives markets is to
transfer risk between market participants.

Question 16

what is institutionalization of financial markets

Answer 16

the shifting of the financial markets from dominance by retail investors to institutional investors

Question 17

what do financial intermediaries do?

Answer 17

Financial intermediaries raise money from investors and provide
financing for individuals, corporations or other organizations.
 E.g., mutual funds, pension funds.
 Financial intermediaries serve as go-betweens for savers and
borrowers.
 engage in process of indirect finance
 pool and invest savings (i.e., borrow $1 and lend $1)
 needed because of transaction costs, different needs and
asymmetric information: higher information and search costs for
bilateral loans

Question 18

what do financial institutions do?

Answer 18

Financial institutions facilitate the flow of funds (pool and
invest savings) and also perform many other services
(e.g., maturity and time intermediation)
 Financial institutions are distinguished by the following:
 whether they accept insured deposits (depository
versus non-depository financial institutions)
 whether they receive contractual payments from
customers
 whether they deal with investment activities

Question 19

what is a brokerages function?

Answer 19

Act as an agent for investors.
 Examples: RBC Dominion Securities,
CIBC World Markets
 Reduce costs through economies of
scale
 Encourage higher rate of savings

Question 20

what is an asset transformer?

Answer 20

Purchase primary securities by selling financial claims
to households.
 These secondary securities often more marketable
and desirable.
 Secondary claims issued by FIs have less price risk.
 FIs are cost-effective in diversifying risks.
 If assets are less than perfectly correlated with each
other, FIs are able to reduce the fluctuation in the
principal value of the portfolio

Question 21

what are depository institutions?

Answer 21

commercial banks, savings associations, credit
unions

Question 22

what are non-depository institutions

Answer 22

Credit type: finance companies
 Contractual type: insurance companies, pension
funds
 Investment type: securities firms and investment
banks, mutual funds

Question 23

what are the 5 benefits to suppliers of funds?

Answer 23

Reduce monitoring costs
 Increase liquidity and lower price risk
 Reduce transaction costs
 Provide maturity intermediation
 Provide denomination intermediation

Question 24

how do fin intermediaries and fin institutions benefit the overall economy?

Answer 24

Conduit through which the Bank of Canada
conducts monetary policy
 Provide efficient credit allocation
 Allow for intergenerational wealth transfers
 Provide payment services

Question 25

what are the 10 risks faced by financial institutions?

Answer 25

Credit.
* Foreign exchange.
* Country or sovereign.
* Interest rate.
* Market.
* Off-balance-sheet.
* Liquidity.
* Technology.
* Operational.
* Insolvency

Question 26

what is the volcker rule?

Answer 26

Insured institutions may not engage in proprietary trading

Question 27

FIs are heavily regulated to:

Answer 27

protect society at
large from market failures

Question 28

what is enterprise risk management?

Answer 28

Recognizes the importance of managing the combined
impact of the full spectrum of risks as an interrelated risk
portfolio.

Question 28

what do regulators attempt to do?

Answer 28

to maximize social welfare
while minimizing the burden imposed by
regulation

Question 29

Regulations impose a burden on FIs;

Answer 29

Canadian regulatory changes were deregulatory in nature.