Lecture 1 - introduction Flashcards
what are financial markets and institutions?
Markets and institutions are primary
channels to allocate capital in our society.
what are 5 things proper capital allocation leads to growth in?
1) societal wealth
2) income
3) economic opportunity
4) economic efficiency and opportunity
5) wealth and income
what are financial markets?
Financial markets are one type of structure through
which funds flow
Financial markets can be distinguished along two
dimensions:
1) primary versus secondary markets.
2) money versus capital markets.
what are the 3 elements of financial system?
1) financial markets
2) financial institutions
3) financial instruments
Financial markets and institutions are the
primary channels of allocating what in our society?
capital
what is direct finance?
no intermediary
what are primary markets?
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.
what are secondary markets
Markets where all subsequent transactions take place
with existing financial instruments traded among
investors (e.g., Toronto Stock Exchange, NASDAQ)
Secondary markets add value to society by supporting
primary markets in the following ways
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.
what are money markets?
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
what are capital markets?
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
what are spot markets?
the immediate (i.e., one or two business days)
exchange of asset at current price agreed. “Cash and Carry.
what are forward markets?
the exchange of asset in the future on a
specific date and at a pre-specified price. “Future Delivery.
what is a derivative security
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.
what is institutionalization of financial markets
the shifting of the financial markets from dominance by retail investors to institutional investors
what do financial intermediaries do?
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
what do financial institutions do?
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
what is a brokerages function?
Act as an agent for investors.
Examples: RBC Dominion Securities,
CIBC World Markets
Reduce costs through economies of
scale
Encourage higher rate of savings
what is an asset transformer?
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
what are depository institutions?
commercial banks, savings associations, credit
unions
what are non-depository institutions
Credit type: finance companies
Contractual type: insurance companies, pension
funds
Investment type: securities firms and investment
banks, mutual funds
what are the 5 benefits to suppliers of funds?
Reduce monitoring costs
Increase liquidity and lower price risk
Reduce transaction costs
Provide maturity intermediation
Provide denomination intermediation
how do fin intermediaries and fin institutions benefit the overall economy?
Conduit through which the Bank of Canada
conducts monetary policy
Provide efficient credit allocation
Allow for intergenerational wealth transfers
Provide payment services
what are the 10 risks faced by financial institutions?
Credit.
* Foreign exchange.
* Country or sovereign.
* Interest rate.
* Market.
* Off-balance-sheet.
* Liquidity.
* Technology.
* Operational.
* Insolvency
what is the volcker rule?
Insured institutions may not engage in proprietary trading
FIs are heavily regulated to:
protect society at
large from market failures
what is enterprise risk management?
Recognizes the importance of managing the combined
impact of the full spectrum of risks as an interrelated risk
portfolio.
what do regulators attempt to do?
to maximize social welfare
while minimizing the burden imposed by
regulation
Regulations impose a burden on FIs;
Canadian regulatory changes were deregulatory in nature.
