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COMM 220 > Midterm #2 > Flashcards

Midterm #2 Flashcards

1
Q

opportunity cost of leisure

A
  • the cost of spending time not working

- what you would have earned

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2
Q

substitution effect

A

demand for leisure decreases if wage rates increase

-workers want to work more because they earn more per hour

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3
Q

income effect

A

demand for leisure increases if wage rates increase

-workers want to work less because they earn more per hour

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4
Q

Utility

A

measure of overall happiness

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5
Q

preference for leisure

A

defined by the amount of utility that one gains from leisure and income
-shown on indifference curve

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6
Q

indifference curve

A

curve showing each combination of leisure and income that would yield the same amount of utility
steep indifference curve= high value placed on leisure
flatter indifference curve= low value placed on leisure

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7
Q

budget constraint

A

line showing every possible combination of leisure and income possible with specific amount of hours and wages
-utility is maximizing point where the budget constraint is tangent to the indifference curve

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8
Q

4 principles of indifference curve

A

1) utility curves cannot intersect
2) they are negatively sloped
3) utility are convex
4) everyone’s utility curve is different

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9
Q

worker’s reservation wage is

A

the lowest wage the person would accept to offer his labour services

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10
Q

expected utility

A

utility that the consumer would expect to receive on average

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11
Q

risk averse

A
  • prefers certain income over risky income of equal value
  • more worried about losing investment, do not like investing in riskier products
  • more likely buy insurance products
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12
Q

risk neutral

A
  • indifferent between certain income and risky income of equal value
  • slope is constant
  • marginal utility is constant at all income levels
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13
Q

risk loving

A
  • some who loves risk

- slope is always increasing

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14
Q

risk premium

A

amount of money a risk averse person will pay to avoid taking risk
risk averse- amount they would have to give up to eliminate risk
risk lover- amount they would have to be paid to eliminate risk

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15
Q

reference point

A

point of view from which you make a decision or an opinion

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16
Q

endowment effect

A

when people value a good more because they own it

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17
Q

loss aversion

A

its when we have something but don’t want to lose it

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18
Q

anchoring

A

being influenced into a decision based on a certain piece of info

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19
Q

framing

A

relying on a context in which a choice is presented when making a decision

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20
Q

the law of small numbers

A

overstate the probability that something will happen when faced with relatively little info

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21
Q

what type of risk is avoidable with proper diversification

A

unsystematic risk

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22
Q

How does the diversification of an​ investor’s portfolio avoid​ risk?

A

buying stocks that are negatively correlated, as the number of stock held increases, the overall variance of the portfolio decreases

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23
Q

What is a financial market?

A

channel from those who have a surplus of funds to those that have a shortage
saved money= lenders
shortage= borrowers

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24
Q

Direct vs indirect finance

A

direct finance- borrowers borrow the funds directly from the lenders in financial markets by selling them securities
indirect finance- financial intermediaries borrow the funds from the lenders and lend them to the borrowers

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25
Q

3 ways to diminish risk

A

1) diversification
2) insurance
3) gain more info

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26
Q

debt

A

contractual agreements between the borrower and the lender

ex) bonds, mortgages, and other loans

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27
Q

borrower

A
  • sells fraction of ownership to the lender in exchange for funds
  • doesn’t get money back
    ex) common shares and preferred shares
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28
Q

Primary market vs secondary

A

primary- where securities are issued for the first time, the investor is buying securities directly from the issuer
secondary- securities are previously issued are resold or traded to other investors

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29
Q

exchanges

A

where buyers, sellers, brokers, and agents meet to conduct trades
ex) Toronto stock exchange

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30
Q

over-the-counter markets (OTC)

A

decentralized exchange where parties buy and sell financial instruments to each other
-various locations

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31
Q

Money market

Capital market

A
  • short term debt and other instruments (maturity is less than one year) are traded in this market
  • long term debt and other instruments (maturity is one year or more) are traded in this market
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32
Q

Money market instruments are

A
  • short term debt instruments
  • little fluctuation in price
  • least risky
  • lower expected returns
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33
Q

Treasury bills (t-bills)

A

short term debt issued by government of Canada with maturity of less than a year
-risk free

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34
Q

Certificates of deposit (CD)

A
  • debt instruments sold by banks to depositors
  • pays annual interest
    ex) bearer deposit notes, term deposit receipts and common names certificates of deposits
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35
Q

commercial paper

A
  • unsecured short term debt instrument issued by bank and corporations
  • interest rate depends on the risk
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36
Q

repurchase agreements (repos)

A

short term loan maturity is less than 2 weeks

-t bills held are collateral

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37
Q

overnight funds

A

overnight loans between banks

interest rate= overnight interest rate

38
Q

capital market instruments are

A

1) longer-term instruments
2) wider price fluctuation
3) more risky
4) higher expected return

39
Q

stocks

A

represent fractional ownership in a corporation

40
Q

mortgages

A

-loans to purchase real estate

41
Q

corporate bonds

A
  • long term bonds issued by corporations

- corporation pays semi annual interest payments to the investor

42
Q

government of Canada bonds

A
  • intermediate term bonds (1-10 years) issued by the government of canada
  • used to finance the government’s deficit
43
Q

canada savings bond

A
  • non marketable government bonds

- do not change in value

44
Q

provincial and municipal government bonds

A

used to finance local expenditures like schools, road, and other programs

45
Q

government agency securities

A

-long term bonds issued by various government agencies

46
Q

consumer and bank commercial loans

A

loans made to consumers and business by banks

47
Q

International bond market

A

1) bonds can be traded internationally

2) type of bond depends on issuer and currency

48
Q

foreign bond

A
  • bonds sold in foreign country

- same currency as foreign country

49
Q

eurobond

A
  • bond is not in the same currency as the country it was issued in
    ex) issued in Japan but in US dollars
50
Q

eurocurrency

A

foreign currency deposited in banks outside of the home country

51
Q

transactional costs

A
  • costs related to financial market transactions
  • includes commissions, brokerage fees
  • higher costs when smaller amounts are invested
52
Q

economies of scale

A

financial institutions can decrease transaction costs by bundling the funds of many investors

53
Q

expertise

A

financial institutions can decrease transaction costs by using expertise they have developed

54
Q

asymmetric information

A

when one party does not have enough info about the other to make an accurate decision

55
Q

adverse selection

A
  • happens BEFORE the transaction because of asymmetric info

- one party has more info than the other party, causing the party with less info to try to mitigate risk

56
Q

moral hazard

A
  • happens AFTER the transaction due to asymmetric info

- when one party behaves in a certain way because they are not responsible for the risk

57
Q

lemons problem

A
  • result of asymmetric info

- investor does not have enough info to differentiate good and bad firms

58
Q

Tools to solve adverse selection problems

A

1) private production and sale of info- does not completely solve the problem due to the free rider effect
- people using info to their advantage
2) government regulations- prevent misleading investors
3) financial intermediation
4) collateral and net worth- property promised to the lender if the borrower defaults

59
Q

principal-agent problem

A

principal- owner of the business
agent- managers of the business in charge of representing the owners
-when the interests of the agents are not aligned with the principals
-form of moral hazard

60
Q

Tools to solve the principal-agent problem

A

1) monitoring- auditing
2) government regulation
3) financial intermediation
4) debt contracts reduce moral hazard
5) lending the firm more money

61
Q

tools to solve moral hazard in debt contracts (loans)

A

1) net worth and collateral
2) monitoring
3) restrictive convenants
4) financial intermediation

62
Q

function of financial intermediaries- indirect finance

A

-lower transaction costs ex) economies of scale
-reduce investors risk exposure ex) diversification
-solve asymmetric info problems
adverse selection- gather info about potential borrowers
moral hazard- sign a contract with restrictive covenants

63
Q

financial capital flows ex)

A

currency market transactions

64
Q

Deep integration

A

trade agreements which do not only contain rules on tariffs and conventional non-tariff trade restrictions, but which also regulate the business environment in a more general sense

65
Q

financial intermediares are

A
  • transform assets
  • borrow from one group of people and lend to another
  • include life insurance companies
66
Q

mortgage backed security

A

bone like debt instrusments

67
Q

government regulates financial markets for 2 main reasons

A

1) to increase info available to investors

2) to ensure soundness of financial intermediaries

68
Q

Secondary markets DON’T

A

match lenders (savers) with borrowers in need of funds

69
Q

intermediate-term

A

Canada bond with maturity 5-10 years

70
Q

chartered bank

A

These financial intermediaries raise funds primarily by issuing chequable​ deposits, savings​ deposits, and term deposits.

71
Q

free rider problem

A

someone who benefits from resources, goods, or services without paying for the cost of the benefit

72
Q

what is a bond?

A

issued by corporations and governments to raise capital for various activities

73
Q

Coupon rate > YTM
Coupon rate < YTM
Coupon rate = YTM

A
  • bond is sold at a premium
  • bond is sold at a discount
  • sold at par
74
Q

zero coupon bonds and T-Bills

A

also known as discount bond
doesn’t pay coupons
bought at a price less than FV

75
Q

4 types of credit market instruments

A

1) simple loan- repay principle with interest
2) fixed payment loan- Pay fixed amount every period throughout loan
3) coupon bond- pay a fixed interest payment every year until maturity date and repay face value
- perpetuity/console bond- no maturity date, pay coupon payments forever
4) discount bond- sells at a price below its FV

76
Q

real interest rate

A

adjusted for changes in the price level (inflation)

77
Q

Prices and returns for long term bonds are

A

more volatile (fluctuations in prices) than those for shorter term bonds

78
Q

the concept on time value of money assumes that

A

money loses value with time

79
Q

the current yield is a good approximation to yield to maturity when

A
  • the bond price is very close to par

- the maturity of bond occurs over 10 year period

80
Q

determinants of asset demand (4)

A

1) wealth
2) expected return
3) risk
4) liquidity- the ease with which the asset can be converted to cash relative to others

81
Q

the fisher effect with bonds

A

1) when inflation decreases Bs increases and Bd decreases
2) Inflation decreases the value of future payments
good for bond issuers= payments are less
bad for bond holders= income is less

82
Q

changes to equilibrium caused by higher inflation

A

interest rates rise
bond prices fall
bond quantity can either rise or fall

83
Q

economic expansion

A

supply and demand for bond both shift to the right
interest rates can rise, fall or stay the same
quantity of bonds rise

84
Q

supply and demand for money

A

determines the equilibrium interest rate in terms of the supply and demand for money
all wealth is stored in two places- bonds and money

85
Q

effects of increasing money supply

A

1) decreases interest rates initially- liquidity effect

2) interest rate increases over time because of income,, price level, and expected inflation effect

86
Q

income effect

A

higher money supply= increases wealth in economy
people spend more money=increase in demand for money
increase in demand for money= increase in interest rates

87
Q

price level effect

A

higher money supply= more money purchasing the same assets
asset prices increase=people need more money
increase in demand for money=increase in interest rates

88
Q

expected inflation effect

A

higher money supply= increases inflation

expectation for more inflation in the future= higher interest rates

89
Q 
Takes action when
liquidity effect
income effect
price level effect
expected inflation effect
A

1) immediately
2) slowly
3) slowly
4) fast or slow

90
Q

why does the liquidity effect dominate the other effects

A

rates fall immediately
increase slowly over time
new interest rate is lower than intial

91
Q

what is NOT function of secondary markets

A

matching lenders with borrower in need of funds

COMM 220 (3 decks)

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