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BSc Actuarial Science 1a > MN-1502 Finance > Flashcards

MN-1502 Finance Flashcards

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1
Q

What are the 4 forces behind the expansion of the financial system?

A
  • Globalisation
  • Technology
  • Deregulation
  • Financial Innovation
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2
Q

Give 3 positives on financial markets of globalisation

A
  • Borrowers are no longer limited to their national markets
  • Agents have more opportunities to invest
  • Financial institutions can have global presence
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3
Q

Give 4 negatives on financial markets of globalisation

A
  • Problems with detecting wrongdoing
  • Increased spillover between markets
  • Stock and bond markets have increasing synchronisation
  • Lack of local market knowledge
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4
Q

Why is stock and bond markets have increasing synchronisation an issue?

A

Investors can’t diversify their portfolio

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5
Q

Give 3 advantages on financial markets of improved technology

A
  • Increased speed of trades
  • Reduced costs of financial firms
  • Created a broader range of trades
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6
Q

Give 4 disadvantages on financial markets of improved technology

A
  • Security and reliability weakened
  • Large capital investment
  • Backward compatibility
  • Altered balance between fixed and variable costs
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7
Q

Give 4 UK policies introduced in the 1980s to encourage more agents into the financial system

A
  • Tax breaks for savers
  • Shifted tax on income to expenditure
  • Privatisation
  • Kept financial products untaxed and increased indirect taxes
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8
Q

Give an advantage of financial innovation

A

More customers in the market because of increased investment opportunities

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9
Q

Give a negative of financial innovation

A

Often created in order to take advantage of tax loopholes

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10
Q

Give the 5 types of Financial Innovation

A
  • Market-Broadening Innovation
  • Risk Management Innovation
  • Arbitraging Innovation
  • Pricing Innovation
  • Marketing Innovation
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11
Q

Explain risk management innovation as a type of financial innovation

A

People aim to shift the risk on them to others

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12
Q

Explain arbitraging innovation

A

People taking advantage of tax loopholes

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13
Q

Explain what is meant by marketing innovation

A

New methods and techniques to buy/sell new products

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14
Q

Define ‘Financial System’

A

A channel of funds from entities with surplus funds to those with a shortage

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15
Q

Give the 3 main roles of the Financial System

A
  • Transfer of funds from surplus units to deficit units
  • Provide a mechanism for the transfer of financial risk
  • Introduce a concept of money into the economy
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16
Q

Define Money

A

Anything that is generally accepted as payment for goods and services or for the repayment of debt

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17
Q

Give the 3 roles of Money (same as from economics)

A
  • Medium of Exchange
  • Store of Value
  • Unit of Account
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18
Q

Explain what is meant by money being a ‘Store of Value’

A

It is a way of transferring purchasing power from present to the future

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19
Q

Explain what is meant by money being a ‘Unit of Account’

A

It provides the terms in which prices are quoted and debt recorded

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20
Q

What are the 4 ordered elements of the finance cycle?

A

Savers -> (financial markets) -> Borrowers

Borrowers -> (financial intermediaries) -> Savers

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21
Q

Define ‘Financial Intermediary’

A

Economics agents who specialise in buying/selling financial contracts

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22
Q

Define ‘Financial Markets’

A

Markets where funds are moved from those with an excess to those with a deficit

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23
Q

Give the 2 basic principles of any financial transactions

A
  • Time has value

- Information is the basis for decision making

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24
Q

Why are financial transactions often weighted one way?

A

Because of asymmetry of information

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25
Q

Which of the following is not a benefit of globalisation on
financial services?
a) Borrowers can raise funds on both domestic and foreign
financial markets.
b) Loss of local knowledge.
c) Financial institutions seek to have global presence both as a
means of expansion and to retain their existing customers.

A

b

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26
Q

Investing in tax-exempt securities is an example of:

a) market-broadening innovation
b) risk-management innovation
c) arbitraging innovation
d) pricing innovation
e) marketing innovation

A

c

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27
Q

A deficit unit is one for whom ______ exceeds _______ .

a) saving; income
b) expenditure; saving
c) expenditure; income
d) income; expenditure

A

c

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28
Q

A surplus unit is one for whom income exceeds expenditure.

a) True
b) False

A

a

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29
Q

Which of the following are functions of a financial system?

  1. The operation of a payments system.
  2. Providing the mechanism for transfer of financial risk.
  3. Helping to reduce unemployment.
  4. Channeling funds between lenders and borrowers.
  5. Helping speculators to bet on price movements.
A

1, 2, 4

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30
Q

Define ‘Direct Finance’

A

The transfer of funds from surplus markets to deficit markets through financial markets

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31
Q

Define ‘Indirect Finance’

A

The transfer of funds from surplus markets to deficit markets through a financial intermediary

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32
Q

What’s the advantage of going through a financial intermediary instead of financial markets?

A

The risk is shifted to the financial intermediary

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33
Q

For surplus agents, which is larger, income or expenditure?

A

income > expenditure

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34
Q

For deficit agents, which is larger, income or expenditure?

A

expenditure > income

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35
Q

Which is more risk averse; surplus agents or deficit agents?

A

Surplus agents

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36
Q

What kind of horizons do surplus and deficit agents tend toward?

A

Surplus Agents -> Short-Term Horizons

Deficit Agents -> Mid/Long-Term Horizons

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37
Q

Define Financial Security

A

Having a legal claim to future cash-flow

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38
Q

Each financial security has an ______ that agrees to make that future cash payment to the ______

A

‘Issuer’

‘Holder’

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39
Q

What is Equity?

A

A share representing a stake in a company where the holder is entitled to periodic dividends that can be sold to other parties at the market price

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40
Q

When a bank is loaning to a person, who is the issuer and who is the holder?

A

Issuer: Person
Holder: Bank

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41
Q

When a firm issues shares to an individual investor, who is the issuer and who is the holder?

A

Issuer: The Firm
Holder: The Individual

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42
Q

What are the 4 types of liability?

A

Type 1: amount known, timing known
Type 2: amount known, timing unknown
Type 3: amount unknown, timing known
Type 4: amount unknown, timing unknown

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43
Q

What type of liability would home insurance be?

A

Type 4: amount unknown, timing unknown

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44
Q

What type of liability would life insurance be?

A

Type 2: amount known, timing unknown

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45
Q

Give the 2 roles of financial markets

A

Pricing Function

Discipline Function

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46
Q

Explain the pricing function of financial markets

A

Provides buyers and sellers with a fair valuation of what they’re buying/selling

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47
Q

Explain the discipline function of financial markets

A

prevention of excessive risk-taking by banks through fear of adverse market reaction

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48
Q

What is a primary market?

A

The exchange of new securities

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49
Q

What 2 things are unique about a primary market?

A
  • Must be ‘underwritten’

- Issuer received share proceeds

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50
Q

What is a secondary market?

A

The exchange of financial securities which have already been exchanged before

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51
Q

Give the 2 reasons why secondary markets are so significant

A
  • Indicates to the original supplier the demand for their shares
  • The liquidity provided by secondary markets decreases the cost of capital of the issuers
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52
Q

What is the role of ‘market makers’?

A

Market makers provide liquidity to the market by quoting bid and ask prices continuously

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53
Q

What are the 2 main types of assets traded in financial markets?

A

Bonds

Equity Shares

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54
Q

Give the 5 different ways that markets can be catagorised

A
  • Maturity of Asset Traded
  • Means of Settlement
  • Obligation to Exchange
  • Organisational Structure of Market
  • Method of Sale/Pricing
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55
Q

Give the 2 types of markets categorised by ‘maturity of asset traded’

A

Money Market or Capital Market

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56
Q

What is the maturity of the asset traded in the money market like?

A

They cater to short-term funding requirements

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57
Q

What is the maturity of the asset traded in the capital market like?

A

Long-term financial securities with maturity longer than a year

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58
Q

Give the 2 types of markets categorised by ‘means of settlement’

A

Cash Market or Forward Market

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59
Q

What is the means of settlement in a Cash Market?

A

Immediate settlement with price agreed today

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60
Q

What is the means of settlement in a Forward Market?

A

An agreement made immediately but the actual transaction takes place some time in the future

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61
Q

Give the 2 types of markets categorised by ‘obligation to exchange’

A

Future Markets or Options Market

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62
Q

What is the obligation to exchange in a Future Market?

A

The buyer is obliged to the future to exchange funds at an already agreed price

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63
Q

What is the obligation to exchange in an Options Market?

A

The buyer has the right to, but not the obligation to, buy the asset on the agreed date

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64
Q

Give the 2 types of markets categorised by ‘organisational structure of the market’

A

Regulated Markets and Over the Counter Markets

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65
Q

What is the organisational structure of a Regulated Market?

A

Trading is organised by a broker

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66
Q

What is the organisational structure of an Over the Counter Market?

A

Buyers and sellers trade between themselves

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67
Q

What is the role of a broker?

A

An expert advisor

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68
Q

Give the 3 types of markets categorised by ‘method of sale/pricing’

A

System of Market Makers, Over the Counter Markets and Pit Trading

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69
Q

What is the method of sale/pricing of a System of Market Markers?

A

Quote buy/sell prices of the product

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70
Q

What is the method of sale/pricing of an Over the Counter Market?

A

Tailor made assets are agreed between buyer and seller

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71
Q

What is the method of sale/pricing of Pit Trading?

A

Occurs inside the exchange

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72
Q

What is an Arbitrageur?

A

People who buy assets where there are pricing anomalies to make low-risk investments

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73
Q

What is a hedger?

A

Those who seek to buy/sell assets in future markets to reduce or eliminate existing risk by agreeing a fixed price on goods they will need in future

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74
Q

What is a speculator?

A

A risky trader who buys/sells assets in order to try and gain a big profit using information

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75
Q

Which 2 costs are incurred through ‘direct lending’ prior to the transaction?

A
  • Search costs

- Verification costs

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76
Q

Which 2 costs are incurred through ‘direct lending’ after the transaction?

A
  • Monitoring costs

- Enforcement costs

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77
Q

What are ‘search costs’?

A

The cost of searching for borrowers, obtaining information about them and negotiating a contract

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78
Q

What are ‘verification costs’?

A

The cost of evaluating borrowing proposals

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79
Q

What are ‘monitoring costs’?

A

The cost of monitoring the actions of borrowers after the loan has been made

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80
Q

What are ‘enforcement costs’?

A

The cost relating to enforcing the terms of the contract if the borrower defaults

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81
Q

What 2 problems arise from asymmetric information?

A
  • Adverse selection

- Moral hazard

82
Q

What is the problem of ‘adverse selection’?

A

Where the worst potential borrowers who are most likely to default are most likely to seek loans

83
Q

What is the problem of ‘moral hazard’?

A

Where the borrower has incentive to engage in immoral activities, making it more likely they won’t repay the loan

84
Q

Due to the 4 types of cost of direct lending and 2 arising from information asymmetry, what alternative do investors regularly turn to?

A

Financial intermediaries

85
Q

Give the 6 roles of financial intermediaries

A
  • Risk transformation
  • Size transformation
  • Maturity transformation
  • Liquidity provision
  • Cost reduction
  • Provision of a payments system
86
Q

Explain the ‘risk transformation’ role of financial intermediaries

A

Financial intermediaries are more willing to take on bigger risks that individual investors aren’t

87
Q

Give 4 ways in which financial intermediaries transform risk

A
  • Screen out bad risks using credit ratings
  • Diversify risk by lending to different types
  • Holding sufficient capital to meet losses
  • Pooling risk
88
Q

What is meant by the term ‘pooling risk’?

A

Giving out huge amounts of small loans so that a few defaulting will still leave them in profit

89
Q

Explain the ‘size transformation’ role of financial intermediaries

A

They bridge the gap between lenders having small sums of money and borrowers desiring large loans

90
Q

Explain the ‘maturity transformation’ role of financial intermediaries

A

They bridge the gap between lenders wanting short-term loans and borrowers wanting long-term loans

91
Q

Explain the ‘liquidity provision’ role of financial intermediaries

A

Lenders want their money liquid whilst borrowers prefer long-term loans. Financial intermediaries help to bridge this

92
Q

Explain the ‘cost reduction’ role of financial intermediaries

A

Intermediaries are able to lower transaction costs due to their vast network of links and also benefit from economies of scale

93
Q

Explain the ‘provision of a payment system’ role of financial intermediaries

A

Intermediaries facilitate payments from a vast number of methods (cash, cheque…)

94
Q

How do intermediaries help reduce (but not solve) the problem of ‘adverse selection’?

A

They produce more information on the borrower’s circumstances

95
Q

Why do Intermediaries not suffer from the free-rider problem?

A

As their transactions are private

96
Q

What do Intermediaries use to reduce the ‘moral hazard’ problem?

A

Restrictive covenants

97
Q

What is a restrictive covenant?

A

A clause in an agreement to fix what the person taking out the loan can use it for

98
Q

Why do banks have an advantage over individual investors in terms of restrictive covenants?

A

Individual investors will struggle to enforce it

99
Q

What does the role of Intermediaries as ‘delegated monitors’ refer to?

A

Their role in enforcing protective covenants

100
Q

What is the free-rider problem?

A

Where a party follows another party who has done their research to reduce information asymmetry at no cost

101
Q

Give the 5 types of Intermediaries

A
  • Deposit Institutions
  • Insurance Companies
  • Mutual Funds
  • Investment Trusts
  • Pension Funds
102
Q

What is a deposit institution?

A

An intermediary that accepts deposits that’s then lend to borrowers

103
Q

What is the main type of deposit institution?

A

Commercial banks

104
Q

For the deposit institution, which of assets and liabilities are loans and deposits?

A 
Assets = loans
Liabilities = deposits
105
Q

Where does the profit come from for a deposit institution?

A

The spread between the interest rate they charge for loans and the interest rate they provide in their deposit accounts

106
Q

Name the 4 types of risks faced by deposit institutions

A
  • Default risk
  • Funding risk
  • Regulatory risk
  • Liquidity risk
107
Q

What’s the ‘default risk’ for a deposit institution?

A

The risk that borrowers bankrupt

108
Q

What’s the ‘funding risk’ for a deposit institution?

A

The risk that adverse moments in the interest rate will reduce profits

109
Q

What’s the ‘regulatory risk’ for a deposit institution?

A

The risk that new regulation will come into place and impact profits

110
Q

What’s the ‘liquidity risk’ for a deposit institution?

A

The risk that the difference between short term deposits and long term loans could bankrupt them

111
Q

What are insurance companies and how do they act as Intermediaries?

A

Non-deposit institutions who carry out the intermediary function by collecting funds from policyholders periodically and invest it

112
Q

What benefit do insurance companies give to consumers?

A

They provide compensation provided the event being insured against occurs

113
Q

How do insurance companies calculate their premiums?

A

Using the person’s history, the likelihood of that event occuring and the magnitude of the payment they’d have to make should the event occur

114
Q

How liquid are insurance company’s reserves?

A

They are invested but liquidly

115
Q

How is the Intermediary function carried out by a Mutual Fund?

A

They pool funds from the public and invest them into equity and bond markets

116
Q

Why are mutual funds able to provide investors with better returns that if they were to invest themselves?

A

They benefit from economies of scale and can diversify

117
Q

Which 2 areas does income from investing in mutual funds come from?

A
  • Share capital appreciation of fund comprised funds

- Share in the flow of income generated by the assets comprised in the fund

118
Q

What do Investment Trusts do?

A

Buy and sell stocks with banks

119
Q

What unique characteristic do Investment Trusts have?

A

They’re ‘closed ended’

120
Q

What is meant by Investment trusts being ‘closed ended’?

A

It’s possible to invest in them only through buying shares from current shareholders

121
Q

How do pension funds act as intermediaries?

A

They accumulate funds over a worker’s life which is invested by the pension fund to keep up with inflation

122
Q

Why are pension funds separate from the company?

A

To ensure that if the company bankrupts, the assets can’t be claimed by creditors

123
Q

Who pays into a pension fund?

A

Both the worker and the employer

124
Q

What is a ‘financial claim’?

A

A legal claim to a future cash flow

125
Q

In a transaction, who is the issuer?

A

The person who has financial liability

126
Q

In a transaction, who is the holder?

A

The person who has the financial asset

127
Q

Give the 7 characteristics of Financial Claims

A
  • Risk
  • Liquidity
  • Maturity
  • Expected Return
  • Real Value Certainty
  • Divisibility
  • Currency Denomination
128
Q

Define liquidity

A

The ease and speed at which a financial instrument can be converted to cash without loss

129
Q

Which 2 terms separate the liquidity of a good?

A
  • Redeemable

- Marketable

130
Q

What is meant by an asset’s ‘maturity’?

A

The time it takes for an asset to expire

131
Q

What 2 things do an asset’s term to maturity depend on?

A
  • Expectations of interest rate changes

- Loss of liquidity in long-term holding

132
Q

What is meant by the ‘real value certainty’ of a financial instrument?

A

Its susceptibility to loss from inflation

133
Q

For which type of financial securities is the ‘real value certainty’ particularly significant?

A

Those with a long maturity

134
Q

What is meant by the ‘divisibility’ of a financial instrument?

A

The degree to which it can be divided into smaller units

135
Q

What is divisibility a determinant of?

A

Liquidity

136
Q

What is meant by financial instruments having ‘currency denomination’?

A

They earn an additional return/loss in non-domestic markets in the form of the exchange rate

137
Q

Why has the significance of ‘currency denomination’ increased in the last 50 years?

A

Globalisation

138
Q

What financial securities are ‘debt’ instruments?

A

Those where a sum of money is lended from one party to another

139
Q

What financial securities are ‘equity’ instruments?

A

Those that provide a share of ownership in a company

140
Q

Give the 4 types of Debt Instruments studied

A
  • Treasury Bills
  • Commercial Papers
  • Bonds
  • Debentures
141
Q

What are Treasury Bills?

A

Short term-, government issued debt instruments for which interest is paid upon full maturity

142
Q

What are Commercial Papers?

A

Short-term, firm issued debt instruments with high risk

143
Q

Why are Commercial Papers risky?

A

If the firm defaults, they aren’t going to be repaid in the liquidation process

144
Q

When a company goes into liquidation, who is paid first: debt holders or shareholders?

A

Debt holders

145
Q

What are Bonds?

A

Long-term, firm or government issued debt instruments

146
Q

What are Bonds known as when they’re government issued?

A

Coupons

147
Q

How do the government sometimes encourage investment into ‘Coupons’ (Government issued Bonds)?

A

Afford investors certain tax breaks

148
Q

What are Debentures?

A

Medium to Long-Term corporate debt assets

149
Q

Name the 2 types of Equity Instruments

A
  • Ordinary shares

- Preference shares

150
Q

What is the alternative name for Ordinary Shares?

A

Common stock

151
Q

Is Common Stock long term or short term?

A

Long term

152
Q

Who has priority in the situation of liquidation: preference shareholders or common stock holders?

A

Preference shareholders

153
Q

Who has priority in the situation of liquidation: preference shareholders or debt holders?

A

Debt holders

154
Q

What incentive is there for Preference Shares over Common Stock?

A

Fixed dividend payments

155
Q

What are Bond Ratings?

A

A measure of investment risk of interest and repayment

156
Q

Who rates Bond Ratings?

A

Commercial Organisations

157
Q

What does a high grade Bond Rating mean?

A

There’s low possibility that they won’t meet the contracted terms

158
Q

On the stock market, does market value equal nominal value?

A

No

159
Q

What are ‘Pre-Emption Rights’?

A

Selling an equity before it goes onto the public market

160
Q

Who bears the residual risk of ordinary shares?

A

The Shareholder

161
Q

The cost of ______ is higher than the cost of preference shares or debt

A

Equity

162
Q

What is equity financing?

A

The sale of equity for finance

163
Q

How is equity finance good for current shareholders?

A

Gives them a way out of their investment through the secondary market

164
Q

Give 5 disadvantages of equity finance

A
  • Listing costs
  • Shareholder Expectation
  • Short termism
  • Public scrutiny
  • Open to takeover bids
165
Q

How often do Common Stock holders receive dividends?

A

At the discretion of management

166
Q

Do Preference Shareholders actually have ownership of the firm?

A

No

167
Q

Where are shares traded?

A

The Stock Exchange

168
Q

What does the market value of shares depend on?

A

Their supply and demand

169
Q

What will happen to the quoted price on the stock exchange if the capital market is efficient?

A

It will reflect market expectations

170
Q

Give the 4 reasons for government intervention in the financial sector

A
  • Externalities
  • Asymmetric information
  • Moral Hazard
  • Principal Agent Problem
171
Q

Explain how Externalities cause a problem whereby the government need to intervene

A

Problems in the financial sector will impact the economy as a whole

172
Q

Explain how Asymmetric Information causes a problem whereby the government need to intervene

A

It created the problem of insider trading

173
Q

Explain how the Moral Hazard can cause a problem whereby the government need to intervene

A

People spending recklessly puts depositors at risk which the government aim to stop

174
Q

Explain how The Principal Agent Problem can cause the government to intervene

A

To prevent foul play, Intermediaries are obliged to disclose information on the firm’s financial performance

175
Q

What is insider trading?

A

The purchase of a security by someone with more information that’s not publically available

176
Q

Give the 5 objectives of government intervention

A
  • Promote financial stability
  • Protect investors against fraud
  • Prevent dissemination of misleading information
  • Promote competition
  • Control activity of financial institutions
177
Q

Give the 3 types of government intervention

A
  • Structural
  • Prudential
  • Investor Protection
178
Q

Explain structural government intervention

A

Limiting the activities of financial institutions, limiting activities, products and geographical boundaries

179
Q

Explain prudential government intervention

A

Limits on internal management

180
Q

Explain investor protection

A

Protecting investors from fund mismanagement, malpractice and fraud

181
Q

Name the 5 types of risks Commercial Banks face

A
  • Systemic risk
  • Financial conjugation
  • Interest rate increases
  • Price risk
  • Fraud and mismanagement
182
Q

What is systemic risk?

A

Risk of bank runs (many people withdrawing at once)

183
Q

What is financial conjugation?

A

The transfer of economic shock from one entity to another (bank, country…)

184
Q

What is the price risk faced by Commercial Banks?

A

Fluctuations in the financial markets (i.e. currency, interest rate…)

185
Q

What is statutory regulation?

A

Where a government agency is in charge of market regulation

186
Q

Define self regulation

A

Where an industry sponsored agency regulates the market

187
Q

Give 3 advantages of self regulation to the market

A
  • More flexible and quickly adaptable
  • Has potential to be more effective
  • Higher production standard
188
Q

Give 2 disadvantages of self regulation to the market

A
  • More sympathetic to the industry over consumers

- Has potential inside interests

189
Q

In what year were the first Basel Accords put into place?

A

1988

190
Q

Give the 2 aims of the First Basel Accords

A
  • Ensure greater consistency of capital adequacy ratios between banks across the world
  • Try to reflect the risk profile of different banks
191
Q

What percentage do the Basel Accounts require Core Capital to be at?

A

8%

192
Q

Give the 3 main criticisms of the First Basel Accounts

A
  • Arbitrary weighting system
  • All commercial loans being treated as equal
  • Banks in all economies being treated equally
193
Q

What did the First Basel Accords lead many Commercial Banks to do?

A

Sell off riskier loans to reduce their capital reserve requirements

194
Q

What is Regulatory Arbitrage?

A

Taking advantage of regulatory treatment across different countries

195
Q

In what year were the Seconds Basel Accords introduced?

A

2004

196
Q

What did the Second Basel Accords do differently to the First?

A

Made things more flexible and divided itself into 3 pillars

197
Q

What did Pillar I of the Second Basel Accords do?

A

Gave banks a choice of using either the standardised approach or an internal ratings based approach

198
Q

What 3 risks do Banks face?

A
  • Market risk
  • Operational risk
  • Credit risk
199
Q

What did Pillar II of the Second Basel Accords do?

A

Ensured that banks using the internal ratings based system report to a supervisory body that they are covering all risk

200
Q

What did Pillar III of the Second Basel Accords do?

A

Required banks to disclose information on their risk levels

BSc Actuarial Science 1a (2 decks)

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