Module 36.1 & 36.2: Markets, Assets, and Intermediaries & Positions and Leverage Flashcards
What are the three main functions of the financial system?
1) Allow entities to save and borrow money, raise equity capital, manage risks, trade assets
2) determine the returns that equate the total supply of savings
3) allocate capital to its most efficient uses
When is the financial system best at fulfilling its three main functions?
when markets are liquid, transaction costs are low, information is readily available, and when regulation ensures execution of contracts.
What is the equilibrium interest rate?
rate at which the amount of individuals, businesses, and governments desire to borrow is equal to the amount that individuals, business desire to lend
What is considered a short term, long term fixed income security?
short term is between one or two years and long term is lover than five to ten years.
What is included in financial contracts?
futures, forwards, options, swaps, insurance
what is the difference between forward and futures?
forward contract is not traded on exchange or in dealer markets, future contracts are (more standardized). Future contracts are more liquid.
What is moral hazard, adverse selection, and fraud for insurance companies?
moral hazard - occurs because the insured may take more risks once he is protected against the losses
adverse selection - when those likely to experience losses are the predominant buyers of insurance
fraud - insured purposefully causes damage
what do clearinghouses provide?
escrow services
guarantees of contract completion
assurance that margin traders have adequate capital
limits on the aggregate net order quantity
What is a long position vs. a short position?
long = an investor who owns or has the right or obligation to purchase is said to have a long position
short = borrowing an asset and selling it, or an obligation to replace the asset in the future.
What occurs in a short sale?
1) the seller simultaneously borrows and sells securities through a broker
2) must return the securities at the request of the lender or when the short sale is closed oout
3) must keep a portion of the proceeds of the short sale on deposit with the broker.
What is a position of leverage? the call money rate?
investors who borrow to purchase an asset results in a leveraged position. the call money rate is the rate on the borrowed money, which is typically higher than the government bill rate. investors with better collateral have a lower money rate.
what is a margin call? What is the formula to determine the margin call price?
a lender will require the investor to maintian a certain equity % in the account. Typically 25% if this is breached, a margin call will be made to bring the equity percentage into compliance.
Po * [ ( 1 - initial margin) / (1 - maintenance margin) ]
