Quiz 1 Memorization of Facts Flashcards
Why Should Financial Markets Be Regulated?
- Increase information available to investors
- Ensure soundness of financial intermediaries
> restrictions on entry
> disclosure
> restrictions on assets and activities
> deposit insurance
> limits on competition
> restrictions on IR
Function of Financial Markets
- Match borrowers and savers
- Facilitate risk sharing
- securitization
- risk shifted to those who can bear it (idiosyncratic vs systemic) - Allocate credit efficiently
- Provide liquidity
- Transform Assets
Financing Investment in 2 Ways
- Internal Finance (retained earnings)
- Direct FInance
- primary market-> secondary markets
- bond or stock
Function of Financial Intermediaries
- Link borrowers and savers
- Lower transaction costs
- Facilitate risk sharing through asset transformation
- Help cure asymmetric information issues
Investment Intermediaries
- finance companies
• issue stocks, bonds
• sell commercial paper
• lend to consumers and small biz - Mutual Funds
• sell shares to many individuals and use proceeds to purchase diversified portfolios of stock and bonds
• Shareholders pool resources and lower transaction costs when buying many stocks and bonds
• Shareholders can redeem shares at any time - Money Market Mutual Funds
• M funds with deposit-like accounts
• Interest on assets paid to shareholders
• Shareholders can write checks against value of shareholdings
Rate of Return on Bonds
A. Only a bond whose return is equal to its initial yield to maturity is one whose time to maturity is equal to its holding period
B. Rise in IR is equal to a fall in the price of a bond = capital losses on bonds whose terms to maturity are longer than holding period
C. More distant a bond’s maturity, the greater the size of a % price change associated with an IR change
D. More distant a bond’s maturity, the lower the rate of return occurs
E. Return can be negative if IR rises
Risk Structure of IR
- Default Risk
- Liquidity
- Income Tax Considerations
Term Structure of IR Theories
- Expectations Theory
- Segmented Markets Theory
- Liquidity Preference Theory
5 Characteristics of Money
- Standardized
- Divisible
- Widely accepted
- Durable
- Portable
Business Cycle Facts
- All outputs decrease at the same time
- Agricultural output is acyclical
- Durable goods are more volatile than nondurable goods
- Profits are very volatile, more volatile than GDP
- Nominal IR are procyclical
Measuring Business Cycle
A. Amplification: how high/low are extremes
B. Duration: how long does a cycle last
C. Persistence: a measure of autocorrelation (ex. Experience GDP growth last quarter, you are more likely to experience it again next quarter instead of contraction OR likelihood of upward movement following an upward movement)
Bonds: IR, coupon rates, pricing
- When coupon bond priced at face value, yield to maturity (IR) = coupon rate
- When i < coupon rate, price today greater than face value
- When i > coupon rate, price today less than face value
- Price of coupon bond and yield to maturity are negatively related
- Yield to maturity > coupon rate when price is below its face value
3 Functions of Money
1) medium of exchange
2) store of value
3) unit of account
