Reading #46

Question 1

Three main functions of the fin. system

Answer 1

1. allow entities to save & borrow money 2. determine returns that = supply and demand 3. allocate capital to most efficient use

Question 2

equilibrium int. rate

Answer 2

rate which amt of individ., bus, and govt desire to borrow = desire to lend

Question 3

define debt securities

Answer 3

promises to repay funds

Question 4

define equity securities

Answer 4

represent ownership positions

Question 5

define derivative contracts

Answer 5

values depend on values of other assets

Question 6

financial derivative contracts versus physical der. contracts

Answer 6

financial based on equities, debt, etc, physical based on value of gold, oil, wheat, etc

Question 7

define spot market

Answer 7

markets for immediate delivery

Question 8

primary versus secondary market

Answer 8

primary is for newly issued securities vs subsequent sales is secondary market

Question 9

money market vs. capital market

Answer 9

money market is for less than year, capital is for longer term debt and equity securities

Question 10

traditional investment markets vs alt. markets

Answer 10

trad = debt and equity, alt = hedge funds and etc

Question 11

define common stock

Answer 11

residual claim on firm’s assets

Question 12

definte preferred stock

Answer 12

equity security with scheduled dividends that do not change usually over security’s life

Question 13

define warrants

Answer 13

similar to options (giving right to buy firm’s equity shares) at fixed exercise price prior to expiration

Question 14

types of pooled investment vehicles

Answer 14

mutual funds, depositories, and hedge funds

Question 15

forward vs future contract

Answer 15

forward is agreement to buy sell asset in future as specific price and not traded on exchanges. future is standardized so that they are liquid investments

Question 16

define swap contract

Answer 16

2 parties make equal payments to one asset being traded for another .(currency swap = one loan in 1 currency for loan of another currency)

Question 17

define option contract

Answer 17

gives owner right to buy or sell asset at specific exercise price at some specified time in the future

Question 18

CALL VS PUT Option

Answer 18

call = gives buyer right to buy option, put = right to sell the

Question 19

define insurance contract

Answer 19

pays cash amt if future event occurs

Question 20

define credit default swaps

Answer 20

form of insurance that makes a payment if an issuer defaults on its bonds

Question 21

define a financial intermediary

Answer 21

stands between buyer and seller

Question 22

define a dealer

Answer 22

they facilitate trading by buying for or selling from their own inventory

Question 23

define broker-dealer

Answer 23

they seek best prices but goal is to profit through prices or spreads

Question 24

define securitizer

Answer 24

pool large amounts of securities and then sell interest in the pool to other investors (ex. mortgages)

Question 25

examples of depository institutions

Answer 25

banks, credit unions, savings and loans. they pay int. on customer deposits and provide transaction services such as checking accounts

Question 26

insurance companies - primary or intermediary?

Answer 26

intermediary that collect insurance premiums in return for providing risk reduction to insured

Question 27

define moral hazard

Answer 27

when insured may take more risks once is he is protected against losses

Question 28

define adverse selection

Answer 28

when most likely to experience losses are most likely to buy insurance

Question 29

define arbitrage

Answer 29

buying an asset in one market and reselling in another at a higher price

Question 30

define clearing house

Answer 30

intermediaries btwn buyer and seller for things like escrow services

Question 31

define counterparty risk

Answer 31

risk that other party to transaction will not fulfill obligation

Question 32

LONG v. SHORT Position

Answer 32

long = right/obligation to purchase an asset, short = right/obligation to replace asset in future

Question 33

define payment in lieu of dividends

Answer 33

in a short sale, when short seller must pay all div to lender

Question 34

define short rebate rate

Answer 34

rate that broker would earn from interest on funds

Question 35

define leverage position

Answer 35

use of borrowed funds to purchase and asset

Question 36

define buying on margin

Answer 36

investors who use leverage to buy securities by borrowing from their brokers

Question 37

define call money rate

Answer 37

interest rate paid on leveraged funds - generally higher than govt’ bill rate, but lower for larger investors with better collateral

Question 38

define initial margin requirement

Answer 38

min. amt of equity for new margin purchase

Question 39

who decides the amt for initial margin requirement?

Answer 39

govt, exchange, broker or clearinghouse

Question 40

define leverage ratio

Answer 40

value of asset / value of equity position