Study Questions 1 Flashcards
direct finance
borrowers borrow funds directly from lenders in financial markets by selling the lenders securities (financial instruments), or claims on the burrowers future income or assets
primary market
a financial market in which new issues of a security, such as a bond or stock, are sold to initial buyers by the corporation or government agency borrowing the funds
[investment banks]
secondary market
a financial market in which securities that have been previously issued can be resold
[New York Stock Exchange]
[National Association of Securities Dealers Automated Quotation System]
[Foreign exchange markets, futures markets, options markets]
security
(also called financial instrument) is a claim on the issuer’s future income or assets (any financial claim or piece of property that is subject to ownership)
investment banks
assists in the initial sale of securities in the primary market by underwriting securities (grantees a price for a corporations securities then sells them to the public)
liquid
easily converted to cash
exchange
buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades
[New York Stock Exchange/Chicago Board of Trade for Commodities]
over the counter (OTC) market
dealers at different locations who have an inventory of securities ready stand ready to buy and sell securities over the counter
money market
a financial market in which only short term debt instruments (one year or less of original maturity terms) are traded
capital market
a market in which longer term debt instruments (generally those with original maturity terms of one year or greater) and equity instruments are traded
money market instruments
- US treasury bills [short term debt instruments]
- negotiable bank certificates of deposit (large denominations) [original purchase price]
- commercial paper [short term debt instrument issued by large banks and well known corporations]
- federal funds [overnight loans between banks at their deposits at the federal reserve]
- security repurchase agreements [effectively short term loans, less than two weeks, use Treasury Bills as a collateral]
federal funds rate
the interest rate charged on overnight loans in the federal funds market, a sensitive indicator of the cost to banks of borrowing funds from other banks and the stance of monetary policy
capital market instruments
debt and equity instruments with maturities of greater than one year
- corporate stocks [equity claims on the net income and assets of a corporation]
- residential mortgages [loans to households or firms to purchase land, housing, or other real structures]
- corporate bonds [long term bonds issued by corporations with very strong credit ratings]
- us government securities [long term debt instruments are issued by the US treasury to finance the deficits of the government]
- us government agency securities [long term bonds are issued by various government agencies to finance such items as mortgages, farm loans, or power generating equipment]
- state and local government bonds [municipal bonds, long term debt instruments issued by state and local gov to finance expenditures on schools, roads, and other large programs]
- bank commercial loans/ consumer loans [made by banks but by finance companies for consumers]
- commercial and farm mortgages
indirect finance
involves a financial intermediary that stand between the lenders-savers and borrowers-spenders and helps transfers funds from one to the other
diversification
entails investing in a portfolio of assets whose returns do not always move together , with the result that the overall risk is lower than the individual asset
asymmetric information
the unequal knowledge that each party to a transaction has about the other party
adverse selection
the problem created by asymmetric information before the transaction occurs (a bad borrower takes a loan)
moral hazard
the problem created by asymmetric information after the transaction occurs (risk the borrower might create because of engaging in activities that are undesirable (immoral) from the lenders point of view AKA lying)
financial intermediary
DEPOSITORY INSTITUTIONS (Banks), CONTRACTUAL SAVINGS INSTITUTIONS, INVESTMENT INTERMEDIARIES
institutions (such as banks, insurance companies, mutual funds, pension funds, and finance companies) that borrow funds from people who have saved and then make loans to others
commercial bank
a financial intermediary who’s sources of funds is deposits and its primary uses of funds is business and consumer loans, mortgages, US government securities, and municipal bonds
wealth
the total collection of pieces or property that serve to store value
income
flow of earnings per unit of time (a flow concept)
medium of exchange (money function)
(money in the form of checks or currency) is used to pay for goods and services
unit of account (money function)
money is used to measure value in an economy
store of value (money function)
a repository of purchasing power available over time
liquidity
the relative ease and speed with which an asset can be converted to a medium of exchange
commodity money
money made up of precious metals or another valuable commodity is called commodity money
fiat money
paper currency decreed by governments as legal tender (must be accepted as legal payments for debts) but not convertible into coins or precious metal
M1
a measure of money that includes currency, travelers checks, and checkable deposits
M2
a measure of money that includes M1 plus: money market deposit accounts, money market mutual fund shares, small-denomination time deposits, savings deposits, overnight repurchase agreements, and overnight Euro dollars
PDV
present discounted value (see formula)
coupon bond (credit market instrument)
pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturity date when a specified final amount (face value or par value) is repaid
coupon rate (part of coupon bonds)
the dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond)
discount bond
a bond bought at a price below its face value (discount), and the face value is repaid at the maturity rate
yield to maturity
(internal rate of return) the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
simple loan
lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date
fixed payment loan
lender provides the borrower with an amount of funds the borrower must repay by making the same payment, consisting of part the principal and interest, every period (such as a month) for a set number of years
rate of return (one period)
the payment to the owner of a security plus the change in the security’s value, expressed as a fraction of its purchase price
