Week 1 Flashcards
What is a financial market?
A market where financial assets are traded.
What is corporate finance?
- Corporate finance involves corporate decisions
- how much funding to obtain
- what types of securities to issue when financing operations.
- The financial markets serve as the mechanism
What is investing management?
- Investment management involves decisions by investors
regarding - how to invest their funds.
- Financial institutions serve as intermediaries within the
financial markets
What are Lender-Savers? (Surplus units)
Lender-savers, also known as savers or lenders, are individuals, businesses, or governments that have surplus funds (revenues exceeding expenditures) and are willing to lend or invest that money, often in exchange for interest or returns.
What are Borrower-Spenders (Deficit units)?
Borrower-spenders are individuals, businesses, or governments that need funds to finance their spending and are therefore in need of borrowing money from lender-savers.
Examples of Lender-Savers (Surplus units)?
- Households
- Business firms
- Government
- Foreigners
Examples of Borrower-Spenders? (Deficit units)
- Business firms
- Government
- Households
- Foreigners
What is Direct Finance?
Borrowers borrow directly from lenders in financial markets by
selling financial instruments which are claims on the borrower’s future income or assets
What is Indirect finance?
Borrowers borrow indirectly from lenders via financial
intermediaries (established to source both loanable funds and
loan opportunities) by issuing financial instruments which are
claims on the borrower’s future income or assets
What are three kinds of securities traded in financial markets?
- Money markets securities
- Capital Market Securities
- Derivative Securities
What are money market securities?
- Debt securities that have a maturity of one year or less
- High degree of liquidity
Examples:
- Treasury bills (issued by the U.S. Treasury)
- commercial paper (issued by corporations)
- negotiable certificates of deposit (issued by depository
institutions) (i.e. ISA in the UK)
What are Capital Market Securities?
- Capital markets facilitate the sale of long-term securities by
deficit units to surplus units. - The securities traded in this market are referred to as capital
market securities - Three common types of capital market securities are:
- Bonds (maturity > 1 year)
- Mortgages & Mortgage-Backed Securities
- Stocks
What are bonds?
- Bonds are long-term debt securities issued by the Treasury, government agencies, and corporations to finance their operations
- provide a return to investors in the form of interest income
- Bonds commonly have maturities of between 10 and 20 years
- Treasury bonds are perceived to be free from default risk
because they are issued by the U.S. Treasury. - In contrast, bonds issued by corporations are subject to
default risk
What are foreign bonds?
- Denominated in a domestic currency
- Issued by a foreign company or bank and sold in the country
where the foreign company or bank operate - A way to raise capital for foreign companies/banks
What are eurobonds?
- Denominated in a currency that is different from the local
currency of the country where it is issued and sold - For example, a UK company issued a euordollar bonds in
Germany (or any countries other than the US) - It allows corporations to raise funds by issuing bonds in a
foreign currency; meet its needs for foreign currency - For example, the UK company may lack access to credit in a
new US market, so it may issue eurodollar bonds in Germany - Now larger than U.S. corporate bond market
What is eurocurrency market?
- Foreign currency deposited outside of home country
- Eurodollars are U.S. dollars deposited, say, London.
- Gives U.S. borrowers (i.e. US multinational companies, or
companies who do international trades with companies in the
US) an alternative source for dollars. - used for short to medium term financing by banks,
multinational corporations, and hedge funds. - Atrractive source of funding due to lower regulatory measures (interest rate regulations, reserve requirements, etc.) compared
to the funding sources in the domestic markets
What are Mortgages?
- long-term debt obligations created to finance the purchase of real estate
Types of mortgages: - Residential mortgages
- Subprime mortgages
- Commercial mortgages
What are residential mortgages?
- obtained by individuals and families to purchase homes
What are subprime mortgages?
- offered to some borrowers who do not have sufficient income to qualify for prime mortgages or who are unable to make a down payment (low credit rating)
What are commercial mortgages?
long-term debt obligations created to finance the purchase of commercial property
Mortgage-Backed Securities?
-debt obligations representing claims on a package of mortgages
- investors who purchase these securities receive monthly
payments that are made by the homeowners on the mortgages
backing the securities
Example of mortgage-backed securities?
- Fannie Mae and Freddie Mac: Government-sponsored enterprises (GSEs) that purchase mortgages from lenders and bundle them into MBS.
- Ginnie Mae: A GSE that guarantees MBS issued by lenders.
What are stocks?
-represent partial ownership in the corporations that issue
them
- they have no maturity
- Some corporations pay dividends
- Other corporations retain and reinvest all of their earnings in
their operations
What are derivative securities?
- Derivative securities are financial contracts whose values are derived from the values of underlying assets
- Options, forwards, futures, swaps, etc.
- Derivative securities enable investors to engage in speculation and risk management.
- Speculation:
derivative securities allow an investor to speculate on
movements in the value of the underlying assets without
having to purchase those assets. - Risk Management
Derivative securities can be used in a manner that will
generate gains if the value of the underlying assets declines
