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Financial > Week One > Flashcards

Week One Flashcards

1
Q

What is direct finance

A
  • Raising funds directly from financial markets rather than from intermediaries like banks. This can involve issuing stocks or bonds directly to investors. It’s a method for companies or governments to obtain funding without going through traditional lending channels.
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2
Q

What is indirect finance

A

An institution stands between lender and borrower.
- We get a loan from a bank or from a finance company to buy a car

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3
Q

What is an asset

A

Something of value you own

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4
Q

What is a liability

A

Something you owe

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5
Q

Who are the users of the financial system (2)

A
  • ultimate lenders
  • ultimate borrowers
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6
Q

What is an ultimate lender

A

Agents whose excess of income over expenditure creates a
financial surplus which they are willing to lend

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7
Q

What is an ultimate borrower

A

Agents whose excess of expenditure over income creates
a financial deficit which they wish to meet by borrowing

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8
Q

Why do borrowers and lenders have conflicting preferences

A
  • borrowers :
    Low liquidity
    Minimum cost
    Minimum risk
    Minimum transaction costs

lenders:
- high liquidity
- maximum return
- minimum risk
- minimum transaction costs

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9
Q

What are the functions of money (3)

A
  • means of payment : used in exchange for goods and servives
  • It is a unit of account: used to quote prices.
  • It is a store of value: used to transfer purchasing power into the future
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10
Q

What is liquidity

A

a measure of the ease with which an asset can be turned into a means of payment

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11
Q

What are the different types of liquidity (2)

A
  • market liquidity : is the ability to sell assets
  • funding liquidity: is the ability to borrow money
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12
Q

What is the inflation and inflation rate

A

The process of rising prices and inflation rate is the measurement of the process

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13
Q

How does inflation link to the basket of goods

A

If inflation rises you need more money to buy the same basket of goods

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14
Q

What is M1

A

Narrow money - the sum of currency in circulation and overnight deposits.

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15
Q

What is M2

A

Intermediate money - the sum of M1, short-term time deposits (i.e. with an agreed
maturity of up to 2-year) and deposits redeemable at notice of up to 3
months.

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16
Q

What is m3

A

Broad money - is the sum of M2 and long-term time deposits.

17
Q

What is CPI

A

How much more would it cost for people to purchase today
the same basket of goods and services that they actually bought at some fixed time in the past

18
Q

How to calculate cpi

A

X
- survey to see what’s they bought
- Figure out what it would cost to buy the same basket of goods and
services today
- Compute the percentage change in the cost of the basket of goods:
CPI =
Cost of the basket in current year /
Cost of the basket in base year ∗ 100

19
Q

What are financial instruments

A

Assets that can be traded such as stocks, bonds, derivatives, commodities, currencies, and mutual funds. They represent a claim to future cash flows or a right to receive something of valu

20
Q

What are the different types of assets (2)

A

Tangible assets - value based on physical properties
Intangible assets - Claim to future income generated (ultimately) by tangible asset(s)

21
Q

What are two fundamental classes of financial instruments

A

Underlying and derivative instruments

22
Q

What are the three principle economic functions of financial assets

A
  • act as mean of payment - employees take stock options as payment for working
  • act as a store of value - Claim to future income generated (ultimately) by tangible asset(s)
  • allow for the transfer of risk - Futures and insurance contracts allow one person to transfer risk to
    another
23
Q

What financial instruments are a store of value

A

Bank loans
Bonds
Home morgatges
Stocks

24
Q

What financial instruments are used to transfer risk

A

Insurance contracts
Future contracts
Options

25
Q

What are financial markets

A

Places where financial instruments are bought and sold

26
Q

What are the economic functions of financial markets

A

Market liquidity + ensure that owners of financial instruments can buy and sell them cheaply and easily.
Information - Pool and communicate information about the issuer of a financial instrument
Risk sharing - Provide individuals a place to buy and sell risk

27
Q

What are different types of financial intermediaries (2)

A

Deposit takers
- retail bank
- commercial bank
Non deposit taker
- insurance companies
- pension funds
- Securities firms (brokers, investment banks, mutual funds, private equity and venture capital firms)
- Finance companies

28
Q

What are the role of financial intermediaries (5)

A
  • Pooling the resources of small savers.
    -Providing safekeeping and accounting services, as well as access to payments system
  • Supplying liquidity by converting savers’ balances directly into a means of payment whenever needed
  • providing ways to diversify risk
  • Collecting and processing information in ways that reduce information costs
29
Q

How do banks pool savings

A

By accepting many small deposits banks empower themselves to more large loans
- must attract substantial numbers of savers
- must convince potential depositors of the institutions soundness

30
Q

How do banks provide safekeeping payment systems access and accounting

A
  • provide reliable and inexpensive payments systems
  • manage our finances
  • provide us with bookkeeping and accounting service
  • These force financial intermediaries to write legal contracts - but one can be written and used over and over again - reducing the cost of
    each
    Take advantage of economies of scales
31
Q

What does providing liquidity look like for banks (6)

A
  • Liquidity is a measure of the ease and cost with which an asset can be
    turned into a means of payment.
  • Financial intermediaries offer us the ability to transform assets into money at relatively low cost - ATMs, for example.
  • Banks can structure their assets accordingly, keeping enough funds in short-term, liquid financial instruments to satisfy the few people who will
    need them and lending out the rest.
  • By collecting funds from a large number of small investors, the bank can reduce the cost of their combined investment, offering each individual
    investor both liquidity and high rates of return.
  • Intermediaries offer both individuals and businesses lines of credit, which
    provides customers with access to liquidity.
  • A financial intermediary must specialise in liquidity management, designing its balance sheet to sustain sudden withdrawals.
32
Q

What does diversifying risk look like

A

-Financial institutions enable us to diversify our investments and reduce risk
- Banks take deposits from thousands of individuals and make thousands of loans with them. Thus, each depositor has a very small stake in each one of the loans
- All financial intermediaries provide a low-cost way for individuals to diversify
their investments.

33
Q

How do banks collect and process information

A

-The fact that the borrower knows whether he or she is trustworthy, while the
lender faces substantial costs to obtain that information, results in an information asymmetry.
- Borrowers have information that lenders do not have
-By collecting and processing standardized information, financial intermediaries reduce the problems that information asymmetries create

34
Q

What is information asymmetries

A
  • Information plays a central role in the structure of financial markets and financial institutions
  • markets require a sophisticated information to work well
  • if the cost of information is too high the markets cease to function
  • Issuers of financial instruments know more about their business prospects and willingness to work than potential lenders/investors
35
Q

What is asymmetric information (2)

A

One party lacks crucial information about
another party, impacting decision-making
- adverse selection - before transactions
- moral hazard - after transactions

36
Q

What are solutions for adverse selection

A
  • goverment require information disclosure
  • private collection of info
  • Pledging of collateral to insure lenders against the borrower’s default
  • Requiring borrowers to invest substantial resources of their ow
37
Q

What are thr solutions of moral hazard

A

Requires mangers to report to owners
Requiring mangers to invest substantial resources of their own
- covenants that restrict what borrowers can do with borrowed funds

Financial (17 decks)

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