1
Q
Define the term financial market
A
Where people who have an excess of available funds directly transfer these funds who have a shortage of funds
2
Q
Explain why financial markets promote economic efficiency and growth in an economy
A
They channel funds from people who do not have a productive use for them to those who do
3
Q
Define the term security
A
is a claim on the issuers future income or assets
- suppliers (demanders) of funds buy (sell) securities
4
Q
Define the term bond
A
bond markets determine interest rates, bondholders must pay interest
5
Q
Define the term interest rates
A
long-term treasury, yield are higher = more interest rates
6
Q
Distinguish between a share of stock and a bond
A
Stocks are more risky
7
Q
Describe what is traded in a foreign exchange market
A
Determines exchange rates, where this conversion of one currency to another takes place
8
Q
Define the term financial intermediary
A
- banks and other financial institutions
- indirectly transfer finds from people who have an excess of available funds to people who have a shortage
- connect people to the ones that want to invest and who have funds to invest
9
Q
Provide and identify examples of financial intermediaries
A
- Depository - banks, credit unions, high-yield savings account
- Contractual Savings - insurance agencies, pension funds
- Investment - mutual fund, hedge fund
10
Q
Define the term money
A
Generally accepted means of payment for goods, services, and debts
- doesn’t have to be actual cash
11
Q
Define the term inflation
A
continual increase in the price level
12
Q
Define the term monetary policy
A
- actions the central monetary authority takes to manage the money supply and interest rates to pursue its macroeconomic policy objectives
- expansion, recessions, inflation
13
Q
Provide and identify examples of monetary and fiscal policy
A
Fiscal - tax cuts, government spending
Monetary - lowering interest rates, buying binds, employment
14
Q
Identify the institution responsible for implementing monetary policy in the U.S.
A
The FED
15
Q
Identify what monetary theory seeks to understand
A
- Supply and Demand of money
- Exchange of money and credit
16
Q
Define and distinguish between the term direct and indirect finance
A
- Direct - spenders obtain funds directly from savers in financial markets (do it yourself)
- Indirect - financial intermediary stand between spenders and savers (going through someone) (intermediary is always indirect)
17
Q
Define and Distinguish between the term debt and equity markets
A
- Debt - market where debt instruments, such as bonds, are issued and traded
- Equity - a market where stocks are traded
18
Q
Provide and identify examples of short-term and long-term debt securities
A
- Short-term - high-yield savings account, less than one year, debt
- Long-term - greater than one year, stocks
19
Q
Define the term equity
A
The quality of being fair and just, especially in a way that takes account of and seeks to address existing inequalities
20
Q
Define and distinguish between the terms primary and secondary markets
A
- Primary - IPO (when a company sells its share to the public for the first time), raise capital by issuing new securities
- Secondary - NYSE, NASDAQ, to allow for the trading of previously issued securities, investors trade with other investors
21
Q
State the role, in the initial sale of securities, of an investment bank
A
- Role is to help the issuing company raise capital
- Investment bank acts as an intermediary between the issuing company and investors
- Helps with legal, guidance, and promoted securities
22
Q
Roles of securities brokers and dealers
A
- Brokers - match buyers and seller of securities, facilitating transactions (Tinder, Airbnb)
- Dealers - link buyers and sellers by buying and selling securities at a stated price from their own account
23
Q
Compare and contrast exchange and over-the-counter market
A
- Exchange - where buyers/sellers (or there agents/brokers) meet in one central location - NYSE
- Over-the-counter - where securities trade via an online broker-dealer network instead of an exchange - online
24
Q
Money vs. capital markets
A
- Money - short-term (less than a year) debt instruments that are seen as low risk
- Capital - comprised of debt and equity instruments with maturities greater than one year (risker)
25
Foreign Bonds
traditional instruments in the international bond market
26
Eurobonds
bonds denominated in a currency different from the currency of the country in which they are sold (cross-country feature) (doesn't have to be euros)
27
Eurocurrencies
foreign currencies deposited in banks outside the home country
28
3 explanations for why indirect finance is the primary route for moving funds from lender to borrowers
- Reduce transaction costs - their expertise allows them to take advantage of economies to scale (liquidity services)
- Facilitate risk sharing - create and sell assets with risk characteristics with which risk-averse investors (banks do)
- Achieve economies of scope - producing one good (service) reduces the cost of another related good (service)
29
Adverse selection
occurs when the potential borrowers who are most likely to produce an undesirable outcome
- before the transaction
30
Moral Hazard
borrower engages in activities that are undesirable from the lender's pov - less likely for loan to get paid back (after transaction)
31
3 categories into which financial intermediaries fall
- Depositary institutions - banks, credit unions
- Contractual savings institutions - pension, life insurance
- Investment intermediaries - mutual funds, hedge funds
32
Distinguish between money, income, and wealth
Money and Wealth are stock variables
Income is a flow variable
33
3 fundamental functions of money
- Medium of exchange - the use of money as a medium exchange promoted economic efficiency by minimizing the time spent exchanging goods/services
- Unit of Account - lowers the transaction costs by lowering the quantity of prices
- Store value - many assets can be used to store wealth
34
Explain why an economy's use of money as a medium of exchange promotes economic efficiency
eliminating barter difficulties, reducing transaction costs, and enabling specialization
35
Inflation
sustained increase in the general price level of goods/services in an economy over time
36
Hyperinflation
an extremely rapid and out-of-control rise in prices
37
Deflation
sustained decrease in the general price level of goods/services (opposite of inflation)
38
Disinflation
decline in the rate of inflation - price are still rising, but at a slower place
39
Liquidity
refers to how easily and quickly an asset can be converted into cash without a significant loss in its value
40
Chronicle the evolution of the payments system
method by which transactions are conducted in the economy
41
Commodity and Fiat money
- Commodity - money made up of precious metals or a valuable commodity
- Fiat - money that the gov. decreases is legal tender
42
The FED's 2 most common monetary aggregates
M1 - most liquid money (currency, demand deposits, over checkable deposits)
M2 - M1 + near-monies
43
Define the concept of present value
based on the notion that a dollar paid to you one year from now is less valuable to you than a dollar paid to you today
43
Simple loan
financial arrangement in which the lender provides the borrower with funds equal to the loans principal, and the borrower repays the lender a lump sum payment, which includes both the principal and interest at maturity (interest and principal rate back at the end)
44
Discount bonds
bond purchased at a price below its face value, with the borrower repaying the lender the full-face value at maturity (treasury market, interest rate and principal rate back at the end)
45
Fixed-payment loan
lender provides the borrower with a specified amount of funds, known as principal (cash flow, interest + principal)
46
Coupon bond
the lender provides the borrower with an amount of funds equal to the bonds price (cash flow, issued by companies or gov, all principals paid at the end, coupon rate is fixed)
47
Yield-to-maturity
total return expected on a bond if its held until it matures
48
Time value of money
dollar today is worth more than a dollar in the future
49
Identify 2 conditions under which the current yield is a reasonable approximation of the yield to maturity
- the bonds price is close to its face value
- the bond has a long time to maturity
50
Holding-period rate of return
actual return earned from holding a bond (or any asset) for a specific period
- actual, short-term return based on what really happens
51
Yield to maturity
expected, long-term yield if held to maturity
52
Interest-rate risk
risk changes in market interest rates will cause the value (price) of a financial asset, especially a bond, to raise or fall
- interest rates increase = bond prices fall
53
Discuss how the volatility of prices for long-term bonds differ from the volatility of prices for short-term bonds
bond price volatility refers to how much a bond's market price changes then interest rates fluctuate
54
Real and nominal interest rates
- Nominal - tells you how fast your money grows
- Real - tells you how much extra goods/services your money can actually buy after accounting for inflation
55
4 determinants of asset demand
a Positively related to wealth
i When wealth increases = demand for assets rise
b Positively related to its expected return relative to the expected returns on alternative assets
i Lower expected return = demand decrease
c Negatively related to its risk of return relative to the risk of return on alternative assets
i Risk decreases, demand increases
d Positively related to its liquidity relative to the liquidity of alternative assets
i Less liquidity = lower demand
56
Explain why disequilibria (shortages and surpluses) in the bond market are temporary.
Occurs when the quantity of bonds demanded does not equal the quantity supplied
57
Explain why the demand for and supply of bonds are, respectively, negatively and positively related to bond prices.
- Higher bond prices reduce borrowing costs, encouraging more issuance by corporations and governments
- Quantity Supplied of bonds is negatively related to yield to maturity
- Quantity supplied of bonds is positively related to price
58
Evaluate how changes in wealth, affect the equilibrium price of bonds
- Wealth – when wealth increases, the demand curve for bonds shifts to the right
59
Evaluate how changes in expected returns affect the equilibrium price of bonds.
Expected returns – when the expected returns on long-term bonds increase, the demand curve for bonds shifts to the right (When expected returns on alternative increase, demand curve for bonds shift to the left) (When the expected rate of inflation increases, the expected return on bonds decrease, and the demand curve for bonds shift to the left)
60
Evaluate how changes in risk affect the equilibrium price of bonds.
Risk – risk of bonds increases, the demand curve for bonds shifts to the left (When alternative assets increase, the demand curve for bonds shifts to the right)
61
Evaluate how changes in liquidity affect the equilibrium price of bonds.
Liquidity – when the liquidity of bonds increases, the demand curve for bonds shifts to the right (When the liquidity of alternative assets increases, the demand curve for bonds shift to the left)
62
Fisher Effect
Describes the relationship between nominal interest rates, real interest rates, and expected inflation
63
Assess how the equilibrium price and quantity of bonds will likely behave during a business cycle expansion
During a business cycle expansion, bond quantities traded increase, but bond prices may rise or fall depending on whether the expansion-driven demand increase outweighs the increased supply. Interest rates typically rise, reflecting lower bond prices and higher borrowing needs
64
Default risk
represents the additional yield investors demand for holding bonds with a higher probability of default
65
Income-tax
accounts for differences in tax treatment among bonds
66
State 3 important facts about yield curves that a good theory of the term structure of interest rates
- Interest rates on bonds with different maturities move together over time
- When short-term interest rates are low (high), yield curves likely slope upward (downward)
- Yield curves almost always slope upwards
67
Name three theories of the term structure of interest rates that economists have put forward to explain yield curve behavior.
- Expectations – can explain the first two empirical facts, but not the third
- Segmented Markets – explain the third empirical fact, but not the first two
- Liquidity premium – combines the first two empirical facts but not the third
68
Identify important facts about yield curve behavior that each theory of the term structure of interest rates can explain
- Expectation theory = based on futures rate expectations
- Liquidity premium = explains persistent upward slope
- Market Segmentation = explains independent movements and unusual shapes
69
Broadly distinguish between the rights of bondholders vs. stockholders
- Bondholders - have priority, fixed-claim, creditor position
- Stockholders – own an interest in the corporation proportional to their percentage of outstanding shares, ownership, voting rights, residual claims
70
Residual claim
stockholders are entitling to the remaining earnings or assets after all obligation have been satisfied
71
Dividend
periodic payments made by stockholders (common stocks value is present is the present value of the cash flows it will generate over its lifetime)
72
Explain how a common stock’s value is related to the cash flows the associated corporation will generate over its life.
- Adaptive – based soley on past information, changes gradually as new data becomes available
(Walking to class while you estimate your arrival time based only on your past averages)
- Rational – represent optimal forecasts using all available information (Walking to class you use all available information arrival times becomes more accurate)
73
Gordon growth model
P0 = D1/ (r - g)
74
Adaptive and Rational expectations
- Adaptive – people form expectations about the future based on past experiences and past values of a variable
- Rational – people form expectations using all available information, including knowledge of economic models and current policy (uncertainty)
75
Explain why, according to rational expectations, the rationally expected holding-period return (Re) satisfies Equation 1, where R∗ represents the market equilibrium value of R.
Re = R∗
Matches the equilibrium return because investors’ expectations and market forces align prices and returns
76
Explain why not everyone in a financial market must be well informed in order for Re = R∗.
As long as enough rational, well-informed investors are active, the market price adjusts so that the rationally expected return equals the equilibrium return
77
Random walk
the movement of a variable where future values are unpredictable based on past info
- given todays value, the next movement (up or down) is equally likely
- EMH asserts that all available info is already reflected in current stock prices
Money and Banking
flashcards
Decks in class (4)
# Cards
