Understanding Financial Markets: Terms, Securities, and Functions, Quizzes of Financial Market

Download Understanding Financial Markets: Terms, Securities, and Functions and more Quizzes Financial Market in PDF only on Docsity! TERM 1 Income Use Options DEFINITION 1 Consumed Saved Y-C = Saved TERM 2 2 Sector Flow DEFINITION 2 Households --> Firms Labor Market- Income Payments, Factor Services Product Market- Goods and Services, Consumer Expenditure Financial Markets Households--> Savings--> Market <--Investments <-- Firms TERM 3 3 Ways Financial Markets Efficient DEFINITION 3 Allocation- fund best projects first Transactional- cost to bring securities to market Informational- security values reaction to info TERM 4 2 Meanings of Investment DEFINITION 4 Economic- spending by business sector on plant/equipment Financial- securities Capital Formation Process TERM 5 Types of Securities DEFINITION 5 Debt (Bonds)- Liabilities Securities (Stock)- Ownership TERM 6 Commercial v. Investment Banks DEFINITION 6 Commercial Bank- takes deposits and makes loans Investment Bank- deals in securities TERM 7 2 Primary Functions of Money DEFINITION 7 Medium of Exchange- how we transact, payments mechanism Unit ofAccount- measured in dollars, measures wealth Happens NOW TERM 8 2 Secondary Functions of Money DEFINITION 8 Storage of Value- borrowing and lending Standard of Deferred Payment- loan deals written in unit of account Happens with a passage of time TERM 9 Money v. Capital Markets DEFINITION 9 Money Markets- ST, 1 year or less Capital Markets- LT, 1 year or longer TERM 10 Primary v. Secondary Markets DEFINITION 10 Primary Markets- new issues of stock, IPO Secondary Markets- seasoned or previously owned stock TERM 21 June 2009- Present DEFINITION 21 SLOW recovery TERM 22 NBER DEFINITION 22 Sets Business Cycle timeline Cambridge, MA TERM 23 Wealth Effect DEFINITION 23 The wealth effect is an economic term, referring to an increase in spending that accompanies an increase in perceived wealth.Equities- 3% stock portfolio goes up $1,000--> feel good, spend $30 more Real Estate- 4% if stays strong, only mild recession can occur TERM 24 SMI / PMI DEFINITION 24 Supply / Purchasing Manager Index no. between 0-100 50+: good economy 50-: bad economy or recession comes out first day of month July= 50.6 --> came down but still good TERM 25 CLI DEFINITION 25 Composite Leading Indicator put out by conference board take 10 indexes and sum together comes out 3rd week of month July= 115.8--> good TERM 26 FV Lump Sum DEFINITION 26 Amount of SINGLE PAYMENT at LATER DATE want interest rate to compound as frequently as possible--> balance grows faster Ex. How much will $1,000 deposited earning 10% compounded annually grow to in 5 years? PV= 1000 N= 5 I/Y= 10 --> if compounded quarterly then 10/4 CPT--> FV= 1610.50 TERM 27 Annuity DEFINITION 27 Equal, consecutive cash flow (deposit or withdrawal) over a number of periods Ordinary Annuity- cash flow made at END of period most common last payment gets 0 interest because brings to amount Annuity Due- cash flow made at BEGINNING of period provides one more period of compounding earns more interest and make smaller payment but must write first check right away TERM 28 FV Annuity DEFINITION 28 Amount of CASH FLOWS to achieve certain amount at LATER DATE make more payments per year to decrease amount of payment--> compounding int. makes money grow quicker Ex. Want to accumulate $1,000,000 in 20 years by making equal, END of year deposits earning 8%. How much to deposit each year? FV= 1,000,000 N= 20 I/Y= 8 --> if quarterly payments, 8/4--> save money in long run CPT--> PMT= 21,852.21 TERM 29 PV Lump Sum DEFINITION 29 Discounting of cash flows--> the longer we wait for a cash flow, the lower the value As rates go up, value goes down: PRICE RISK Ex. $10,000 today or $30,000 in 7 years if can invest at 9% annually? FV= 30,000 N= 7 I/Y= 9 CPT--> PV= 16,411.03 --> take the $30,000 Breakeven Rate: 17% (FV=30000 PV=10000 N=7) TERM 30 PV Annuity DEFINITION 30 Value TODAY of CASH FLOWS in the future could discount each payment back and then sum up Ex. How much willing to pay (lend) for expected yield of $5,000 at END of each year for next 5 if demand 15% return? PMT= 5,000 N= 5 I/Y= 15 --> if 5% then PV= 21,647 CPT--> PV= 16,760.78 (They're paying you 5000x5=25000 and you're lending 16760.78) TERM 31 Role of Compounding DEFINITION 31 make money grow faster compound as frequently as possible how frequently you get interest higher rates affected even more by compounding make more payments--> decreases payment TERM 32 Par/Face Value DEFINITION 32 What you will get if hold bond until MATURITY TERM 33 Maturity DEFINITION 33 How long you wait to get face amount Date that par or face is paid Date of last coupon TERM 34 Coupon Rate / Payments DEFINITION 34 Interest you receive % of par Face Value x Rate TERM 35 Coupon Bonds DEFINITION 35 Non-Callable (Debt Security) pay periodic interest TERM 46 *Total Return- Violate Reinvestment Assumption DEFINITION 46 Immediate change in interest ratesReinvest coupons at higher rate bc of shift in yield curveHolding period yield = realized yield TERM 47 2 Forms of Interest Rate Risk for Bonds DEFINITION 47 Reinvestment Risk- reinvest bond at different rates Price Risk- price and interest rates move in different directions TERM 48 3 Ideas about Price Risk DEFINITION 48 Market rates and bond prices move in opposite directions, as rates increase prices decrease-by how much depends on Duration For a given change in rates (+/-), LT bonds have bigger price swings than ST bonds For a given change in rates (+/-), Low coupon bonds have bigger price swings--> more price risk Long-Term and Low Coupons have most price risk TERM 49 Security Prices DEFINITION 49 Present Value of the expected cash flows discount at the required rate of return move in opposite direction as yields When current rates fall, "old" securities become more valuable because they promise more cash TERM 50 Price Change DEFINITION 50 Present Value of the extra interest earned or lost with change TERM 51 Bond Values and Market Rates DEFINITION 51 If coupon = market rate --> bond sells at parRate changes are symmetrical but price changes are not downward sloping curved line- convexity Good bc when rates going down, price JUMPING--> when rates going up, price coming down SLOW LT bonds have greater price swing and risk TERM 52 Duration DEFINITION 52 Single no. that measures combined effect of maturity, coupon rate, and yield on a bond's price sensitivity to a change in yield measures speed of cash flow streams measures price risk way to measure "effective" or "average" maturity essentially an elasticity measure bc gives a way in which a bond's price changes for a change in the discount factor TERM 53 What do Durations say about Cash Flow Streams DEFINITION 53 Smaller duration--> faster cash flowLarger duration--> slower cash flowIf cash flow speeds up--> Duration gets smallerIf cash flow slows down--> Duration gets larger TERM 54 Calculating Duration DEFINITION 54 Sum of PV of cash flows multiplied by Time / Price of asset Bloomburg--> CVSIP# identifies unique security If Durations of 2 bonds different--> know deals aren't the same TERM 55 Using Duration DEFINITION 55 As Duration increases--> Price change (RISK) increasesDuration = approx. change in price / change in rate - bc price and rates move in opposite directions approx. bc of errors due to convexity Ex. If own Bond A, Maturity is 10 years, Coupon is 4%, Duration is 8 years--> Rates increase 2%, What's Price Change? 2 (rate change) x 8 (maturity) = 16% decrease TERM 56 Modified Duration DEFINITION 56 Duration divided by current rates--> makes math easierDuration approx.= percent change price / percent change rates1% --> 2% big difference than 8%--> 9% even though both 100 bps change, actual % change different TERM 57 Nominal Rate DEFINITION 57 Observed Rate = Real Rate + Factors Real Rate (economic theory idea)- rate for single period uncomplicated deal in reality, always factors involved TERM 58 Fisher Effect DEFINITION 58 Price Expectations--> Expected Inflation plays role in interest rates Factor in idea that price has gone up and probably will in future too so can purchase same amount in future Nominal Rate = Real Rate + Rate of Price Change Expected Rate of Price Change Expected = Inflation Premium TERM 59 4 Factors added into Nominal Rate DEFINITION 59 Price Expectations- Fisher Effect Default Premiums- Credit Risk Marketability Term Structure- Yield Curves TERM 60 Marketability v. Liquidity DEFINITION 60 Marketability- can sell in secondary marketLiquidity- Preservation of Value can sell asset for what it's supposedly worth Ex. Car NOT liquid, Stock is