Understanding Financial Markets: Types of Securities, Borrowers, Lenders, and Importance, Quizzes of Economics

Download Understanding Financial Markets: Types of Securities, Borrowers, Lenders, and Importance and more Quizzes Economics in PDF only on Docsity! TERM 1 What is a financial Market? DEFINITION 1 A financial market is a market for funds where people with shortage of funds can borrow from people who have surplus of funds. TERM 2 In a financial market, a lender is a DEFINITION 2 Saver TERM 3 In a financial market, a borrower is a DEFINITION 3 Spender TERM 4 Security or financial instrument: DEFINITION 4 a tradable asset which gives the owner (buyer) a claim on the issuers (borrower) future income or assets. There are two types of securities: TERM 5 Debt security: DEFINITION 5 a type of security requires the issuer to repay the borrowed money, with the terms that specifies the interest rate and maturity date. TERM 6 Equity: DEFINITION 6 is a kind of security that provides ownership claim (of the firm) to the holder. An example of equity is stock. TERM 7 Stocks and Bonds DEFINITION 7 A common stock (commonly known as simply stock) is a security that represents a claim on the earnings and assets of the issuing corporation. A bond is a debt security that promises the buyer a stream of payments (or a single payment) periodically for a specified period of time. TERM 8 Direct Finance DEFINITION 8 the funds are transferred from lenders to borrowers directly by sale of secu- rities in the financial market. TERM 9 Indirect finance: DEFINITION 9 the funds are channeled from lenders to borrowers through financial inter- mediaries such as banks, and credit unions. TERM 10 Why are financial markets important? DEFINITION 10 Promotes economic activity: provides investment opportunity to the savers, and with funds to the people with business ideas. TERM 21 Secondary Market: DEFINITION 21 Previously issued securities are resold. For example, The New York Stock Exchange, and National Association of Securities Dealers Automated Quotation System (NASDAQ), foreign exchange markets. TERM 22 Brokers and dealers DEFINITION 22 work in secondary markets, the former match buyers with sellers of securities and the latter facilitate the sale of securities by buying securities from the sellers and selling them to the buyers at stated prices. TERM 23 Secondary markets are important because they DEFINITION 23 make it easier to buy and sell the existing securities. make financial instruments more liquid. determine the price of security in primary market as well. TERM 24 Two ways to organize secondary markets DEFINITION 24 Exchanges such as the New York Stock Exchange where trade is conducted at one central location. TERM 25 Two ways to organize secondary markets DEFINITION 25 Over-the-counter (OTC) market in which anyone can buy and sell securities at different locations through dealers. TERM 26 Money market instruments: DEFINITION 26 are less risky compared to capital market instruments since they undergo least price fluctuations. TERM 27 List of money market instruments DEFINITION 27 US Treasury BillsNegotiable Bank Certificate of Deposit (CD)Commercial PapersRepurchase Agreements (Repos)Federal (Fed) Funds TERM 28 U.S. Treasury Bills DEFINITION 28 are one-, three-, and six-month maturity debt instruments issued by the Federal government. It specifies the buying amount and the selling amount. Most liquid of all money market instruments. Default-free. Held by banks (primarily), households and corporations. TERM 29 Negotiable Bank Certificates of Deposit (CD): DEFINITION 29 CDs are debt instruments sold by commercial banks to raise funds. Negotiable CDs are those sold in the secondary market. It pays an annual interest rate and pays back original purchase price at maturity. TERM 30 Commercial Papers DEFINITION 30 The short-term debt instruments that are issued by large banks and reputed corporations. TERM 31 Repurchase Agreements (Repos) DEFINITION 31 the borrower places treasury bills (equal to the loan amount) as collateral and promises to purchase them back at a slightly higher price than the price it was sold to the lender. These are short-term loans usually with maturity less than 2 weeks. TERM 32 Federal (Fed) Funds DEFINITION 32 overnight loans made by banks to one-another out of their deposits at the Federal Reserve. TERM 33 Capital Market Instruments DEFINITION 33 are risky because of wider price fluctuations compared to money market instruments. TERM 34 List of Capital Market Instruments DEFINITION 34 StocksMortgages andMortgage-Backed SecuritiesCorporate BondsU.S. Government SecuritiesU.S. Government Agency SecuritiesState and Local Government BondsConsumer and Bank Commercial Loans TERM 35 Stocks DEFINITION 35 The value of the total stock in the United States was greater than any other type of security in at the end of 2010. TERM 46 Eurocurrencies DEFINITION 46 are foreign currencies deposited in banks outside the home country. Eu- rodollars are U.S. dollars deposited in foreign banks outside the United States or foreign branches of U.S. banks. TERM 47 Function of Financial Intermediaries: Indirect Finance DEFINITION 47 Financial Intermediation is the process used by financial intermediaries through which the funds are transferred from saver to borrowers. TERM 48 The financial intermediaries: enjoy economies of scale DEFINITION 48 as the number (scale) of transaction increases the cost per transaction decreases. TERM 49 The financial intermediaries: reduce transaction cost DEFINITION 49 the cost of completing a transaction such as time and money spent. TERM 50 The financial intermediaries: involve in risk Sharing and asset transformation activities DEFINITION 50 The financial intermediaries sell less risky assets and invest in more risky assets. The process is known as risk-sharing and sometimes, asset transformation. TERM 51 The financial intermediaries: help customers diversify their portfolio DEFINITION 51 Diversification refers to the collection of assets whose returns do not move together, such that the overall risk is lower for the portfolio than for individual assets. TERM 52 The financial intermediaries: Reduce asymmetric information DEFINITION 52 Asymmetric information arises when one of the involved parties has better knowledge than the other. TERM 53 The asymmetric information creates two other problems, DEFINITION 53 1. Adverse Selection: where the banks may give out loans to risky borrowers. Thus, adverse selection problem arises before transaction. 2. Moral Hazard: problem takes place after the transaction has already occurred. For example, a person may invest in more risky projects once his loan is approved. TERM 54 The financial intermediaries: enjoy economies of scope, DEFINITION 54 i.e., they can reduce the cost of obtaining information for each service by using information received from one source to various services. For example, once a bank has gathered information about a firms credit risk, it can decide whether or not to make loans to the firm as well whether or not to sell or buy the bonds from this firm. TERM 55 The financial intermediaries: sometimes may face conflicts of interest DEFINITION 55 which is a kind of moral hazard problem and refers to the situation when an institution providing multiple services faces a conflict between its different objectives. A conflict of interest will make the financial markets and the economy less efficient because the information may be distorted either concealed or misled. TERM 56 Types of Financial Intermediaries DEFINITION 56 Depository Institutions Contractual Savings Institutions: Investment Intermediaries: TERM 57 Depository Institutions DEFINITION 57 the institutions that accept deposits and make loans. TERM 58 Examples of Depository Institutions: DEFINITION 58 Commercial Banks Thrift institutions (thrifts): TERM 59 Commercial Banks DEFINITION 59 They issue savings, time and checkable deposits to acquire funds. Make loans to consumers and businesses and invest money in government securities and municipal bonds. TERM 60 Thrift institutions (thrifts) DEFINITION 60 (a) Savings and Loan Associations and Mutual Savings Banks: Makes savings, time and checkable deposits. In past, these were constrained in their activities ans primarily made mortgage loans for residential housing. (b) Credit Unions: These are small cooperative lending institutions organized around a particular group, which acquire funds from deposits called shares, and primarily make consumer loans. TERM 71 How do they increase information available to investors? DEFINITION 71 TheSecurities and Exchange Com- mission (SEC)requires the security issuing corporation to disclose certain information re- garding their sales, assets, and earnings to the public. It also restricts trading by the largest stockholders, also known asinsiders, in the corporation. TERM 72 By increasing the amount of infor- mation available to public, the government regulation aims at DEFINITION 72 Reducing the adverse selection problem and moral hazard problems to encourage people to invest in the financial market. Enhance the efficiency of the financial market. Prevent the manipulation of security prices by insiders and protecting the investors. TERM 73 Reason of Regulating the Financial System DEFINITION 73 Ensuring the Soundness of Financial Intermediaries TERM 74 How do they ensure the Soundness of Financial Intermediaries DEFINITION 74 Public may not be aware of which institutions are sound because of the asymmetric information. This may sometime lead to the public withdrawing their funds from all the financial institutions leading to the collapse of financial system, known as financial panic. TERM 75 There are six types of regulations to prevent financial panics DEFINITION 75 Restrictions on Entry: DisclosureRestriction on Assets and Activities Deposit Insurance Limits on Competition Restriction on Interest Rates TERM 76 Restrictions on Entry DEFINITION 76 A charter is from the state or the federal government is required to establish a financial institution. TERM 77 Disclosure: DEFINITION 77 Strict guidelines on the bookkeeping (subject to periodic inspection) of the financial institutions. TERM 78 Restriction on Assets and Activities DEFINITION 78 Different financial institutions have certain restrictions on what kind of assets they can invest in depending upon assets riskiness. TERM 79 Deposit Insurance DEFINITION 79 People are insured against large financial losses if the financial intermediary that holds their deposits fails. For example, each depositor at a commercial bank or mutual savings bank is insured up to a loss of $250,000 per account by the Federal Deposit Insurance Corporation (FDIC). TERM 80 Limits on Competition DEFINITION 80 Sometimes restrictions are placed on banks opening branches in additional locations or in other states. TERM 81 Restriction on Interest Rates DEFINITION 81 Sometimes an upper limit is imposed on the interest rate that can be offered on deposits in order to prevent risky competition among the banks which might lead to a bank failure.