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152 Cards in this Set
- Front
- Back
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To understand how to practice finance and have the best chance of achieving our objective of _______ return and _______ risk, we must understand:
- the financial _______(securities) we can create to borrow money - the financial _______ on which these instruments are traded - the financial _______ that both create and trade financial instruments |
maximizing, minimizing, instruments, markets, institutions
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the complex of financial markets and institutions of the economy
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financial sector
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A _______ system encompasses the instruments, institutions, markets, and rules governing the conduct of trade that expedite the routing of funds from buyers to sellers and from savers to lenders.
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financial
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The _______ system is the part of the financial system that encompasses only the institutions, including the central bank, that are involved in the creation and distribution of money.
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monetary
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Markets in which users of funds raise funds through new issues of financial instruments.
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primary markets
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a type of market that involves the trading of existing securities, provides liquidity and pice information to investors
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secondary markets
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2 alternative mechanisms of fundraising
1. _______ financing 2. _______ financing |
direct, indirect
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Money markets meet _______-term needs (<1 year) of corporations and institutions and are also known as _______ markets.
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short, over the counter
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Treasury bills, jumbo CDs, commercial papers are examples of _______ market securities.
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money
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Money markets are _______ denomination and _______ risk.
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high, low
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Borrowers raise cash for long-term investment needs through _______ markets.
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capital
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Capital markets ARE/ARE NOT riskier than money markets
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are
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Examples of Capital securities
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stocks & bonds
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Capital markets have _______ price fluctuations than money markets, but expect _______ returns.
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wider, higher
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_______ Markets are ways to hedge foreign exchange risks.
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Foreign Exchange
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transactions for immediate delivery and payment (go to the bank and buy euros)
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spot transactions
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transactions that transpire in the future, with the terms set today (hedging) - agree on the exchange rate today, but delivery won't occur until in the future.
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forward transactions
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a financial security whose payoff is linked to another previously issued security, such as a security traded in the capital or foreign exchange markets
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derivative security
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Options, futures contracts, swap contracts - are all examples of a _______ security.
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derivative
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In a derivative security market, the value is derived from an _______ security.
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underlying
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The Financial Market is regulated by the _______ (exchanges) and the _______.
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Securities and Exchange Commission (SEC) and the National Association for Security Dealers (NASD)
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The primary purposes of regulations are:
- to prevent _______ - to ensure _______ as promised - to ensure that the public has enough _______ to evaluate the riskiness of an investment. Regulations protect investors. |
fraud, performance, information
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Financial Market Regulation IS NOT an attempt to ensure an investor earns a minimum rate of _______, but to ensure investors have full and accurate _______ available about corporate issuers.
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return, information
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Types of institutions that offer liquid, government-insured claims to savers, such as demand deposits, savings deposits, time deposits, and share accounts
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Depository Institutions
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Examples of Depository Institutions Include:
- _______ Banks - make a variety of consumer and commercial loans (direct claims) to borrowers - _______ Institutions (Savings Associations and Savings Banks) - perform services similar to banks, but tend to concentrate on loans in one segment 3. _______ Unions - receive share account deposits and make consumer loans; membership requires a common bond, such as a church or labor union. |
Commercial, Savings, Credit
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Non-depository Institutions include:
- _______ companies - provide life insurance and long-term savings opportunities for savers - _______ Companies - provide auto, home insurance, purchase direct financial securities with paid-in-advance premiums from insurance purchases - _______ funds - issue claims to savers or provide investment plans that allow savers to transfer wealth through time and to future generations |
life insurance, casualty insurance, pension
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a type of financial intermediary that borrow (issue liabilities) directly from banks and directly from savers (commercial paper) and make/purchase riskier consumer and business loans
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finance companies
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a type of financial intermediary that offers indirect mutual fund shares to savers and purchase direct financial assets
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mutual funds
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a type of financial intermediary that purchases securities from borrowers and repackages the payment streams, creating new securities to sell to savers, assist borrowers in selling direct claims to savers
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securities firms and investment banks
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_______ provide securities trading services over the Internet
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E-brokers
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Unique Economic Functions Performed by Financial Institutions (FIs) -
1. _______ Costs - fund suppliers appoint financial institution as a delegated monitor to act on their behalf 2. _______ liquidity risk - often claims issued by financial institutions have liquidity attributes that are superior to those of primary securities 3. _______ price risk |
monitoring, lower, lower
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Additional Benefits FIs provide to suppliers of funds:
_______ transaction costs due to _______ in information production |
reduced, economies of scale
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Additional Benefits FIs Provide to Suppliers of Funds:
_______ - accomplished when a FI grants a saver an investment with a maturity different from the FI's own claims on borrowers. An additional dimension of financial institutions' ability to reduce risk by diversification is their greater ability, compared to a small saver, to bear the risk of mismatching the maturities of their assets and liabilities. |
Maturity Intermediation
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Additional Benefits FIs provide to suppliers of funds:
_______ - small savers overcome constraints to buying assets. Because many assets are sold in very large denominations, they are either out of reach of individual savers or would result in savers holding very undiversified asset portfolios. By pooling the funds of many small savers (such as by buying shares in a mutual fund with other small investors), small savers overcome constraints to buying assets imposed by large minimum denomination size. |
denomination intermediation
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The concept that cost reduction in trading and other transaction services results from increased efficiency when FIs perform these services
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economies of scale
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Additional Benefits FIs provide to suppliers of funds:
- _______ liquidity - _______ risk |
improved, reduced
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The downside of all of the safety and convenience benefits financial institutions provide is a lower _______.
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rate of return (ROR)
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Economic Functions FIs Provide to the Financial System as a Whole
- transmission of _______ policy - their claims are part of the money supply. Because deposits are a significant component of the money supply, which in turn directly impacts the rate of economic growth and the ration of inflation, depository institutions - particularly commercial banks - play a key role in the transmission from the central bank (the Federal Reserve) to the rest of the economy |
monetary
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Economic Functions FIs Provide to the Financial System as a Whole:
_______ allocation - they are the major source of financing for particular sectors of the economy pre-identified by society as being in special need of financing, e.g. residential real estate farming |
credit
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Economic Functions FIs Provide to the Financial System as a whole: _______ wealth transfers or _______ intermediation - FIs are granted special tax status to assist in transferring wealth through time or to the next generation
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intergenerational, time
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Economic Functions FIs Provide to the Financial System as a Whole
- _______ service - e.g. check clearing, wire transfers |
payment
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a type of risk incurred by a financial institution because they hold some assets that are potentially subject to default or _____ risk (such as loans, stocks, and bonds)
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credit
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2 types of risks incurred by a financial institution when they expand their services to non-U.S. customers or even domestic customers with business outside the U.S.
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foreign exchange risk, country or sovereign risk
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a type of risk incurred by a financial institution because they tend to mismatch the maturities of their balance sheet assets and liabilities to a greater or lesser extent and are thus exposed to _______ risk
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interest rate risk
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a type of risk incurred by a financial institution when they actively trade assets and liabilities rather than hold them for longer-term investments, they are further exposed to ______ risk
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market
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a type of risk incurred by a financial institution because they hold contingent assets and liabilities off the balance sheet
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off-balance-sheet risk
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a type of risk incurred by a financial institution - liability withdrawal or ______ risk, depending on the type of claims they have sold to liability holders
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liquidity
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2 types of risks incurred by all financial institutions because the production of financial services requires the use of real resources and back-office support systems (labor and technology combined to provide services)
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technology and operational risks
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a type of risk incurred by a financial institution because they may not have enough capital reserves to offset a sudden loss incurred as a result of one or more of the risks it faces
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insolvency risk
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Government must regulate depository institutions because of the ______ liability.
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deposit insurance
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Regulation is necessary to prevent ______ and ______ practices.
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fraud, discriminatory
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Regulation is an attempt to enhance the ______ welfare benefits and mitigate the ______ of the provision of FI services.
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social, costs
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Recent U.S. regulatory changes have been ______ in nature.
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deregulatory
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dollar-denominated bonds issued mainly in London and other European centers
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Eurodollar bonds
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Causes for the growth in foreign financial markets:
- increase in the pool of ______ in foreign countries - international investors have turned to U.S. and other markets to expand their investment opportunities and improve their investment portfolio ______ and ______ characteristics - information on foreign investments and markets is now more ______ and thorough - low ______ methods to invest in foreign securities have increased greatly - the ______ is fast becoming the world's most important currency for international transactions -______ around the world has allowed investors to purchase more foreign securities |
savings
risk, return accessible cost euro deregulation |
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There is an ______ relationship between interest rate and PV. If interest rate increases, PV ______ at a ______ rate (%).
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inverse, decreases, decreasing
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series of payments (same amount, regular intervals, we know the # of payments we expect)
If we don't know the number of payments we expect, it's a ______. |
annuity, perpetuity
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If interest rate increases, FV ______ at a ______ rate (%).
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increases, decreasing
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The PV of an annuity due (>/<) the present value of an ordinary annuity
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>
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What theory explains interest and interest rate movements?
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loanable funds theory
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Who is the largest supplier in the U.S.?
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household
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Other participants in the supply of loanable funds (besides households) include: ______, ______ and ______ investors
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business, government, foreign
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Changes in interest rate results in changes in ______ supplied. Would that result in a shift of the supply curve or movement along the supply curve?
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quantity, movement along the supply curve
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Factors that affect supply and cause the supply curve to shift -
______ wealth ______ of financial security ______ spending needs ______ expansion ______ conditions |
total, risk, near-term, monetary, economic
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If total wealth increases, the supply of loanable funds increases at every interest rate and thus the supply curve SHIFTS to the ______.
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right
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If the risk of financial securities increase, the quantity of loanable funds supplied ______ at every interest rate and the supply curve SHIFTS to the ______.
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decreases, left
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If near-term spending needs decreases, the supply curve shifts to the ______ so that the quantity supplied is greater at every interest rate. At this point the quantity supplied is greater than the quantity demanded and there is a state of ______, a ______ of funds, therefore the interest rate ______ to restore equilibrium and the Q' is higher.
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right, disequilibrium, surplus, decreases
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If economic conditions in foreign countries improve relative to domestic countries, the supply of loanable funds ______ and the supply curve therefore shifts to the left (meaning there is a lower quantity supplied at every interest level). At this point, the quantity supplied is ______ than the quantity demanded and there is a state of ______, a ______ of loanable funds and therefore the ______ increases and Q' is lower.
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decreases, less, disequilibrium, shortage, interest rate
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Demand of Loanable Funds - As interest rate increases, the quantity demanded ______. This results in movement along the demand curve.
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decreases
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Factors that affect demand shifts:
- ______ (satisfaction or pleasure) derived from assets purchased with borrowed funds - restrictiveness of ______ conditions on borrowing - ______ conditions |
utility, non-price, economic
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If restrictiveness decreases (fees, collateral, requirements or restrictions on the use of funds [covenants]), the loan is more desirable. Therefore the demand curve shifts to the ______ and the quantity demanded increases at every interest rate. Now the quantity demanded is ______ than the quantity supplied, and there is a state of ______, a ______ of loanable funds. Therefore, ______ increases and the ______ increases.
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right, greater, disequilibrium, shortage, interest rate, quantity
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If economic condition is stagnant, the quantity demanded decreases at every interest rate, so the demand curve shifts to the ______. Now the quantity demanded is ______ than the quantity supplied. There is a state of disequilibrium, a ______ of loanable funds, and therefore the interest rate ______ and the quantity ______.
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left, less, disequilibrium, surplus, decreases, decreases
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the continual increases in the price level of a basket of goods and services
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inflation
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nominal interest rate that would exist on a security if no inflation were expected
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real interest rate
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risk that a security issuer will default on the security by missing an interest or principal payment
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default risk
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risk that security cannot be sold at a predictable price with low transaction costs at a short notice
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liquidity risk
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provisions (e.g., taxability, convertibility, and callability) that impact the security holder beneficially or adversely and as such are reflected in the interest rates on securities that contain such provisions
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special provisions
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length of time a security has until maturity
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term to maturity
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The ______ Effect theorizes that nominal interest rates observed in financial markets (e.g., the one-year T-bill rate) must compensate investors for (1) any reduced purchasing power on funds lent (or principal lent) due to inflationary price changes and (2) an additional premium above the expected rate of inflation for forgoing present consumption.
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Fisher
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NOTE:
Determinants of Interest Rates for Individual Securities: 1. Inflation 2. Real Interest Rate 3. Default or Credit Risk 4. Liquidity Risk 5. Special Provisions or Covenants 6. Term to Maturity |
NOTE
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a static function that relations term to maturity to yield to maturity at a given point in time
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yield curve
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four types of yield curves:
1. ______ sloping (normal) 2. ______ sloping 3. ______ 4. ______ |
upward, downward, humped, flat
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The current relationship between short-term & long-term interest rates is determined by the expectations of market participants regarding future short-term interest rates. This is known as the ______ theory.
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unbiased expectations
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The term structure is said to be unbiased if the expected ______ interest rates are equivalent to the ______ rates computed from observed bond prices.
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future, implied
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Investors have a preference for liquidity and are willing to accept a lower ROR in order to obtain greater liquidity in their investment. Therefore, investors are willing to accept lower rate of return for short-term as opposed to long-term securities because the former tend to be more liquid. This is known as the ______ theory.
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liquidity premium (preference)
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Interest rates for a given maturity are explained mainly by the supply of & demand for funds of that specific maturity. This is known as the ______ theory.
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market segmentation
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the annual (or periodic) cash flow that the bond issue contractually promises to pay the bond holder
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coupon rate
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Coupon rate is interest promised to be paid, usually ______ interest payments. It doesn't consider what you buy the bond at or the value of the bond changes (TVM).
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semiannual
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the interest rate the investor should receive on the security given its risk
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required rate of return
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The Required rate of return is determined by current ______ interest rate.
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market
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The return you expect if you hold the bond until it matures, based on the current market price.
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expected rate of return
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If a market is efficient the expected rate of return is ______ to the required rate of return.
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equal
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actual rate of return, the interest rate actually earned on an investment in a financial security
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realized rate of return
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The pure bond value and interest rate is an ______ relationship. When interest rate increases, PBV ______.
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inverse, decrease
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Bond prices and bond value approach par values as time to maturity declines toward ______.
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zero
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The longer time to maturity, the (MORE/LESS) price sensitive to interest rate changes.
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more
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The higher the coupon rate, the ______ the pure bond value at any given interest rate.
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higher
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The higher the coupon rate, the ______ the price change on the bond for a given change in interest rate.
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smaller
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The higher the coupon rate of a bond, the less ______ rate sensitive
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interest
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______ measures the period of time required to recover the initial investment in a bond.
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Duration
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the sensitivity, or elasticity, of that asset's or liability's value to small interest rate changes; describes the percentage price, or present value, change of a financial security for a given (small change) in interest rates
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duration
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The higher the duration, the ______ the sensitivity to interest rates.
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greater
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The greater the duration, the ______ the % change in value impact.
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greater
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The longer the duration, the ______ the impact of a given change in interest rates on price.
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greater
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As maturity increases, duration ______ but ______ than the maturity of the bond.
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increases, less
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The higher the market rates of interest, the ______ the duration.
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lower
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As the coupon rate rises, duration ______.
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decreases
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Factors affecting Duration:
1. ______ 2. ______ Rates (Yield) 3. ______ Rate |
Maturity, Market, Coupon
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Value of stock = PV of expected future ______
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dividends
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Anything after duration = ______.
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profits
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There is a ______ relation between maturity and duration. As maturity increases, duration also increases but not in proportion to # of years. It increases at a decreasing rate.
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positive
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There is an ______ relationship between market interest rate and duration.
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inverse
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central bank of the United States
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Federal Reserve (the Fed)
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The Fed's original duties were to provide the nation with a ______, more ______, and more ______ monetary and financial system.
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safer, flexible, stable
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The objectives of the federal reserve system are:
- ______ growth in line with the economy's potential to expand - a high level of ______ - ______ prices - moderate long-term ______ rates |
economic, employment, stable, interest
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Major Functions of the Federal Reserve System include:
- conducting ______ policy - supervising and regulating ______ institutions - maintaining the stability of the ______ system - providing payment and other financial services to the U.S. government, the public, financial institutions, and foreign official institutions |
monetary, depository, financial
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Functions of the Federal Reserve Banks include:
- assistance in the conduct of ______ policy (OMC) - supervision and ______ - ______ services - new ______ issue - ______ clearing - ______ transfer services - ______ services |
monetary
regulation government currency check wire research |
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The organization of the federal reserve banks include:
- ______ Federal Reserve Districts - each reserve bank acts as a depository institution for the banks in its district - each has its own ______-member board of directors that oversees its operations - ______ organizations |
12, 9, nonprofit
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The Board of governors is a ______-member board, headquartered in ______.
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7, Washington, D.C.
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The primary responsibilities of the Board of Governors are the ______ and conduct of monetary policy and the ______ and regulation of banks.
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formulation, supervision
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major monetary policy-making body of the Federal Reserve System
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Federal Open Market Committee (FOMC)
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The main responsibilities of the Federal Open Market Committee (FOMC) are to formulate policies to promote:
- ______ employment - economic ______ - ______ stability - a sustainable pattern of ______ trade |
full, growth, price, international
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the main policy tool that the Fed uses to achieve its monetary targets
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Open Market Operations
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The FOMC sets ranges or the growth of the monetary aggregates, directs operations of the Federal Reserve in foreign exchange markets; monitors and guides the reserve requirements and the discount rate.
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NOTE
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Liabilities of the Federal Reserve:
- Currency ______ Banks 37.7% - ______ 47.3% *Required Reserves + Excess Reserves 45.1% *Vault Cash 2.2% |
outside (money in your pocket), reserves
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Currency in circulation plus reserves is referred to as the Fed's ______ base.
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monetary or money
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Assets of the Federal Reserve:
- U.S. ______ Agency Securities 52.9% - ______ Securities 33.2% - Gold and ______ Exchange 1.5% - Treasury ______ 1.8% - Loans to ______ Banks 0.5% |
government, treasury, foreign, currency, domestic
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Monetary policy tools want to influence the level of ______ supply and ______ rates will also be affect.
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money, interest
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the Fed's buying and selling of government securities through the Trading Desk, the most common means by which the Fed controls the money supply
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Open Market Operations
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a statement on the monetary aggregate or interest rate level determined by the FOMC that is forwarded to the trading desk
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policy directive
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Open Market Operations - The FOMC objectives are specified in the form of a ______ range.
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target
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The Fed [does/does not] have to disclose open market operations.
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does not
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When the Fed purchases securities, the money supply ______ and they loan out more money from the reserve.
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increases
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When the Fed sales securities, it ______ the money supply.
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decreases
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The trading desk often uses ______ or repos to offset such temporary shortfalls in bank reserves and liquidity. With a repo, the Fed purchases government securities from a dealer or a bank with an agreement that the seller will repurchase them within a stated period of time (generally 1 to 15 days) as specified in the agreement.
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repurchase agreements
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Repurchase agreements are used to increase the aggregate level of bank funds ______.
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temporarily
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Even though most interest rates are market determined, the Fed can have a strong influence on these rates by controlling the supply of______ funds. When the government purchases securities, the money supply increases, and the interest rate ______.
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loanable, decreases (can lend at a lower rate)
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______ operations are implemented to increase or decrease the level of funds.
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Dynamic (Open Market Operations)
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______ operations offset the impact of other conditions that affect the level of funds.
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Defensive (Open Market Operations)
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rate of interest federal reserve banks charge on loans to depository institutions in their district
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discount rate
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Any type of credit extended by the Fed represents an ______ in funds at DIs. If, on the other hand, DIs borrow from one another, funds are simply ______ among institutions, and the total level of funds is not increased.
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increase, transferred
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To increase the money supply, the Fed can authorize a ______ in the discount rate.
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reduction --> cheaper to borrow
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When the Fed lowers the discount rate, this generally results in a lowering of ______ rates in the economy. (Expansionary)
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interest
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The Fed rarely uses the discount rate as a monetary policy tool because it is difficult for the Fed to predict changes in bank discount window borrowing when the discount rate changes. Another reason is because of the ______ importance - a discount rate change often has great effects on the financial markets
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signaling - sends out a strong signal, which the Fed doesn't want to do
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When the board reduces the reserve requirement ration, it ______ the proportion of a bank's deposits that can be lent out by DIs. As the funds lent out are spent, a portion of them will return to the DIs in the form of new deposits -- ______ effect. The lower the reserve requirement ratio, the ______ the lending capacity of DIs, so any initial change in bank reserves can cause a larger change in money supply. (Expansionary)
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increases, multiplier, greater
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Disadvantages of discount rate adjustment:
- will affect the money supply only if depository institutions ______ - any adjustment in funds resulting from an increase or decrease in loans from the Fed is only ______ |
respond, temporary
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Disadvantages of reserve requirement ratio adjustment:
- can cause erratic shifts in the ______ supply, thus,the probability of missing the target money supply level is ______ when using the reserve requirement ratio |
money, higher
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The Fed most frequently uses open market operations because:
- they are convenient and do not suffer from the limitations that discount rate/reserve requirement ratio adjustments do - open market operations can be used without ______ the Fed's intentions and can easily be reversed without the public's knowing |
signaling
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You can only target one of two variables:
______ supply and ______ targeting |
money, interest rate
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Targeting the ______ supply can lead to periods of relatively high volatility in interest rates - interest rate must be allowed to fluctuate relatively ______.
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money, freely
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When targeting ______, bank reserves and the money supply must be allowed to fluctuate relatively freely.
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interest rates
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______ intervention is similar to that of open market purchases and sales of Treasury securities.
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Foreign exchange
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