Study your flashcards anywhere!

Download the official Cram app for free >

  • Shuffle
    Toggle On
    Toggle Off
  • Alphabetize
    Toggle On
    Toggle Off
  • Front First
    Toggle On
    Toggle Off
  • Both Sides
    Toggle On
    Toggle Off
  • Read
    Toggle On
    Toggle Off

How to study your flashcards.

Right/Left arrow keys: Navigate between flashcards.right arrow keyleft arrow key

Up/Down arrow keys: Flip the card between the front and back.down keyup key

H key: Show hint (3rd side).h key

A key: Read text to speech.a key


Play button


Play button




Click to flip

58 Cards in this Set

  • Front
  • Back
Financial Institutions: entities that move funds from fund suppliers to fund users.

What are seven types of financial institutions?
1) Insurance Companies
2) Mutual Funds
3) Pensions Funds
4) Commercial Banks: depositories with a wide range of loans for assets and deposits as liabilities
5) Finance companies: make loans
6) Investment Banks and Securities Groups: underwrite securities and create markets for trade.
7) Thrifts: similar to Commercial banks but with loans confined to a specific type.
Four economic functions financial institutions provide to the entire financial system:
1) Credit provision: major source of loans
2) Intergenerational money transfers or one time intermediation.
3) Transmission of monetary policy
4) Efficient payment services
Financial institutions tolerate ten risks in providing economic functions benefiting fund suppliers, FIs, and the entire financial system.
1) Country or sovereign risk
2) Off-balance-sheet risk
3) Liquidity risk
4) Interest rate risk
5) Credit Risk
6) Market Risk
7) Operational Risk
8) Technology risk
9) Insolvency risk
10) Foreign exchange risk
1) Before the stock market crash in 1929, banks often provided a full range of financial services
2) In the 1930s, banks moved away from a full-service role.
3) In the 1970s and 1980s, growth in new financial services industries (mutual funds) resulted in continued separation in providing financial services
4) Today, some are moving back toward full financial service, thanks to regulation changes.
Financial Markets: structured financial avenues for the exchange of funds.

Two ways to distinguish between financial Markets:
1) Primary vs Secondary Markets
2) Money vs Capital Markets
Primary Markets: Where fund users raise funds with new issues such as stocks & bonds. They are usually arranged by other companies acting as intermediaries called investment banks.

1) Firm Commitment Underwriting
2) IPO
1) An investment bank buys and entire issue of stocks or bonds for resell in pieces to individual investors
2) Exchanged on the primary market, first time issues from a corporation that allow public investors to buy the stock for the first time.
Secondary Markets: financial instruments purchased on the Primary Market are repurchased and resold (traded) by other investors.

Three familiar secondary markets:
3) NASDAQ, National Association of Securities Dealers Automated Quotation
Advantage of the secondary market to issuers: acquire information demonstrating the amounts investors are willing to pay for issuers' financial instruments.

Four advantages of the secondary market to investors:
1) Diversification
2) Information about the value of investments an investor holds.
3) Liquidity
4) Lower cost for trades
Two important kinds of foreign exchange market trades:
1) Spot Foreign Exchange Transations: immediate exchange of currency at present rates.
2) Forward foreign exchange transactions: exchange of currency at the rate that will exist on a specific date in the future.
Five reasons for the growth in foreign financial Markets:
1) Greater Access for US investors due to deregulation
2) Foreign investors hold US investments
3) Low cost foreign investment opportunities are offered
4) Information about foreign markets is more readily available.
5) Pool of savings increased in foreign countries.
The Federal Reserve Bank: the central bank of the US that was founded by Congress in 1913 to provide a stable, flexible and safe monetary system.

Four Duties:
1) Maintain the stability of the financial system
2) Supervise and regulate depository institutions
3) Conduct monetary policy
4) Provide payment and financial services to the US government, financial institutions, the public, and foreign institutions.
Four services of the Federal Reserve to the US Government:
1) Is the commercial bank of the US Treasury
2) Holds collateral of government agencies
3) Issues and redeems Treasury securities and savings bonds.
4) Makes periodic interest payments on these securities.
Board of Governors of the Federal Reserve System (Federal Reserve Board): located in D.C. and consists of 7 members appointed by the US President and confirmed by the Senate to serve nonrenewable 14-year terms.

Three primary responsibilities of the Board:
1) Formulating and conducting monetary Policy
2) Supervising and regulating banks
3) The chairperson of the Board acts as an adviser on economic policy to the US president and serves as the spokesperson of the Federal Reserve System.
Currency in circulation is the largest liability of the Federal Reserve System.

Reserves: the amount of available cash at a commercial bank plus the depository institution's reserves in accounts at Federal Reserve Banks used to settle accounts of depository institutions when checks and fund transfers are cleared.

Two types of reserves:
Required Reserves: reserves that banks are required to hold by the Federal Reserves

Excess Reserves: additional reserves beyond what is required
Monetary base: the amount of currency in circulation plus reserves.

Assets of the Federal Reserve:
1) Treasury Securities
2) Currency
3) Loans to domestic banks; represent only a small portion
Monetary Tools
1) Reserve Requirements
2) Open Market Operations
3) Discount Rate

These have two main effects on the economy:
Expansionary: Increase the money supply, lower interest rates, increase economic expansion.

Contractionary: Increase interest rates and slow economic growth.
Six important components of the money supply:
1) Monetary Base
2) M1
3) M2
4) M3
5) L
6) Debt
Three monetary policy tools used by the Federal Reserve to control bank reserve levels:
1) Reserve Requirements: minimum amount of reserve assets banks must hold by law.
2) Open Market Operations: when the Federal Reserve purchases or sells securities in the US Treasury securities market.
3) Discount Rate: the rate charged by Federal Reserve Banks on emergency loans to local banks.
1) Adjustment Credit
2) Seasonal Credit
3) Extended Credit
1) Adjustment Credit: discount window loan offered for short-term liquidity problems resulting from temporary deposit outflow.
2) Seasonal Credit: discount window loan that offsets seasonal liquidity problems.
3) Extended Credit: discount window loan offered to banks with serious liquidity issues that cannot be quickly resolved.
US monetary policy has a major impact on foreign exchange rates; the current policy is to allow exchange rates to fluctuate.
Foreign Exchange Intervention: a commitment between countries that concerns institutional intervention in the influence of exchange rates by buying and selling currencies, especially in the case of unstable markets.

Foreign exchange intervention allows central banks to control rapid appreciation or depreciation of a foreign currency, influencing economic factors.
Money Market: financial market for trading debt securities with maturities of less than a year.

Six Characteristics:
1) Immediate cash needs are addressed
2) Default risk is minimal
3) Sold in large denominations
4) Trade on a secondary market
5) Interest rate received is higher than transaction costs paid.
6) Return is greater than holding cash.
Six participants in money markets:
1) Commercial Banks
2) Corporations often raise funds through issuing commercial paper.
3) Money market dealers and brokers
4) US Treasury issues the most actively traded money market instruments: T-Bills
5) Federal Reserve
6) Financial institutions besides banks.
Six types of money market securities:
1) Negotiable CDs
2) Commercial paper
3) Repurchase agreement
4) Acceptances
5) Federal Funds
6) Treasury Bills
Negotiable CDs: time deposit issued by a bank specifying a maturity date and interest rate.

Six Characteristics:
1) Maturity ranges from 14 days to one year
2) one negotiable CD can be traded multiple times.
3) money market mutual funds often purchase these
4) Form of CDs was not negotiable until the 1960s
5) Approx 15 brokers trade these on a secondary market
6) Denominations are from $100K to $10M
Define: Commercial Paper
a short-term, unsecured promissory note issued by a corporation to obtain short-term cash
Banker's Acceptances: time drafts in which payment to a seller of goods is guaranteed by a bank

8 Characteristics:
1) Interest rates are low
2) Maturities range from 30 to 270 days
3) Denominations are based on the original transaction
4) Only the largest banks in the US actively participate in the banker's acceptance market.
5) Collateral is involved
6) Default risk is reduced due to the involvement of two banks vs. one
7) Actively traded in a secondary market
8) Discounted basis is used.
Federal Funds: Short-term funds transferred between financial institutions for a period of up to 24 hours, usually overnight:

5 Steps to this transaction:
1) A bank has surplus reserves kept at a FRB
2) Bank with the surplus contacts correspondent banks to ask if the banks need overnight reserves
3) Original bank sells the surplus to the bank offering the highest ROR for the fed funds.
4) Excess funds are transferred from the original bank's FRB to the correspondent bank's FRB
5) the following day, the funds plus interest are transferred back to the original bank
T-Bills: federal government-issued short-term obligations.

Two reasons the government issues them:
1) Refinance the government's debts.
2) Cover deficits in the federal budget
Four characteristics of T-Bills:
1) Maturities of T-bills are 91 days, 182 days or one year
2) Almost no default risk
3) Issued in $1,000 increments
4) Newly issued t_bills are generally sold in lots of $5 million for competitive bids
Formula for the bond equivalent yield of a T-bill:

i = (face value - purchase price / purchase price) X 365 / number of days until maturity
Formula for calculating the discount yield of a T-Bill:

i = (face value - purchase price / face value) X 360 / number of days until maturity
Two ways money markets are growing internationally:

1) Foreign investors are selling and purchasing more US money market securities
2) Foreign money market securities are growing
Three types of Euro Money Market Securities:
1) Eurodollar CDs
2) Euronotes
3) Eurocommercial Paper
Bonds: Long-term debt obligations

- Bond issue proceeds are used to raise funds in support of the issuer's long-term operations such as projects involving capital expenditures.
- Bond issuers promise to pay investors a specific amount when the bond matures, along with coupon interest
Bond markets are used by government units, corps, and individuals to transfer excess funds to gov. units and corps needing funding for long-term debt.
Three Classes of bond markets:
1) Municipal
2) Corporate
3) Treasury notes and bonds
Suppliers and demanders of long-term funds are bought together in bond markets.

- The major suppliers of long-term funds are businesses, government units, foreign investors and households
- The major demanders of long-term funds are corps and locat, state and federal governments
- Financial business firms such as insurance companies and banks held 20% of T-bonds and 62% of municipal bons and 57% of corporate bonds in 2001
- Households deposit funds in financial business firms and as a result are indirect investors in the bond market.
During the period on 1980 to 1999, general changes in yields for 30-year T-bonds, high-grade corporate bonds and municipal bonds were highly correlated.
1) Changes in default risk, tax status and marketability can cause yield spreads among bonds to vary.
2) Changes in economic conditions can also cause yield spreads to vary over time, especially during slow economic growth periods when investors demand higher default risk premiums.
Free online access is available to the St. Louis Federal Reserve Bank database of US economic and financial data, which provides the following five pieces of information:
1) US interest rates
2) Monetary business indicators
3) Balance of payments
4) Exchange rates
5) Regional economic data
STRIPS (Separate Trading of Registered Interest and Principal Securities): Treasury securities in which periodic interest payments may be separated from each other and from the final principal payment.

Treasury zero-coupon bonds: single components of a STRIP in which investors receive only the single stripped payments for an investment.
STRIPS are not issued directly to investors by the Treasury and may only be purchased through government securities brokers and dealers and financial institutions.

STRIPS are sold for a $K minimum face value in multiples of 1K and most T-bonds and T-notes are eligible to be STRIPS
Municipal Bonds: securities issued by local governments to fund temporary budge imbalances or to finance long-term projects requiring capital expenditures.
1) Municipal bonds are repaid with revenues or taxes from a project
2) Interest payments are exempt from most income taxes.
Investor s are willing to accept lower interest rates on municipal bonds compared to taxable bonds resulting in lower interest borrowing costs to governments.
Best Efforts Underwriting: Securities issuance in which the underwriter does not guarantee the issuer a firm price and participates as a distribution or placing agent for a fee based on placement success; underwriters avoid setting the market price securities are offered at a price the municipality originally sets.
1) A municipality or corp., with the aid of an investment bank, may seek to find a large institutional purchaser or group of purchasers for the private placement of a whole issue.
2) Interest rates paid to holders of privately placed bonds are higher than interest rates for publicly placed bond issues because a lack of information regarding privately placed bonds results in greater risk.
T-Bonds and T-Notes: long-term debt obligations issued by the US Treasury to finance government expenditures and the national debt.

1) No default risk
2) Pays low interest
3) Not completely risk free
Comparison of T-Bonds and T-Notes to T-Bills

- Both are fixed principal and inflation indexed paying semiannual coupon interest; T-bills are sold on a discount basis from the face value.

-T-notes have original maturities between one and 10 years and T-Bonds have original maturities between 10 and 30 years; T-bills have an original maturity of less than a year.
Primary and Secondary market trading of T-Notes and T-Bonds: T-Bonds and T-Notes are sold by the Treasury through competitive and noncompetitive auctions.

1) Press releases are issued by Treasury one week before auction and include date of auction, amount to be sold and other details regarding securities.
2) Government securities dealers, individuals and business may submit bids through a FRB.
3) Treasury auctions are discriminating, meaning different bidders pay different prices and priority is given to the highest bid prices.

Secondary market trading of these takes place directly through dealer and broker trading; FRB of NY reports average daily Tb/Tn trading in the hundreds of billions of dollars.
Four characteristics of international bond markets:
1) Trade bonds underwritten by international syndicates
2) Offer bonds to investors in several countries at the same time.
3) Offer unregistered bonds
4) Issue bonds outside any single country's jurisdiction.
International bond market grew rapidly between 1994 and 2001 with growth being driven by investor demand.
Four classes of int'l bonds:
1) Eurobonds
2) Foreign Bonds
3) Brady bonds
4) Sovereign bonds
1) Primary Markets
2) Firm Commitment Underwriting
Primary Market: financial markets where corporations raise funds with new issues

Firm Commitment Underwriting: an investment bank buys and entire new issue of stocks or bonds from a corporation for one price, then tries to sell the new issue in bits and pieces to individual investors at a profit.
Seven steps in offering a new issue of stock to the public:
1) Corporation decides to issue stock
2) Corp sends registration statement to the SEC
3) SEC requests more info or changes
4) Corp sends red herring prospectus to potential buyers
5) SEC approves and registers the issue
6) Corp sets final stock price and issues the official prospectus
7) Stock is offered to the public
Three Main US Stock Exchanges:
Holders of corporate common stock have three rights and privileges:
1) Voting on certain issues with significant corp impact
2) Ownership rights in proportion to the amount of stock owned
3) Residual claims on corporate assets if the corporation fails
Two types of corp stock:
1) Common
2) Preferred

Two Differences:
1) All public corporations issue common stock but many do not issue preferred
2) Common stock dividends are uncertain and vary with time; preferred stock dividends are set at a fixed rate and are therefore certain.
Common Stock: basic ownership stakes in public corporations

Five Characteristics:
1) Voting Rights
2) Absentee, proxy, voting
3) Limited Liability
4) Optional Dividends
5) Residual claim
Preferred Stock: securities with characteristics of common stock as well as bonds. Preferred stockholders have ownership interests and rights to periodic fixed dividend payments.
1) Preferred stockholders are paid before common stockholders but after bond owners and creditors
2) Preferred stockholders usually do not have voting rights; however, an exception may be granted if the corp does not make dividend payments as promised.
- Preferred stock is usually cumulative and nonparticipating
- Preferred stock has two disadvantages
1) Dividend payments not made as promised decrease a corps ability to raise new capital.
2) Dividend payments must be made from after-tax profits.
Participants in the stock market:
- Most people in the US own stock either directly or indirectly
- Households hold more corporate stock than any other group
- Even though more than half of all stockholders are under 45 years old, this group owns only 23% of all outstanding stock.
- 34% of stockholders are professionally employed an 38% have earned a college degree
- The mean family income of all stockholders is $84K, and the mean value of all stockholders' investment portfolios is $148,000
Investors are interested in international investments because diversification can decrease some risks. However, diversification cannot eliminate all risks.

International investments carry three specific risks:
1) Information about foreign stocks is often incomplete and delayed.

2) Country or sovereign risk: risk that foreign entities will interfere with payments to foreign investors.

3) Exchange risk: risk that an Fi's foreign investments will be affected by foreign exchange rate swings.
Market efficiency: the rate at which security prices adapt to interest rate changes, new information about corps and other factors affecting security values.

Three gauges of market efficiency:
1) Weak Form: holds that current stock prices reflect all public information about a corporation to date and past prices do not indicate future stock prices.
2) Semistrong Form: holds that current stock prices reflect all new public, information about the corporation form the moment information becomes known.
3) Strong form market efficiency: Holds that current stock prices reflect all public and private information about the corporation, which means that even "inside" information does not indicate future stock prices.
Finance companies: institutions designed to provide individual and business loans.

Finance companies fall into three major categories:
1) Personal credit institutions
2) Business credit institutions
3) Sales finance institutions
Finance companies have five advantages over commercial banks in offering business loans:
1) Industry and product expertise as subsidiaries of corporate-sector holding companies
2) Willingness to accept risky borrowers
3) Overhead is lower than commercial banks
4) Regulations do not restrict products and services
5) Deposits are not accepted by finance companies, so bank-type regulators are not looking directly at finance companies.
Thrift institutions: financial institutions performing residential mortgage services and household lending services in addition to services comparable to commercial banking.

Three categories of thrift institutions:
1) Savings associations
2) Savings banks
3) Credit unions
Credit unions lend only to members and as such are prohibited from serving the public at large.

The banking industry filed to suits to limit credit union growth in 1997:
1) The American Bankers Association and four North Carolina banks challenged the AT&T Family Credit Union's acceptance of members from unrelated companies.
2) The American Bankders Association requested that the court prevent the federal government from letting occupation-based credit unions convert to community-based credit unions.
Credit Union balance sheets.

Assets, as of 2001

-Credit unions had combined assets equaling $505.5 Billion with a growth rate of 162% from 1988 to 2001
- Credit union member loans equaled 65.3% of total assets.
- Investment securities equaled 23.5% of total assets
Liabilities, as of 2001
- Regular share draft transaction accounts equaled 34.2% of all deposits.
- CDs equaled 27% of all deposits
- Share accounts equaled 12.4% of all deposits.
Savings associations wer called savings and loan associations until the 1980s, when federally chartered savings banks appeared in the US having the same regulations and regulators as S&Ls; together, savings banks and S&Ls are referred to as savings associations.

A large number of savings associations failed between 1982 and 1992 and the industry's asset growth declined rapidly.
Recent savings association industry trends:
- The savings association industry is facing fierce competition for mortgages from specialized mortgage brockers and commercial banks.

- Savings associations are exposed to significant liquidity, credit and interest rate risks from long-term mortgage lending.
Savings association balance sheets.

Assets, as of December 2001.
- Mortgages and mortgage-backed securities mad e up 73% of total assets.
- Consumer loans made up 6.2% and commercial loans made up 2.71% of total assets
- Treasury securities and cash made up 7.15%
- Corp stocks and bonds made up 2.2%
Liabilities, as of December 2001
- Small time and savings deposits made up 60%
- Borrowing from the 12 Federal Home Loan banks owned by savings associations was the second most important source of borrowed funds.
- The book value of net worth to total assets ratio equaled 8.21% for savings associations.
Mutual organizations: savings associations in which liability holders are the legal owners; stock is not issued.

Mutual organizations are less risky than organizations issuing stock because no equity investment return is demanded and managers are able to focus on low-risk investments and organizational failure prevention.
- Member deposits make up the savings association's equity and no stockholders exist.

- Many savings associations have moved form utual organizations to stock charters because the ownership of stock attracts higher levels of capital investment than can be achieved in mutual organizations.