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52 Cards in this Set

  • Front
  • Back
Function of financial markets
1. promote economic efficiency
2. reduce risk
3. reduce transaction costs
direct finance

indirect finance
borrowers aquire funds directly from savers

""" from fin. intermediaries who in turn acquire funds from savers
#yrs until debt instrument's expiration date
short-term maturity

long-term maturity
10yrs or longer
common stock; claims to share in NI and Assets
often pay dividends
LT b/c have no maturity
holder is a residual claimant - corp must pay all its debt holders b4 it pays equity holders
benefit directly from any increases in profitability or asset value b/c confer ownership rights
primary market
new issues of a security are sold to initial buyers by corp/govt agency borrowing the funds
corp acquires new funds
secondary market
securities that have been previously re-issued can be resold
NY and American Stock Exchange and NASDAQ, foreign exchange markets, futures markets, options markets
investment banks
underwrite securities: guarantee a price for a corp.s securities and then sells them to the public
agents of investors who match buyers w/sellers of securities
link buyers and sellers by buying and selling securities at stated prices
Functions of secondary markets
make it easier and quicker to sell financial instruments to raise cash, and make fin. instruments more liquid. Also they det. the price of the security that the issuing firm sells in the primary market
buyers and sellers of securities meet in one central location
over the counter (OTC) market
dealers at different locations who have an inventory of securities stand ready to buy and sell securities over the counter to anyone who comes to them and is willing to accept their prices
fin. market w/only ST debt instruments are traded; more liquid and widely traded. less fluctuations, gen. safer investments
capital market
LT debt and equity instruments are traded
Money market instruments
ST debt instruments; least risky
Negotiable CDs
Commercial paper
Banker's Acceptances
Repurchase agreements
Federal Funds
most liquid; safest; almost no default
-fed govt can always meet obligations b/c can raise taxes or issue currency
-held by banks
Negotiable CDs
Money Market Instrument. Certificate of deposits (CDs) pay annual interest of a
given amount and the principal at maturity.
-CDs that are sold
in the secondary markets. liquid, ST maturity, Low risk.
-issued by major commercial banks.
Important source of funds for commercial banks, from:
- corporations,
- money market mutual funds,
- charitable institutions,
- government agencies.
Municipal Bonds
Capital Market Instrument. LT debt instruments that
state and local governments issue to finance their expenditures. There is a
secondary market, but its size is smaller than that of the US government securities
-riskier and less liquid than US government
securities but not as risky as equity and more liquid than loans. Interest payments
are exempt from federal income tax and generally from state
tax of the issuing state. Main buyers:
-commerical banks
- wealthy individuals in high income tax brackets
- insurance companies.
Residential Mortgages
Capital Market Instrument. loans to households to
purchase housing (which works at the same time as collateral for these loans).
- savings and loans associations,
- mutual saving banks,
- commercial banks.
Less liquid. Not the safest but not as risky as equity.
Repurchase Agreements
Money Market Instrument. ST loans (maturity less than two weeks) in
which Treasury bills serve as collateral. They are an important source of bank
funds. The most important lenders are large corporations.
Banker's acceptance
Money Market Instrument. bank drafts issued by a firm,
payable at some future date, and guaranteed for a fee by the bank. The firm
issuing the instrument is required to deposit the required funds into its account to
cover the draft. There is a secondary market. With the guarantee by the bank,
banker's acceptances are not risky.
Federal Funds
Money Market Instrument. Overnight loans between banks of their deposits at the
Fed. Less risky.
Commercial Paper
ST debt instrument issued by large banks and well known corporations
Foreign Bonds
sold in a foreign country and
denominated in that country’s currency
bond denominated in a currency
other than that of the country in which it is sold
foreign currencies deposited
in banks outside the home country
U.S. dollars deposited in foreign
banks outside the U.S. or in foreign branches of
U.S. banks
Capital Market Instruments
Debt and equity instruments of maturities >1yr; greater price fluctuations and higher risk
Corporate bonds
LT bonds issued by coprs w/strong credit ratings. convertible bonds: allow holder to convert htem into specified # of shares of stock at any time to the maturity date
US Govt securities
LT debt finance deficit of fed govt. most widely traded bonds in US; most liquid in captial market
held by FED, banks, households, and foreigners
US Govt Agency Securities
LT bonds issues by govt agencies
finance mortgages, loans, etc.
Indirect Finance
• Lower transaction costs
Regulation of fin. system
To increase the information available to investors:
Transaction costs
time and $ spent in carrying out fin. transactions
economies of scale
reduction in transaction costs per $ of transactionsa s the size/scale of transactions increases
liquidity services
services that make it easier for customers to conduct transactions
-checking accts
uncertainty about the returns investors will earn on assets
risk sharing
create and sell assets with risk char. that people are comfortable with, and the intermediaries then use the funds they acquire by selling these assets to purchase other assets that may have far more risk
asset transformation
risky assets are turned into safer assets for investors
asymetric information
in fin. markets, when one party often does not know enough about the other party to make accurate decisions
adverse selection
asymetric info b4 the transaction occurs
moral hazard
asymetric info after the transaction occurs
degree of uncertainty as to payment.
Equity generally has the highest risk. Next is various
grades of debt, then unsecured debt such as consumer
loans. Safest: treasury and insured deposits
How quickly converted into medium
of exchange (money). Demand deposits, followed by
savings deposits, treasury securities. CDs have
penalties for early withdrawal.
Sales Costs
Cost of matching buyers and sellers
- Primary Markets: Investment bankers market to
potential buyers and guarantee a minimum initial
price for a fee.
- Secondary Markets: Brokers and Dealers
Legal Costs
Loans and securities are legal contracts
which must be written carefully to be enforced. Loans
are more complicated – covenants and collateral.
Regulatory costs
Securities. SEC filing
requirements. Must file registration statement,
prospectus, periodic financial statements.
Thrift institutions
depository institutions
savings and loan associations, mutural savings banks, credit unions
Contractual savings institutions
insurance companies and pension funds; acquire funds at periodic intervals on a contractual basis
liquidity of assets is not as impt
primarily LT securities
Investment intermediaries
finance companies, mutual funds, money market mutual funds
Financial panic
aysmmetric info can lead to widespread collapse of fin. intermediaries
restriction on entry, disclosure, restrictions on assets and activities, deposit insurance, limits on competition, restrictions on interest rates