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98 Cards in this Set
- Front
- Back
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Money |
Medium of exchange, unit of account, store of value |
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Money market securities (MMS) |
Short term (less than 1y) DEBTsecurities No coupon payments = sold at discount |
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Information impact on value of securities |
1. Economic conditions 2. Industry conditions 3. Company information Assess expected Cashflows Assess security value Take position y/n |
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Liquidity match |
Depository institutions provide demanded size/maturity loan to deficit unit. |
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Depository institutions |
Take deposit from surplus units, provide loans to deficit units. Provide: liquid accounts to depositors, liquidity match to deficit units. |
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Commercial banks |
Deposits, loans, investing in debt securities |
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Savings bank |
Depository institution Focus on mortgages |
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Credit unions |
Depository institution Raiffeisenbank - NPO, members only |
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Finance companies |
Non-depository Borrow large sums: lend to individuals/ small companies |
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Mutual funds |
Non-depository Issue stocks and invest in securities portfolio |
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Investment banks/securities firms |
Non-depository Variety of often advisory/fee based functions (broker, dealer, issuance of stock) |
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Insurance companies |
Non-depository Invest premiums in FM |
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Pension funds / asset management |
Non-depository Manage and invest funds until withdrawl due to e.g. Retirement |
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Lonable funds theory |
Market interest rate determined by (factors that control) supply and demand for loanable funds. |
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Fisher effect |
Market interest = expected inflation + real interest Real interest generally 2-3% |
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Factors influencing market interest rates |
Economic growth/slow down Inflation Monetary policy Fiscal policy (government budget deficit) Foreign flow of funds |
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Crowding-out effect |
When big government budget deficit, government borrows large amounts: inelastic demand = no matter the interest rate, government still borrowing. Higher interest rates not demanded by private sector = crowded out |
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Expectation theory |
Term structure (short term vs long term yields) reflected in yield curve is based on the expectations of interest rates. Expected increase = upward sloping yield curve: longer maturity offers higher yield Expected decrease = downward sloping yield curve: shorter maturity offers higher yield |
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Term structure |
Determined by 3 theories: 1. Expectations theory 2. Liquidity premium preference theory 3. Segmented market theory |
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Liquidity premium preference theory |
Investor prefer short term, liquid securities. Long term investment only with premium as compensation. |
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Segmented market theory |
Investors choose maturity that best fits their future cash needs. |
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Fed's goal |
Full employment (unemployment rate below 5%), price stability (inflation rate below 2%) |
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Fed's structure (district banks) |
12 federal district banks - NY most important |
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Fed's structure: board of governors |
7 governors Appointment by potus - 14y non-renewable term. 1 governor chairman potus appointed 4y renewable |
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Fed's structure: FOMC |
Federal open market committee 7 board members + ny district president + 4 rotating presidents of district banks Determine monetary policy |
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Fed's structure: advisory committees |
Several advisory councils: e.g. consumer advisory council Advise on monetary policy |
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Open market operations |
Fed buys/sells securities (increases/decreases money supply) to decrease/increase federal funds rate. Decrease federal funds rate = lower market interest rate = increase consumption (price level rises = higher inflation) --> fuel economy (decrease unemployment rate) Increase federal funds rate = higher market interest rate = slows down economy = price level stable (lower inflation) |
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Reserve requirement ratio |
Portion of deposit to be held in reserve. Tool for central banks to increase or decrease the money supply --> multiplier effect (deposits : reserve rate = total money created including initial deposits) |
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Primary credit lending rate |
Fed's interest rate for loans to depository institutions. Set above federal funds rate to encourage interbank lending. |
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Federal funds rate |
Rate of interest for interbank loans. Not set by anyone but determined by market according to money supply. |
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ECB's goal |
Price stability (Support economic development of members) |
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ECB's tasks |
Monetary policy, hold foreign reserves for members, exchange currency, promote payment system. Other: Advise, supervise banks, collect data, bank notes, international cooperation. |
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Tasks Euro NCBs |
Implement monetary policies, manage reserves, maintain payment system, collect data, manage bank notes in country. |
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ECB's structure |
Governing council: formulate monetary policy Executive board: implement monetary policy General council: advise |
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Governing council |
19 €-members, 4 votes for D, F, IT, ES, NL (vote rotates), 10 votes for rest 15 (vote rotates) |
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How do central banks determine monetary policies? |
Monitor indicators of economic growth and inflation. |
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Types of economic indicators |
Leading: predict future developments. Coincidental: report on things happening presently. Lagging: show results after business cycle. |
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Leading economic indicators |
Most important, used to counteract bad developments. Examples: average weekly hours in manufacturing --> productivity / future possible value added; Issued building permits --> growth / recession |
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Coincidental economic indicators |
Reported sales |
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Lagging economic indicators |
Labor cost per unit, average duration of unemployment |
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Indicators of inflation |
Producer and consumer price indices --> supply and retail price level. Also consider economic indicators. Other: Wage rate growth Oil price = causes inflation Gold price = tends to move with inflation |
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Credit crunch |
Despite loose monetary policy banks don't give out loans out of fear that creditors go bankrupt --> during times of high uncertainty. |
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Limits of monetary policy |
- Credit crunch - inflation (rising price level) counters money supply growth - Lagged effect |
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Lagged effect |
Recognition lag: time till problem is noticed. Implementation lag: time till new policy is implemented --> Fed can adapt policies only every 1.5 months. Impact lag: time till problem is solved by policy. |
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Fed's tradeoff |
Employment and inflation counteract each other. Proposal to drop unemployment rate focus, like ECB. |
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T-bill |
MMS Highly liquid Basis for prices of all other MMS No coupon payment = sold at discount
Price: 3% interest (required return) 1000:1.03=970.87 |
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Commercial paper |
By large well known corporations 20-45 days maturity (can up to 270 days) Rated by agencies Offers higher yield than tbills = default risk and lower liquidity. |
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Federal funds |
Interbank loans Yield slightly above tbill = default risk |
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Banker's acceptance |
Bank takes responsibility for payment of client in transaction between two unfamiliar (international) parties. Payments comes at maturity, but acceptance can be sold at discount to get money earlier. Very liquid market. |
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Globalization of MM |
Eurodollar = $-deposit outside US Euronotes Euro commercial paper International interbank market |
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Bonds |
Maturity of 10y+ Lower liquidity OTC |
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Bearer securities |
Buyer not registered |
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Registered security |
Buyer registered with issuer of security, when selling on new buyer registered as well. Enables relationship building, no silent takeover of debt by hedge funds possible. |
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Bond types |
Tbonds, federal agency bonds, municipal bonds, corporate bonds |
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Federal agency bonds |
Federal national mortgage association = Fannie Mae Federal home loan mortgage association = Freddie Mac Used to buy mortgages on secondary market. |
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Municipal bonds with general obligation |
Bonds supported by tax income of municipality Contain call provision |
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Municipal revenue bonds |
Bonds issued for specific project (toll bridge) and only supported by project. Project bankrupt = money gone Contain call provision |
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TIPS |
Treasury inflation protected securities = principal pegged to inflation rate. |
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STRIPS |
Stripped bonds Stripped to principal only or interest only bonds. Might offer tax advantages in certain regions, where interest income is taxed higher or lower. |
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Provisions in bonds |
Sinking funds: requirement to buy back certain amount of bonds (retire bonds) Call provision Collateral: y/n Variable rate: coupon rate adjustable (e.g. According to inflation) Convertible: bond exchangeable for equity. |
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IPO |
Initial public offering |
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IPO steps |
Extensive documentation & prospectus --> file with SEC At least $50m stock offer |
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Measures for price stability IPO |
Underwriter buys shares after IPO on secondary market Lock up: original owner not allowed to sell for certain time. |
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Abuses in IPO |
Spinning Laddering Excessive commission |
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Spinning |
Underwriter offers IPO shares to possible business partners as bribes. |
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Laddering |
Brokers encourage investors to high bids on IPO --> artifical price manipulation |
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Excessive commission |
On promising IPOs brokers take high commission, knowing that flipping return will be high and investors will still pay. |
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Selling and buying of stock |
Exchanges --> NYSE OTC --> Nasdaq Indices can be bought: include multiple stocks, often grouped by company size. |
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Sarabanes-Oxley act 2002 |
Regulations to ensure trustable financial auditing and reporting. |
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Order types stock market |
Limit Market Stop-loss: sell stocks automatically at specified price below current market price. Stop buy: buy stocks automatically at specified price above current market price. |
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Margin trading Initial margin requirement |
Amount of trade in % that has to be covered by investor. |
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Margin trading
Maintenence margin |
Min % of investors own capital in margin account of current market price. 25% required
100k bought, 50k debt, 50k investor's capital. Price down to 60k: 50k debt, 10k investor's capital --> maintenence margin = 10:60= 17% |
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Margin trading
Margin call |
Amount investor has to add to margin account to cover the 25% maintenence margin if maintenance margin is too low.
17% currently: 10k investor's capital, 50k debt, 60k stock price
60:4=15=25% --> investor called for 5k to add to margin account. |
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Short selling |
Sale of borrowed securities when prices are expected to decline. Sell borrowed securities immediately and rebuy later at cheaper price, then give back to lender. Difference in sale and buy price is profit. |
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Short selling regulation |
No naked shorting: sellers need to deliver borrowed securities within 3 days to buyer --> shorter needs to actually have security before selling it. Uptick rule: shorting only after upwards price movement --> prevents profiting from continuous down movement and prevents chain reaction of selling |
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Stock transactions execution |
By brokers or market makers |
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Market maker |
Broker function but also buys sells for own profit. --> makes up part of the market |
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Spread on stocks |
Difference between bid and ask price as a % of ask price |
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Factors affecting spread on stocks |
Order costs: transaction cost = spread + Inventory cost: maintaining stock inevtory = spread + Volume: liquidity of stock = spread + if low, - if high (low liquidity = inventory needed) Risk: volatile price = spread + Competition: multiple market makers = spread - |
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Circuit breakers |
Halg trading of index or specific stock when stock reaches specific threshold. (e.g. S&P 500 drops 15% in a day, company x share price rises 20% within the hour) |
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Trading halts |
Stop trading of specific stock to prevent sudden price movement (in anticipation of a news release or other future event) and give market time to gather information. |
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SEC |
Securities and Exchange Commission |
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SEC divisions |
Corporate finance: reviews IPO candidates, monitors financial reports. Market regulation: requires disclosure of security trades. Enforcement: assesses violations, takes legal action. |
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Fair disclosure (FD) |
SEC market regulation: companies must disclose information simultaneously to all investors. |
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Recent developments in stock market |
Reduction transaction cost: consolidation of exchanges, digitalization. Reduction information cost: internet enables informed decisions for more, internet info free. |
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Commercial banking market structure |
Consolidation = # banks declining Baks owned by holdings = more flexibility |
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Sources of funds |
Deposits = main source Borrowed funds Long term sources of funds |
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Transaction deposit |
Regular checking account, no interest |
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Savings deposit |
Savings account no checking possible, higher interest |
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Time deposits |
Certificates of deposit (CD): money deposited for agreed upon maturity Negotiable CDs |
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Federal funds purchased |
Funds borrowed from other banks, interest payed is federal funds rate. Often to correct short term fund imbalances. |
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Borrowing from central bank |
Borrow at primary credit lending rate. Done to correct temporary shortage of funds. |
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Repos |
As source of funds for commercial banks. |
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Eurodollar borrowing |
Borrow from non domestic banks in domestic currency, as a source of funds for commercial banks. |
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Bank's Bonds issuance |
Long term source, to finance fixed assets. |
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Bank capital |
As a source of funds for commercial banks. Represents equity: acquired by issuing stock or through retained earnings. Must be sufficient to cover possible losses, requirement depends on bank's risk. |
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Uses of funds by commercial banks |
Cash: for reserve requirement Bank loans: business and consumer, focus on consumer mortgages Investment: keep money liquid, still earn interest Lending: federal funds sold (loaned out) , repos, eurodollar loans, Fixed assets: buildings, land to make operating possible. Trading: trade securities for capital gain. |
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Off BS activities by commercial banks |
Loan commitment: agreement to give loan on customer's request Standby letters of credit: bank backs customer's obligation to third party. Forward contract on currencies: agreement to exchange currency in future for agreed upon rate. Interest swap contract Credit default swap contract |
