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98 Cards in this Set

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Medium of exchange, unit of account, store of value

Money market securities (MMS)

Short term (less than 1y) DEBTsecurities

No coupon payments = sold at discount

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

Liquidity match

Depository institutions provide demanded size/maturity loan to deficit unit.

Depository institutions

Take deposit from surplus units, provide loans to deficit units.

Provide: liquid accounts to depositors, liquidity match to deficit units.

Commercial banks

Deposits, loans, investing in debt securities

Savings bank

Depository institution

Focus on mortgages

Credit unions

Depository institution

Raiffeisenbank - NPO, members only

Finance companies


Borrow large sums: lend to individuals/ small companies

Mutual funds


Issue stocks and invest in securities portfolio

Investment banks/securities firms


Variety of often advisory/fee based functions (broker, dealer, issuance of stock)

Insurance companies


Invest premiums in FM

Pension funds / asset management


Manage and invest funds until withdrawl due to e.g. Retirement

Lonable funds theory

Market interest rate determined by (factors that control) supply and demand for loanable funds.

Fisher effect

Market interest = expected inflation + real interest

Real interest generally 2-3%

Factors influencing market interest rates

Economic growth/slow down


Monetary policy

Fiscal policy (government budget deficit)

Foreign flow of funds

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

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

Term structure

Determined by 3 theories:

1. Expectations theory

2. Liquidity premium preference theory

3. Segmented market theory

Liquidity premium preference theory

Investor prefer short term, liquid securities. Long term investment only with premium as compensation.

Segmented market theory

Investors choose maturity that best fits their future cash needs.

Fed's goal

Full employment (unemployment rate below 5%), price stability (inflation rate below 2%)

Fed's structure (district banks)

12 federal district banks - NY most important

Fed's structure: board of governors

7 governors

Appointment by potus - 14y non-renewable term.

1 governor chairman potus appointed 4y renewable

Fed's structure: FOMC

Federal open market committee

7 board members + ny district president + 4 rotating presidents of district banks

Determine monetary policy

Fed's structure: advisory committees

Several advisory councils: e.g. consumer advisory council

Advise on monetary policy

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)

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)

Primary credit lending rate

Fed's interest rate for loans to depository institutions.

Set above federal funds rate to encourage interbank lending.

Federal funds rate

Rate of interest for interbank loans.

Not set by anyone but determined by market according to money supply.

ECB's goal

Price stability

(Support economic development of members)

ECB's tasks

Monetary policy, hold foreign reserves for members, exchange currency, promote payment system.


Advise, supervise banks, collect data, bank notes, international cooperation.

Tasks Euro NCBs

Implement monetary policies, manage reserves, maintain payment system, collect data, manage bank notes in country.

ECB's structure

Governing council: formulate monetary policy

Executive board: implement monetary policy

General council: advise

Governing council

19 €-members, 4 votes for D, F, IT, ES, NL (vote rotates), 10 votes for rest 15 (vote rotates)

How do central banks determine monetary policies?

Monitor indicators of economic growth and inflation.

Types of economic indicators

Leading: predict future developments.

Coincidental: report on things happening presently.

Lagging: show results after business cycle.

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

Coincidental economic indicators

Reported sales

Lagging economic indicators

Labor cost per unit, average duration of unemployment

Indicators of inflation

Producer and consumer price indices --> supply and retail price level.

Also consider economic indicators.


Wage rate growth

Oil price = causes inflation

Gold price = tends to move with inflation

Credit crunch

Despite loose monetary policy banks don't give out loans out of fear that creditors go bankrupt --> during times of high uncertainty.

Limits of monetary policy

- Credit crunch

- inflation (rising price level) counters money supply growth

- Lagged effect

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.

Fed's tradeoff

Employment and inflation counteract each other.

Proposal to drop unemployment rate focus, like ECB.



Highly liquid

Basis for prices of all other MMS

No coupon payment = sold at discount


3% interest (required return)


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.

Federal funds

Interbank loans

Yield slightly above tbill = default risk

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.

Globalization of MM

Eurodollar = $-deposit outside US


Euro commercial paper

International interbank market


Maturity of 10y+

Lower liquidity


Bearer securities

Buyer not registered

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.

Bond types

Tbonds, federal agency bonds, municipal bonds, corporate bonds

Federal agency bonds

Federal national mortgage association = Fannie Mae

Federal home loan mortgage association = Freddie Mac

Used to buy mortgages on secondary market.

Municipal bonds with general obligation

Bonds supported by tax income of municipality

Contain call provision

Municipal revenue bonds

Bonds issued for specific project (toll bridge) and only supported by project. Project bankrupt = money gone

Contain call provision


Treasury inflation protected securities = principal pegged to inflation rate.


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.

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.


Initial public offering

IPO steps

Extensive documentation & prospectus --> file with SEC

At least $50m stock offer

Measures for price stability IPO

Underwriter buys shares after IPO on secondary market

Lock up: original owner not allowed to sell for certain time.

Abuses in IPO



Excessive commission


Underwriter offers IPO shares to possible business partners as bribes.


Brokers encourage investors to high bids on IPO --> artifical price manipulation

Excessive commission

On promising IPOs brokers take high commission, knowing that flipping return will be high and investors will still pay.

Selling and buying of stock

Exchanges --> NYSE

OTC --> Nasdaq

Indices can be bought: include multiple stocks, often grouped by company size.

Sarabanes-Oxley act 2002

Regulations to ensure trustable financial auditing and reporting.

Order types stock 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.

Margin trading

Initial margin requirement

Amount of trade in % that has to be covered by investor.

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%

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.

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.

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

Stock transactions execution

By brokers or market makers

Market maker

Broker function but also buys sells for own profit. --> makes up part of the market

Spread on stocks

Difference between bid and ask price as a % of ask price

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 -

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)

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.


Securities and Exchange Commission

SEC divisions

Corporate finance: reviews IPO candidates, monitors financial reports.

Market regulation: requires disclosure of security trades.

Enforcement: assesses violations, takes legal action.

Fair disclosure (FD)

SEC market regulation: companies must disclose information simultaneously to all investors.

Recent developments in stock market

Reduction transaction cost: consolidation of exchanges, digitalization.

Reduction information cost: internet enables informed decisions for more, internet info free.

Commercial banking market structure

Consolidation = # banks declining

Baks owned by holdings = more flexibility

Sources of funds

Deposits = main source

Borrowed funds

Long term sources of funds

Transaction deposit

Regular checking account, no interest

Savings deposit

Savings account no checking possible, higher interest

Time deposits

Certificates of deposit (CD): money deposited for agreed upon maturity

Negotiable CDs

Federal funds purchased

Funds borrowed from other banks, interest payed is federal funds rate.

Often to correct short term fund imbalances.

Borrowing from central bank

Borrow at primary credit lending rate.

Done to correct temporary shortage of funds.


As source of funds for commercial banks.

Eurodollar borrowing

Borrow from non domestic banks in domestic currency, as a source of funds for commercial banks.

Bank's Bonds issuance

Long term source, to finance fixed assets.

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.

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.

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