Money And Banking #2

Front 1

Cash Flows

Back 1

stockholders receive whatever remains after all other claims against the firm's assets have been satisfied.

Front 2

Moral Hazard

Back 2

happens after the transaction occurs. The lender runs the risk that the borrower will engage in undesirable activities, because they are playing with someone else's money.

Front 3

Default Risk

Back 3

when the issuer of the bond is unable or unwilling to make interest payments when promised or pay off the face value when the bond matures.

Front 4

Inflation Risk

Back 4

The possibility that the value of assets or income will decrease as inflation shrinks the purchasing power of a currency. Inflation causes money to decrease in value at some rate, and does so whether the money is invested or not.

Front 5

According to Liquidity Premium Theory, A flat yield curve indicates that short-term interest rates are expected to?

Back 5

decline moderately

Front 6

Expectations Theory of the Term Structure

Back 6

Hypothesis: The interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond.

2. Yield curve tends to slope up when short-term interest rates are high.

Front 7

Liquidity Premium Theory

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1. Investors regard bonds of different maturities as substitutes, but not perfect substitutes.

2. Interest rates on different maturity bonds move together over time

Yield curves tend slope upward when short-term rates are high

Front 8

According to Liquidity Premium Theory, A moderately increasing yield curve indicates that short-term interest rates are expected to?

Back 8

future short-term interest rates are expected to stay the same

Front 9

According to Liquidity Premium Theory, A negative slop yield curve indicates that short-term interest rates are expected to?

Back 9

Future short-term interest rates expected to fall sharply

Front 10

Dividends

Back 10

are payments made periodically, usually every quarter, to stockholders

Front 11

A clause in a contract that requires one party to do, or refrain from doing, certain things. Often, a restriction on a borrower imposed by a lender.

Back 11

Restrictive Covenant

Front 12

The four things that efficient Markets predicts

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1. Investment advisors cannot help us outperform the market
2. A hot tip is probably information already contained in the price of the stock
3. Stock prices respond to announcements only when the information is new and unexpected
4. A "Buy and Hold" strategy is the most sensible strategy for the small investor

Front 13

What happened during tulip mania ?

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A bubble was created as the asset prices exceeded the intrinsic value

Front 14

A situation where sellers have information that buyers don't (or vice versa) about some aspect of product quality.

Back 14

Adverse Selection

Front 15

he difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent, such as the problem of potential moral hazard and conflict of interest

Back 15

The principal-agent problem

Front 16

Term? Deciding the amount of capital the bank should maintain and then acquire the need capital

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Capital Adequacy Management

Front 17

Term? Bank managers must pursue an acceptably low rate of default and by diversifying asset holdings

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Asset Management

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purpose of Liquidity Management

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Keeping enough cash on hand.

Front 19

Term? to acquire funds at a low cost.

Back 19

Liability Management

Front 20

Asset Transformation is accomplished by

Back 20

borrowing short and lending long

Front 21

Four Principles of Asset Management

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1. Finding borrowers to pay high interest with low chance of default
2. Finding securities with high returns and low risk
3. Diversify the bank's asset holdings to minimize risk
4. Hold some liquid assets like US-T Bills

Front 22

Three rules of Liability Management

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1. checkable deposits are a bank's lowest-cost source of funds
2. Checkable deposits have decreased in importance as a source of bank funds
3. Banks make more $ by issuing CD's or from borrowing from other banks

Front 23

Benefits of Capital Adequacy Management

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1. Helps prevent bank failure
2. Benefits the owners of a bank by making their investment safe

Front 24

Four Principles of Asset Management

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1. Finding borrowers to pay high interest with low chance of default
2. Finding securities with high returns and low risk
3. Diversify the bank's asset holdings to minimize risk
4. Hold some liquid assets like US-T Bills

Front 25

Cons of Capital Adequacy Management

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3. Costly, to the bank because of the higher required bank capital, and the lower return on equity

Front 26

Three rules of Liability Management

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1. checkable deposits are a bank's lowest-cost source of funds
2. Checkable deposits have decreased in importance as a source of bank funds
3. Banks make more $ by issuing CD's or from borrowing from other banks

Front 27

Four Principles of Asset Management

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1. Finding borrowers to pay high interest with low chance of default
2. Finding securities with high returns and low risk
3. Diversify the bank's asset holdings to minimize risk
4. Hold some liquid assets like US-T Bills

Front 28

Five ways to manage Credit Risk

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1.Screening and monitoring
2. Long-term customer relationships
3. Loan commitments
4. Collateral and compensating balances
5. Credit rationing

Front 29

Benefits of Capital Adequacy Management

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1. Helps prevent bank failure
2. Benefits the owners of a bank by making their investment safe

Front 30

Three rules of Liability Management

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1. checkable deposits are a bank's lowest-cost source of funds
2. Checkable deposits have decreased in importance as a source of bank funds
3. Banks make more $ by issuing CD's or from borrowing from other banks

Front 31

Cons of Capital Adequacy Management

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3. Costly, to the bank because of the higher required bank capital, and the lower return on equity

Front 32

Benefits of Capital Adequacy Management

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1. Helps prevent bank failure
2. Benefits the owners of a bank by making their investment safe

Front 33

Four Principles of Asset Management

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1. Finding borrowers to pay high interest with low chance of default
2. Finding securities with high returns and low risk
3. Diversify the bank's asset holdings to minimize risk
4. Hold some liquid assets like US-T Bills

Front 34

Three rules of Liability Management

Back 34

1. checkable deposits are a bank's lowest-cost source of funds
2. Checkable deposits have decreased in importance as a source of bank funds
3. Banks make more $ by issuing CD's or from borrowing from other banks

Front 35

Benefits of Capital Adequacy Management

Back 35

1. Helps prevent bank failure
2. Benefits the owners of a bank by making their investment safe

Front 36

Cons of Capital Adequacy Management

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3. Costly, to the bank because of the higher required bank capital, and the lower return on equity

Front 37

Five ways to manage Credit Risk

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1.Screening and monitoring
2. Long-term customer relationships
3. Loan commitments
4. Collateral and compensating balances
5. Credit rationing

Front 38

Cons of Capital Adequacy Management

Back 38

3. Costly, to the bank because of the higher required bank capital, and the lower return on equity

Front 39

Five ways to manage Credit Risk

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1.Screening and monitoring
2. Long-term customer relationships
3. Loan commitments
4. Collateral and compensating balances
5. Credit rationing

Front 40

Five ways to manage Credit Risk

Back 40

1.Screening and monitoring
2. Long-term customer relationships
3. Loan commitments
4. Collateral and compensating balances
5. Credit rationing

Front 41

Banks can economize excess reserves by?

Back 41

lending reserves to federal funds market

Front 42

4 ways to keep a bank from failing?

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1. Borrowing funds from the federal funds market
2. Go to the discount window
3. Calling in or selling off loans
4. Sell securities

Front 43

The facility at which banks can borrow reserves from the Federal Reserve is called?

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Discount Window

Front 44

Term? When borrowers with the most risky investment plans are more likely to seek borrowers with safer investment plans

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Adverse Selection

Front 45

Risk that is related to uncertainty about future interest rates

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interest rate risk

Front 46

rate sensitive liabilities and rate sensitive assets

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Gap analysis

Front 47

Measures the sensitivity of bank's profits to changes in the interest rates

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Basic Gap analysis

Front 48

Rof=R* tells us

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that current prices in a financial market will be set so that the optimal forecast of a security's return using all available information equals the security's equilibrium return.

Front 49

3 types of Conflicts of Interest

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1. Underwriting and Research in Investment Banking
2. Auditing and consulting in Accounting Firms
3. Credit Assessment and Consulting in Credit-Rating Agencies

Front 50

2 remedies for conflicts of interest

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1. Sarbanes-Oxley Act of 2002
2. Global Legal Settlement of 2002

Front 51

When managers own only a small fraction of the firm they work for, the sotckholders who own most of the firm's equity (called the principals) are not the same people as the managers of the firm, who are the agents of the owner. Think of steve the ice cream investor

Back 51

Principal agent problem

Front 52

4 roles of covenants

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1. discourage undesirable behavior
2. encourage desirable behavior
3. keep collateral valuable
4. provide information

Front 53

An example of an equity contact is

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common stock

Front 54

What happened in Rogue Trader?

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trader made unauthorized trades in index finances loss 1.3 Billion. Use the banks assets to invest and put the losses in the 88888 account.

Front 55

Asymmetric information

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when one party's insufficient knowledge about the other party involved in a transaction makes it impossible to make accurate decisions when conducting the transaction

Front 56

When managers own only a small fraction of the firm they work for, the sotckholders who own most of the firm's equity (called the principals) are not the same people as the managers of the firm, who are the agents of the owner. Think of steve the ice cream investor

Back 56

Principal agent problem

Front 57

4 roles of covenants

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1. discourage undesirable behavior
2. encourage desirable behavior
3. keep collateral valuable
4. provide information

Front 58

An example of an equity contact is

Back 58

common stock

Front 59

What happened in Rogue Trader?

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trader made unauthorized trades in index finances loss 1.3 Billion. Use the banks assets to invest and put the losses in the 88888 account.

Front 60

Moral Hazard occurs...

Back 60

after the transaction

Front 61

Adverse selection occurs....

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before the transaction

Front 62

people with lemons want to sell between the lemon and a good car. Peach owners want know that their car is undervalued.

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Lemons problem

Front 63

the theory that stock prices are essentially unpredictable

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Random Walk

Front 64

Term? returns on a security that are larger than what is justified by the characteristics of that security

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Unexploited profit opportunities