The Financial Sector ch8

These flashcards cover essential concepts from the financial sector, including banks, the bond market, and stock market fundamentals.

What are the three key pillars of the financial sector?

Banks, the bond market, and the stock market.

What roles do banks perform?

Banks pool savings, spread lending risk, solve information problems, provide payment services, and create long-term loans from short-term deposits.

What is a bank run?

A situation when many customers try to withdraw their savings at the same time.

What is deposit insurance?

A government guarantee that protects depositors by ensuring their money is safe up to a certain amount.

What is a shadow bank?

A financial firm that operates similarly to a bank but is not subject to the same regulations.

How do banks make money?

By charging higher interest rates on loans than they pay on deposits.

What is maturity transformation in banking?

The process of using short-term deposits to fund long-term loans.

What is the bond market?

A marketplace where companies and governments issue bonds to raise money.

What is a bond?

An IOU, or a promise to pay back a loan with interest.

What are the main risks associated with bonds?

Default risk, term risk, and liquidity risk.

What does liquidity mean in the context of the bond market?

The ability to quickly sell a bond without losing significant value.

What are dividends?

Payments made by a corporation to its shareholders from profits.

What is an IPO?

Initial Public Offering, the first sale of stock by a company to the public.

What is the price-to-earnings ratio?

A measure that compares a company's current share price to its per-share earnings.

What is the efficient market hypothesis?

The theory that stock prices reflect all available information, making it difficult to outperform the market consistently.

What are the two approaches used to value financial assets?

Fundamental analysis and relative valuation.

What is a speculative bubble?

A market phenomenon where asset prices rise significantly above their fundamental value.

What is the greater fool theory?

The belief that one can sell an overpriced asset to someone else (the 'greater fool') for a profit.

What is liquidity risk?

The risk that an asset cannot be sold quickly enough to prevent a loss.

How can one evaluate bonds?

By assessing default risk, term risk, and liquidity risk.

What does it mean for stocks to spread risk?

Shareholders face reduced risk since their share of the company’s performance is diluted over many investors.

What is the primary purpose of the stock market?

To facilitate buying and selling of existing stocks to provide liquidity.

What is the role of the U.S. government in the bond market?

The U.S. government issues bonds to fund its debt and is the largest player in the bond market.

What are some examples of shadow banks?

Investment banks, payday lenders, insurance companies, and private equity firms.

What advantage does the stock market provide to companies?

It allows them to raise money for expansion or new projects through sales of stocks.

What is fundamental value?

The present value of a company's expected future profits.