Econ final

Asset-backed security

A security whose value and income payments are derived from and backed by a specified pool of underlying assets. Pooling the assets into financial instruments allows shares to be sold to general investors and may be intended to reduce risk. The pools can include common payments from credit cards, auto loans, and mortgage loans.

Bank run (bank panic)

A series of unexpected cash withdrawals caused by a sudden decline in confidence or fear that the bank will fail. Because the cash reserve a bank keeps on hand is only a small fraction of its deposits, a large number of withdrawals in a short period can deplete available cash and force the bank to close.

Bond

A loan to a government or corporation in return for a promised repayment at a specified interest rate.

Capital

The wealth—cash or other financial assets—used to establish or maintain a business.

Central bank

The principal monetary authority of a nation, which issues currency and influences the supply of credit in the economy. The Federal Reserve is the central bank of the U.S.

Commercial bank

A bank that offers a broad range of deposit accounts (checking/savings) and extends loans to individuals and businesses.

Common stock

An ownership share of a corporation. Offers no guarantee that it will hold its value or pay dividends.

Credit

What individuals and institutions borrow, promising to pay back in the future.

Credit crunch

A situation where banks and lenders suddenly and significantly reduce lending because they're uncertain how much they'll have to lend and whether borrowers can repay.

Credit default swap

A type of insurance against a security falling in value — the owner of a mortgage-backed security pays a fee in return for a much larger payment if the security falls in value. The risk of default is "swapped" to the seller.

Debt

Money owed; also known as liability.

Default

Failure to meet the terms of a credit or loan agreement.

Equity

Ownership interest in an asset after liabilities are deducted (e.g., a house's value minus the mortgage).

Fannie Mae and Freddie Mac

Government-created institutions that buy mortgages from banks and sell them as investment products, to make more money available for home loans. Both were taken over by the federal government in September 2008.

FDIC

An independent agency created by Congress in 1933 to maintain stability and confidence in the banking system. Protects accounts up to $250,000 per depositor (was $100,000 before October 2008).

Federal Reserve System

The U.S. central bank — a 7-member Board of Governors in D.C., 12 regional Federal Reserve Banks, and 25 branches.

Foreclosure

The legal process used to force payment of debt secured by collateral (like a house), where the property is sold to satisfy the debt.

Futures contract

A legally binding agreement to buy or sell a commodity/security at a future date for a price fixed now.

Hedge fund

An investment fund with a limited number of investors, focused on a specific strategy; tends to have less regulation than mutual funds.

Investment bank

A bank offering services like trading securities, raising capital, and managing M&A (e.g., Goldman Sachs, the former Bear Stearns).

Leverage

Borrowing to expand the size of an investment, which can increase both potential return and risk.

Liquidity

The degree of difficulty in converting an asset into money.

Liquidity risk

The risk that a bank won't have enough cash/liquid assets to meet borrower and depositor demand.

Moral hazard

When an investor takes on more risk because they don't have to bear all the costs of that risk.

Mortgage

An agreement to pay interest and eventually pay back a loan made on a house.

Mortgage-backed securities

Pools of mortgages bought by investment firms, then sold in parts (securities) to other investors who can trade them.

Mutual fund

A group of financial investments, often of a specific kind, managed by professionals for many investors.

Nationalization

Government taking ownership and/or control of a business.

Options

The right (not obligation) to buy or sell a specific amount of stock, commodities, currencies, or debt at a set price within a set period.

Private equity funds

Investment funds that purchase most/all of a company, often to make major changes to its management or operations — may take public shares off the market.

Regulation

A principle, rule, or law designed to control or govern how a market works.

Return (rate of return)

Money earned from an investment (profits, interest, appreciation, or a combination). Rate of return = money earned ÷ amount invested.

Risk

The degree of uncertainty associated with the return on an asset or its value.

Securitization

The process of taking an illiquid asset (or group of assets) and transforming it into an investment that can be sold or traded.

Subprime mortgages

Mortgages made to individuals with low incomes, few assets, and weak credit history — higher default risk than prime loans, sometimes with low introductory rates expected to rise later.