Financial Markets and Institutions: Key Concepts and Risks

Primary market

Where new securities are issued (IPOs)

Secondary market

Where existing securities are traded

Money markets

Short-term debt (≤ 1 year), low risk

Capital markets

Long-term securities (> 1 year), higher risk/return

Commercial banks

Take deposits and make loans

Thrifts

Savings institutions (S&Ls, credit unions)

Insurance companies

Protect against financial risk

Investment banks

Help firms issue securities

Finance companies

Provide loans to individuals/businesses

Investment funds

Pool money to invest

Pension funds

Retirement savings institutions

FinTech

Technology-based financial services

Credit risk

Borrower may not repay

Interest rate risk

Changes in rates affect value

Liquidity risk

Can't meet short-term obligations

Market risk

Asset prices fluctuate

Insolvency risk

Not enough capital to cover losses

Supply of funds

Increases when interest rates rise

Demand of funds

Increases when interest rates fall

Required rate of return

What investor should earn

Expected return

What investor expects to earn

Realized return

Actual return earned

Coupon rate

Bond's interest payment rate

Federal Reserve

Central bank of the U.S.

FOMC

Main monetary policy group

Open market operations

Buying/selling securities

Discount rate

Interest rate charged to banks

Reserve requirements

% of deposits banks must hold

Treasury bills

Short-term government debt

Federal funds

Overnight bank loans

Repurchase agreements (repos)

Sell securities with agreement to repurchase

Commercial paper

Short-term corporate debt

Negotiable CDs

Tradable bank deposits

Banker's acceptances

Bank-guaranteed payments

Bond

Long-term debt security

Treasury bonds/notes

Government-issued, no default risk

Municipal bonds

State/local government bonds with tax advantages

Corporate bonds

Bonds issued by companies

AAA rating

Lowest risk bond rating

Junk bonds

High risk, high return bonds

Mortgage

Loan backed by real estate

Fixed-rate mortgage

Interest rate stays constant

Adjustable-rate mortgage

Rate changes with market

Fully amortized loan

Paid off over time

Balloon mortgage

Large final payment

Home equity loan

Borrow against home value

Second mortgage

Loan on already mortgaged property

Securitization

Pooling loans and selling as securities

Stock

Ownership in a company

Common stock

Stock with voting rights

Preferred stock

Stock with fixed dividends

IPO

First public sale of stock

Dividends

Payments to shareholders

Limited liability

Investors not personally liable

Assets (banks)

Loans and securities

Liabilities (banks)

Deposits and borrowings

Transaction deposits

Checking accounts

Savings deposits

Interest-bearing accounts

Time deposits (CDs)

Fixed-term deposits

Liquidity risk (banks)

Inability to meet withdrawals

Credit risk (banks)

Loans not repaid

Interest rate risk (banks)

Rate changes hurt balance sheet

Capital adequacy

Bank's capital strength (CAMELS)

Asset quality

Loan quality (CAMELS)

Management

Leadership effectiveness (CAMELS)

Earnings

Profitability (CAMELS)

Liquidity

Ability to meet short-term needs (CAMELS)

Sensitivity to risk

Exposure to market changes (CAMELS)

CAMELS 1

Strong bank

CAMELS 5

Likely failure

Loan commitments

Promise to lend in future

Letters of credit

Payment guarantees

Derivatives

Contracts based on asset values

FDIC

Insures deposits

OCC

Regulates national banks

Savings associations

S&Ls focused on mortgages

Savings banks

Banks focused on residential lending

Credit unions

Nonprofit, member-owned institutions

Common bond requirement

Members must share connection

Sales finance companies

Loans tied to products

Personal finance companies

Consumer lending

Business finance companies

Corporate lending/leasing

Insurance

Protection against financial loss

Life insurance

Covers death and retirement risks

Property-casualty insurance

Covers accidents and damages

Underwriting

Evaluating risk for insurance

Annuities

Provide retirement income

Investment banking

Raising capital for firms

Underwriting (securities)

Guaranteeing sale of securities

Brokerage services

Buying and selling securities

Venture capital

Investing in startups

Private equity

Investing in established firms

Mutual fund

Pooled investment fund

Open-end fund

Issues/redeems shares anytime

Money market mutual funds

Short-term investments

Equity funds

Invest in stocks

Bond funds

Invest in bonds

Hedge funds

High-risk pooled investments

Hedge fund strategies

Short selling, leverage, derivatives

Pension fund

Retirement savings plan