Chapter 7

Financial markets

Systems where financial assets (stocks, bond, etc.) are bought and sold.

Financial institutions

Organizations (banks, funds, etc.) that facilitate the flow of money in the economy.

Payments mechanism

Allows people and businesses to make transactions (credit cards, banks, etc.).

Savings vehicle

Provides a place to store money (banks accounts, investments).

Credit supplier

Provides loans to individuals and firms.

Wealth storehouse

Allows people to store wealth over time (stocks, bonds).

Liquidity source

Makes it easy to convert assets into cash quickly.

Risk reducer

Offers ways to reduce risk (diversification, insurance).

Policy vehicle

Used by governments/central banks to influence the economy (interest rates, money supply).

Deficit-budget unit

Spends more than it earns (needs to borrow money).

Balanced-budget unit

Spends exactly what it earns.

Surplus-budget unit

Earns more than it spends (has extra money to invest).

Direct transfer

Borrower receives funds directly from lender (no middleman).

Semi-direct transfer

Uses a broker to facilitate the transaction.

Broker

Connects buyers and seller but does not take ownership of funds.

Indirect transfer

Funds go through a financial intermediary (like a bank).

Financial intermediary

Institution that collects funds from savers and lends to borrowers.

Money markets

Markets for short-term debt (less than or equal to one year). Used for liquidity and short-term needs.

Capital markets

Markets for long-term debt and equity (greater than one year). Used for long-term financing.

Primary market

Market where new securities are issued and sold for the first time.

Investment banker

Helps companies issue new securities. Provides advice and analysis, underwrites securities (guarantees sale proceeds), organizes selling group, stabilizes market price after issue.

Underwriting

Investment bank guarantees the company will receive funds even if securities don’t sell.

Flotation cost

Cost of issuing new securities.

Components of flotation cost

Underwriting spread (managing fee, risk fee, selling concession), administrative costs (legal fees, SEC registration, printing, taxes). Higher risk=higher flotation cost.

Private Placement

Selling securities directly to investors without going public.

Advantages of private placement

Faster (no SEC registration), private (less disclosure), flexible terms, lower cost for small issues.

Secondary market

Market where existing securities are traded between investors.

Functions of secondary market

Permit trading (allows buying/selling of securities), provide information (prices and data are publicly available), create liquidity (makes it easy to sell investments), protect participants (regulated to prevent fraud), improve capital distribution (moves money to best uses).

New York stock exchange

Major physical stock exchange in the U.S.

NASDAQ

Electronic network where dealers trade securities.

Regional exchanges

Smaller domestic exchanges.

International exchanges

Markets in other countries.

Institutional block trading

Large trades handled separately (like primary markets).

Electronic communication networks (ECNs)

Private electronic systems for trading securities.

Market index

Tracks overall market performance.

Dow Jones index

Tracks major U.S. companies.

S&P index (standard & poor’s)

Broader measure of market performance

Composite index

Tracks multiple groups of stocks.

Multimarket index

Tracks across different markets.

Foreign index

Tracks markets outside the U.S.

Active investor

Attempts to outperform the market.

Technical investor

Focuses on price patterns and trends. Believes psychology drives short-term prices.

Fundamental investor

Focuses on intrinsic (true) value of a stock. Buys when value > price (margin of safety).

Passive investor

Avoids trying to beat the market. Markets are efficient, prices follow a “random walk,” invest in ETFs or index funds.

Algorithmic traders

Use computer programs to trade automatically.

Pros of algorithmic traders

High liquidity, consistency.

Cons of algorithmic traders

Potential unfair advantage, speed advantage.

Activist investors

Buy large stakes to influence company decisions.

Short-term activists

Focus on quick profits (corporate raiders, LBO firms).

Long-term activists

Focus on sustainable impact (pension funds, ESG investors).

Deposit intermediaries

Commercial banks, credit unions, accept deposits and make loans.

Contractural intermediaries

Insurance companies, pension funds, collect funds based on contracts.

Investment intermediaries

Mutual funds, pool money to invest in securities.

Amount intermediation

Combining small deposits into large loans.

Risk intermediation

Reducing risk through diversification.

Maturity intermediation

Matching short-term deposits with long-term loans.

Portfolio mix intermediation

Creating diversified investment portfolios.

Information intermediation

Providing expertise and financial analysis.