Financial Markets and Institutions Practice Flashcards

A comprehensive set of vocabulary flashcards covering basic money definitions, banking institutions, credit instruments, regulation, capital markets, and derivative valuation based on the finance lecture notes.

Fiat Money

What a government determines as money; the government declares it to be legal tender, requiring all people and firms to accept it as a means of payment.

Fiduciary Money

Money that takes value because of the confidence of the public that it will be generally accepted as a medium of exchange; the issuer promises to exchange it back for a commodity or fiat money.

Commercial Bank Money

Claims against financial institutions that can be used to purchase goods or services, specifically money on a sight account at a bank.

Central Bank Money

Money that constitutes a direct claim on the assets of the Central Bank, such as coins and bills.

Electronic Money (e-money)

An electronic store of monetary value on a technical device that may be used for making payments to entities other than the issuer, acting as a prepaid bearer instrument.

$$M1$$

The money supply in a narrow sense, containing currency in circulation plus overnight deposits.

$$M2$$

The money supply that includes financial assets not immediately redeemable but that can be swiftly turned into transaction money; also known as near money.

$$M3$$

The broadest definition of money, containing all sorts of financial assets held outside of the banking system.

Base Money

All liabilities the monetary authorities have vis-à-vis the banks and the general non-bank public, including bank reserves ($R$).

Transaction Demand for Money

The demand for cash influenced by income ($Y$) and wealth ($W$), where higher values increase consumption but also increase savings.

Interest Rate Opportunity Cost

The rental income forgone by consuming instead of saving; higher rates lead to a lower preference for cash ($dk/di < 0$).

Reserve Coefficient Opportunity Cost

The cost of keeping cash on the balance sheet that does not generate income from loans, influenced by the interest rate ($dr/di < 0$).

Investment Bank

An institution covering diverse activities such as supplying venture capital, issuing equity or bonds for third parties, advising on mergers/IPOs, and trading securities.

Venture Capitalists

Entities that supply money to start-ups in exchange for equity and often provide management assistance to realize profit through added value.

Seed Money

Capital injected into a company during the first phase to permit the realization of a concept.

Mezzanine Financing

Funding for companies beyond break-even generating positive cashflows, but not yet established enough for regular capital market bonds or equity.

Holdings

Companies whose purpose is to buy other companies, often holding controlling stakes to generate a stream of dividends.

Portfolio Management

The discretionary management of assets for institutional investors or wealth clients, compensated through a yearly fee on total assets under management.

Branch 21

Life insurance with periodic premium payments considered an investment product yielding a guaranteed minimum return.

Branch 23

Insurance tied to a fund where the return depends solely on the underlying investment portfolio with no guaranteed return.

REITs (Real Estate Investment Trusts)

Typical examples of closed funds created with a predetermined number of shares that invest in real estate assets.

Shadow Banks

Institutions that perform credit intermediation or non-bank financial intermediation without a banking licence.

External Financing

The system of attracting funds from another economic agent (third party) using contracts specifying reimbursement and remuneration.

Internal Financing

The act of saving current income to spend later without engaging a third party; companies typically use this before borrowing because it is cheaper.

Bank Intermediation

The process where banks attract deposits at predetermined rates and grant loans in their own name, absorbing all risks.

Covenants

Clauses in contracts that limit what a borrower can do after a loan or bond is given, such as an interest rate coverage ratio relating payments to $EBITDA$.

Indirect Financing

Financing that involves balance sheet intermediation and asset transformation by an institution between the lender and borrower.

Overnight Accounts

Deposits that are immediately redeemable and have no maturity, used primarily for transactions.

Current Account

An overnight account specifically for corporations, often connected to a credit line or overdraft facility.

Sight Deposit

An overnight account intended for retail clients.

$$SEPA$$

The Single European Payment Area, which utilizes a unified international bank account number ($IBAN$) system.

Savings Deposits

Non-maturing deposits that, in Belgium, must meet specific conditions regarding return, limited transactions, and offering types to be regulated.

Term Accounts

Deposits with a determined maturity (such as $1\text{ week}$ or $1\text{ month}$) remunerated at a rate fixed by the tenor of the loans.

Cash Bonds

Interest-bearing savings certificates with a predetermined coupon and a fixed term.

Capitalisation Bond

A savings certificate where the interest is reinvested at the coupon rate and paid in one lump sum at maturity.

Commercial Paper ($CP$)

Short-term securities issued by a non-financial corporate; also known as treasury notes.

Overdraft

A funding instrument tied to a current account allowing a company to withdraw funds up to a specified amount, incurring a reservation fee and credit premium.

Straight Loan

A fixed-term advance (short-term loan) with a predetermined interest rate and a term typically limited to a maximum of $1\text{ year}$.

Investment Loan

A long-term loan (typically $3$ to $15\text{ years}$) charged as the sum of a market rate and a credit spread, used to fund investments.

Roll-over Credit

A credit facility where long-term loans are drawn as a sequence of straight loans, providing flexibility in timing and amount.

Operational Leasing

A contract where the lessor is the lawful owner, maintains the good, and retains part of the economic property.

Financial Leasing

A contract where the lessor is the lawful owner but the economic property is transferred in full to the lessee.

Factoring

A service where a company collects invoices on behalf of a corporate, allowing the corporate to receive immediate cash and eliminate non-payment risk.

Off-balance Sheet Items

Items like liquiditiy lines that do not trigger real cash flows until drawn but represent potential contractual obligations and risks.

Contagion

The phenomenon where the bankruptcy or failure of one bank drags other banks into systemic trouble through interconnections.

Moral Hazard

The risk that a measure with good intentions, like a deposit guarantee, leads to riskier behavior by banks because they feel protected.

Adverse Selection

A situation caused by asymmetric information where regulation deters some players while others find means to circumvent rules.

Deposit Guarantee Scheme

A system that guarantees deposits (up to $\text{EUR } 100,000$ in the $EU$) even if the institution is in trouble to prevent bank runs.

Prudential Supervision

Surveillance aimed at ensuring banks can meet financial obligations, split into micro (stability of the institution) and macro (sector-wide risks) facets.

$$Basel\text{ }III$$

International banking standards introduced after the $2008$ crisis requiring banks to hold significantly more equity.

Risk Weighted Assets ($RWA$)

The sum of exposures where the nominal amount of each asset is multiplied by a risk weight factor capturing its risk.

Probability of Default ($PD$)

One of the three key concepts in credit risk, representing the likelihood of a borrower's failure.

Exposure at Default ($EAD$)

The amount of claim on a borrower at the time of failure, taking the credit line size into account.

Loss Upon Default ($LGD$)

The amount the bank is in danger of losing in case of default after considering collateral.

$$SREP$$

The Supervisory Review and Evaluation Process, a summary of a supervisor's analysis of a bank's risk management and capital buffers.

Core Equity Tier 1 ($CET1$)

The highest quality of capital, typically stock traded on an exchange with no due date and no guaranteed interim payments.

Liquidity Coverage Ratio ($LCR$)

A ratio that must be at least $100\text{\%}$, ensuring banks can absorb a $30\text{-day}$ liquidity run-off.

Net Stable Funding Ratio ($NSFR$)

A ratio aimed at managing liquidity outflows over a $1\text{ year}$ time horizon, requiring a minimum of $100\text{\%}$.

$$MIFID\text{ }2$$

European regulations governing market behavior and the relationship with private clients, involving duties of advice and care.

Lender of Last Resort

The role of the Central Bank providing ultimate liquidity or emergency lending to institutions in trouble.

Resolution

A process allowing a bank to be dissolved in an orderly manner using bail-ins from creditors without defaulting into bankruptcy.

Bail-in

A principle where capital and debt (bonds) are used to write off losses, sometimes converting debt into shares, but never applied to retail deposits.

The Doom Loop

A vicious cycle where banks invest in their government's bonds, and as the government's credit quality falls due to propping up banks, the value of those bonds decreases, worsening the bank's solvency.

$SSM$ (Single Supervisory Mechanism)

A system where the $ECB$ regulates large system banks and National Competent Authorities regulate smaller banks to reduce failure risk.

$SRM$ (Single Resolution Mechanism)

A mechanism to deal with bank failures efficiently with minimal cost to society, including tools like bridge banks and asset separation.

Primary Market

The market where new securities are created through a contract between the debtor and the initial creditors.

Secondary Market

The market where initial investors transact and trade bond or share positions with each other after the first day of issuance.

Face Value

The nominal or notional amount of a loan that is paid back to the investor on the final expiry day.

Foreign Bonds

Bonds issued in a home market by a foreign institution, regulated by the home country's legislation.

Euro Bonds

Bonds issued by international companies in the euro area, expressed in euro, and internationally marketable.

Subordinated Bonds

Bonds used first to compensate for losses after capital is exhausted; they offer higher coupon rates due to increased risk.

Senior Bonds

Safer bonds that incur losses only after subordinated bonds are exhausted, resulting in lower coupon rates.

Bid-Offer Spread

The difference between the ask (offer) price and the bid price, covering market maker costs and price volatility risk.

Investment Grade

A rating category ranging from $AAA$ (exceptionally strong) to $BBB\text{-}$ (acceptable) representing low probability of default.

Junk Bonds

Speculative grade bonds (rated $BB+$ and below) representing weaker companies with higher default risks.

Zero Coupon Bond

A bond that has no intermediate coupons and pays out a single sum of money on the final expiry day.

Spot Interest Rate

An interest rate with a $1$ to $1$ relationship with maturity, allowing the calculation of the value of money at a specific future time.

Yield Curve

The term structure of interest rates capturing the relationship between interest rates and maturity.

Bootstrapping

A method used to derive spot interest rates from market prices.

Price-Book Value ($P/B$)

A valuation approach comparing market price to the accounting value of equity divided by the number of shares.

Price-Earnings Ratio ($P/E$)

A ratio indicating how many times the current price covers current profit; its inverse is the earnings yield.

Dividend Yield

The ratio of the dividend paid per share to the current market price of the stock.

Gordon Shapiro Formula

A simplified Dividend Discount Model assuming a fixed growth rate ($g$) to calculate the equilibrium price of a share.

Enterprise Value

The total value of a company calculated by discounting cash flows at the weighted cost of capital before deducting total debt.

Passive Management

An investment strategy aiming to approach index performance as closely as possible, often through index replication.

Active Management

A labor-intensive investment strategy that attempts to outperform the stock exchange or benchmark index.

$ETF$ (Exchange Traded Fund)

An investment fund that copies an index and is continuously tradable on the stock exchange.

Beta ($\beta$)

A measure of a stock's volatility compared to the market index; estimated by regression analysis usually over $60\text{ months}$.

Defensive Stocks

Stocks that generally fluctuate less than the index, characterized by a beta ($\beta$) lower than $1$.

Aggressive Stocks

Stocks that move more than the index, typically having a beta ($\beta$) higher than $1$.

Style Rotation

An active management technique switching between small/large cap stocks or growth/value stocks based on economic conditions.

Section Rotation

An active management technique where sectors are selected according to their performance in different phases of the economic cycle.

Technical Analysis

The study of past price behavior patterns (trend lines, resistance points) to predict future price developments.

Futures Contract

A standardized contract on a regulated market relating to a transaction at a specified time and cost in the future.

Clearing House

An intermediary in futures markets that fixes margins to minimize counterparty risk between buyers and sellers.

Mark to Market

A technique where profit and loss on contracts are followed daily, and extra margins are requested to ensure commitments are fulfilled.

Open Interest

The total number of open contracts in a market, providing an indication of liquidity.

Basis

The difference between the cash (spot) price and the future price of an asset.

Hedging

An investment strategy using derivatives to limit risks or fix the purchase price of an instrument.

Call Option

A financial contract giving the buyer the right (but not the obligation) to buy an asset at a defined exercise price.