BUSI 321 - Exam 2 Terms

Open market operations

The Fed buying or selling Treasury securities; the main tool to change the money supply.

Discount rate

The interest rate the Fed charges banks that borrow from its discount window.

Required reserve ratio

The fraction of deposits banks must hold in reserve and cannot lend out.

Contractionary policy

Fed actions to fight inflation: sell securities, raise the discount rate, raise reserves.

Expansionary policy

Fed actions to stimulate the economy: buy securities, lower the discount rate, lower reserves.

Federal Open Market Committee (FOMC)

The Fed body that sets monetary policy and directs open market operations.

Money supply target

When money demand falls, the Fed must shrink money supply to hold the interest-rate target.

Deposit (money) multiplier

The factor 1 / required reserve ratio showing how deposits expand through the banking system.

Excess reserves

Reserves a bank holds above the required minimum; the portion available to lend.

Money market

Market for debt securities with original maturities of one year or less.

Treasury bill

Short-term U.S. government debt sold at a discount; the safest money market security.

Federal funds

Overnight loans of reserves between banks; the fed funds rate is a key policy benchmark.

Repurchase agreement (repo)

A short-term collateralized loan: sell a security now and buy it back later at a set price.

Commercial paper

Short-term unsecured debt issued by large, creditworthy corporations.

Negotiable CD

A large-denomination bank time deposit that can be traded in the secondary market.

Banker's acceptance

A short-term, bank-guaranteed payment instrument used in international trade.

Discount yield

i_d = ((Pf - P0)/Pf) x (360/n); the quoting convention for T-bills using a 360-day year.

Bond-equivalent yield

i_be = ((Pf - P0)/P0) x (365/n); return based on price paid and a 365-day year.

Effective annual return (EAR)

(Pf/P0)^(365/n) - 1; the true annual return accounting for compounding.

Discount security

A security sold below face value that pays no coupon; return is the gain to par.

Eurodollars

U.S. dollar deposits held in banks outside the United States.

Liquidity

How quickly and cheaply a security can be converted to cash without losing value.

Bond market

The capital market where long-term debt (over one year) is issued and traded.

Treasury note / bond

Long-term U.S. government debt; notes 2-10 years, bonds over 10 years.

Municipal bond

Debt issued by state or local governments; interest is usually exempt from federal tax.

General obligation bond

A muni backed by the full taxing power of the issuer.

Revenue bond

A muni repaid only from the revenue of a specific project it financed.

Corporate bond

Long-term debt issued by a company; higher risk and yield than government bonds.

Indenture

The legal contract specifying a bond's terms, covenants, and the bondholders' rights.

Firm commitment

Underwriting where the bank buys the whole issue and bears the resale risk.

Best efforts

Underwriting where the bank only acts as agent and sells what it can, with no guarantee.

Callable bond

A bond the issuer can redeem early (usually when rates fall); pays a higher coupon.

Convertible bond

A bond that can be exchanged for a set number of the issuer's shares; pays a lower coupon.

Sinking fund

A provision requiring the issuer to set aside money to retire bonds early, lowering default risk.

Treasury quote (32nds)

Prices quoted in 32nds of a point; 97:16 = 97 + 16/32 = 97.50% of par.

Bid price

The price a dealer will pay to buy a security from you.

Ask price

The price a dealer will sell a security to you.

Taxable-equivalent yield

Muni rate / (1 - tax rate); the pretax yield a taxable bond needs to match a muni.

After-tax yield

Corporate rate x (1 - tax rate); the return kept after taxes.

Default risk premium

Extra yield demanded to compensate for a borrower's chance of not repaying.

Mortgage

A long-term loan secured by real property, repaid through amortized payments.

Securitization

Pooling loans like mortgages and repackaging them into tradable securities sold to investors.

Lien

The lender's legal claim on a property, giving the right to foreclose if the borrower defaults.

Conventional mortgage

A mortgage not government-insured; typically needs a 20% down payment to avoid PMI.

Private mortgage insurance (PMI)

Insurance a borrower pays when the down payment is under 20%, protecting the lender.

Adjustable-rate mortgage (ARM)

A mortgage whose rate resets periodically; the borrower suffers when rates rise.

Fixed-rate mortgage

A mortgage with a locked rate; the lender suffers when market rates rise above it.

Amortization

Paying off a loan through regular payments split between principal and interest.

Discount points

Upfront fees paid to the lender to buy down the mortgage interest rate.

15- vs 30-year mortgage

15-year: higher payment, far less total interest; 30-year: lower payment, much more interest.