Studied by 16 people
Five core principles of money & banking
Time has value
Risk requires compensation
Information is the basis for decisions
Markets determine prices & allocation resources
Stability improves welfare
Participants of financial markets
Firms & individuals
Importance of financial markets
Financial markets are essencial to the economy, chanelling resources, minimizing cost of gathering information & making transactions.
Evolution of money
Money has evolved from coins and paper to electronic funds.
Functions of the financial system
saving money for the future
borrowing money for current use
rasing equity capital
exchanging assets for immediate & future deliveries
trading of information
Types of finance
direct & indirect
Direct finance
Borrowers sell securities directly to lenders
Indirect finance
An institution stands between the lender & borrower
Assets
something of value that you own
Liabilities
something you owe
Financial instruments
A legal obligation of one party to transfer something of value to another party at some future date under certain condiditons.
Uses of financial instruments
means of payment, store of value, transfer of risk
Characteristics of financial instruments
Standarization, communicate of information
Role of financial institutions
reduction of transaction & information costs, issuing of short-term liabilities & purchase of long-term loans
Financial industry structure
Depository institutions, insurance companies, pension funds, security firms, finance companies, goverment sponsored enterprises
Depository institutions
take deposit and make loans
Insurance companies
accept premiums, pay out based on events
Pension funds
invest contributions, provide payments to retirees
Security firms
provide access to financial markets
Finance companies
raise funds in financial markets, make loans
Government sponsored enterprises
raise funds in financial markets, make loans, provide guarantees
Primary capital markets
markets in which companies & governments raise capital
Most actively traded assets
securities, currencies, contracts, commodities
Securities
generally include debt instruments, equities & shares in pooled investment vehicles
Currencies
money issued by national monetary authorities
Contracts
agreements to exchange securities, currencies, commodities or other contracts in the future
Commodities
include precious metals, energy products, industrial metals & agricultural products
Real assets
tangible properties such as real estate, airplanes or machinery
Futures markets
markets that trade contracts that call for delivery in the future
Spot markets
markets that trade for immediate delivery
Options markets
trade contracts that deliver in the future, but delivery takes place only if the holders of the options choose to excercise them
Primary market
when issuers sell securities to investors
Secondary market
when investors sell securities to others
Money makrets
trade debt instruments maturing in one year or less
Capital markets
trade instruments of duration longer than a year
Traditional investments
include all publicly traded debts, equities and sheres in pooled investment vehicles
Alternative investments
include hedge funds, private equities, commodities, real estate securities & properties, securitized debts, operating leases, machinery, collectibles, precious gems
Securities
Organizations, companies & goverments sell them to raise money, include bonds, notes, commercial paper, mortgages, common stocks, preffered stocks
Fixed-income instruments
contractually include predetermined payment schedules
Equities
represent ownership rights in companies, include common and preffered shares
Common shareholders
own residual rights to the assets of the company
Prefered shares
equities that have preffered rights to the cash flows & assets of the company
Warrants
securities issued by a corporation that allow the holders to buy a security issued by that corporation
Pooled investment vehicles
mutual funds, trusts, depositories & hedge funds that issue securities that represent shared ownership in the assets that these entries hold
Mutual funds
Investment vehicles tht pool money from many investors for investment in a portfolio of securities
Open-end pooled investment vehicles
issue new shares & redeem existing shares on demand, usually on a daily basis
Closed-end pooled investment vehicles
issue shares in primary market offerings that the fund or its investment banks arrange, investor cannot sell their shares back to the fund
currencies
money issued by monetary authorities
contract
an agreement among traders to do something in the future
forward contract
an agreement to trade the underlying asset in the future at the price agreed upon today
swap contract
an agreement to exchange payments of periodic cash flows that depend on future asset prices or interest rates
commodity swap
one party typically makes fixed payments in exchange for payments that depend on future prices of a commodity such as oil
currency swap
the parties exchange payments denominated in different currencies
equity swap
the parties exchange fixed cash payments for payments that depend on the returns to a stock or stock index
credit deafult swap
insurance contract that promise payment of principal in the event that a company deafults on its bonds
option contract
allows the holder an option to buy or sell an underlying instrument at a specified price at or before the specified date in the future
call option
gives the buyer the option to buy shares at the strike price
put option
givesr the buyer the option to sell shares at the strike price
contract for difference
allow people to speculate on price changes for an underlying asset, such as a common stock or an index
commodities
include products such as precious metals, energy products, industrial metals, agricultural products, carbon credits
real assets
include tangible products such as real estate, airplanes, machinery, lumber stands
financial intermediaries
services and products that allow their clients to solve financial problems more efficiently that they would by themselves
investment banks
provide advice to their mostly corporate clients and help them arrange transactions such as initial and seasoned securities offerings
note
a legal document that serves as an IOU from a borrower to a creditor or to an investor
treasury note
a debt security backed by the full faith and credit of the United States government with a maturity between one and 10 years
municipal note
a short-term debt security issued by a local or state government, has a maturity from three months to three years
mortgage-backed note
a derivative whose value is derived from unpaid mortgages
structured note
a debt security issued by financial institutions, which return is based on equity indexes, a single equity, a basket of equities, interest rates, commodities or foreign currencies
brokers
agents who fill orders for their clients
exchanges
provide places where traders can meet to arrange their trades
alternative trading systems
also known as electronic communications networks or multilateral trading facilities are trading venues that function like exchanges but that do not excercise regulatory authority over their subscribers
dealers
fill their clients’ orders by trading with them
securitization
the process of buying assets, placing them in a pool, and then selling securities that represent ownership
depository institutions
include commercial banks, savings and loan banks, credit unions and similar institutions that raise funds from depositors and other investors and lend it to borrowers
insurance companies
companies that help people and companies offset risks that concern them
insurance contract
transfers risk from those who buy the contract to those who sell them
credit deafult swap
is also an insurance contract, but historically they have not been subject to the same reserve requirements that most governments apply to more traditional insurance contracts
arbitrageurs
trade when they can identify opportunities to buy and sell identical or essentially similar instruments at different prices in different markets
clearinghouses
arrange or final settelment for trades, guarantee futures contract performance and in other markets may act only as escrow agents
long position
people have that position when they own assets or contracts
short position
people have that position when they have sold assets that they do not own or when they write and sell contracts
levraged position
in many markets traders can buy securities by borrowing some of the purchase price
the leverage ratio
the ratio of the value of the position to the value of the equity investment in it
order
consists of instructions to a broker or brokerage firm to purchase or sell a security on an investor's behalf
well-functioning financial system
a system in which investors xan easily move money from the prestent to the future at a fair rate of return, borrowers can obtain funds that they need, hedgers can trade away or offset the risk that concerns them and traders can easily trade currencies for other currencies or commodities that they need
index
represents a given security market, market segment or asset class, often constructed as portfolios of marketable securities
price return index
reflects only the prices of the constituent securities within the index
total return index
reflects not only the prices of the constituent securities but also the reinvestment of all income received since inception
index weighting
the weighting decision determines how much of each security to include in the index and has a substantial impact on an index’s value
price weighting
the simplest method to weight an index, the weight on each constituent security is determined by dividing its price by the sum of all the prices of the constituent securities
equal weighting
assigns an equal weight to each constituent security at inception
market-capitalization weighting
the weight on each constituent security is determined by dividing its market capitalization by the total market capitalization of all the securities in the index
fundemental weighting
weighting attempts to address the disadvantages of market-capitalization weighting by using measures of a company’s size that are independent of its security price to determine the weight on each constituent security
rebalancing
refers to adjusting the weights of the constituent securities in the index
reconstitution
is the process of changing the constituent securities in an index, it is similar to a portfolio manager deciding to change the securities in his or her portfolio
Note 
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