Lecture 1: Financial System & Interest Rates

These flashcards cover key vocabulary terms and definitions related to the financial system and interest rates, as discussed in the lecture.

Financial System

A network of financial institutions and markets that facilitates the exchange of funds between lenders and borrowers.

Financial Institutions (FI)

Institutions that manage financial transactions such as deposits, investments, and providing credit facilities, acting as intermediaries between lenders and borrowers.

Primary Market

A market in which new securities are created and then issued or sold for the first time to the public.

Initial Public Offering (IPO)

The first sale of stock by a company to the public, where new shares are issued.

Secondary Market

A market where previously issued securities are traded among investors.

Organized Security Exchanges

Formal and centralized organizations that facilitate the trading of securities through brokers.

Over-the-Counter (OTC) Market

A decentralized market where trading of securities occurs outside of formal exchanges.

Investment Banker (IB)

Financial specialists who underwrite and distribute new securities and advise corporate clients on raising funds.

Floatation Costs

Transaction costs incurred when a company raises funds by issuing a security.

Nominal Interest Rate

The interest rate quoted by banks, which has not been adjusted for inflation and is influenced by various risk premiums.

Real Risk-Free Interest Rate

The interest rate on a fixed-income security with no risk in a zero inflation environment.

Liquidity-Risk Premium

An extra return required by investors for securities that cannot quickly be converted into cash at predictable prices.

Term Structure of Interest Rates

The relationship between the interest rates of debt securities and the time until the debt matures.

What are interest rates?

Interest rates are the cost of borrowing money or the return on investment earned on savings, usually expressed as a percentage of the principal.

How do interest rates affect borrowing?

When interest rates are low, borrowing becomes cheaper, encouraging spending and investment. Conversely, high interest rates increase borrowing costs.

What is a nominal interest rate?

A nominal interest rate is the rate of interest before adjustments for inflation.

What is a real interest rate?

A real interest rate is the nominal interest rate adjusted for inflation, reflecting the true cost of borrowing.

What factors influence interest rates?

Factors influencing interest rates include inflation, monetary policy, economic conditions, and the demand for loans.

What is a central bank's role in setting interest rates?

A central bank sets interest rates to influence economic activity, control inflation, and stabilize the currency.

What is the difference between fixed and variable interest rates?

Fixed interest rates remain constant throughout the loan term, while variable rates can change based on market conditions.

How do interest rates impact savings?

Higher interest rates lead to greater returns on savings, encouraging individuals to save more.

What is the impact of interest rates on investment?

Higher interest rates can discourage investment due to increased borrowing costs, while lower rates encourage investment.