Chapter 15: The Financial Sector

Vocabulary flashcards covering the key concepts, institutions, market structures, valuation methods, and financial theories from Chapter 15: The Financial Sector.

Maturity Transformation

The practice of using short-term loans or deposits to make long-term loans.

Bank Run

A situation occurring when many bank customers try to withdraw their savings at the same time.

Interference Principle

The idea that your best choice depends on what others will do, and vice versa, which can generate self-fulfilling panics.

Deposit Insurance

A government guarantee that you won't lose the money you deposit in the bank, covering up to $250,000$ per account.

Shadow Banks

Financial firms that act like banks by taking funds from investors to make longer-term investments, but do not have to follow the same rules as traditional banks and lack deposit insurance.

Bond

An IOU; specifically, a promise to pay back a loan with interest.

Issuer

The borrower who creates and sells a bond.

Principle (Bond)

The amount of borrowed money that must be repaid on a bond.

Maturity Date

The due date for the repayment of a loan or bond principal.

Coupons

The periodic interest payments paid to a bondholder along the way before the bond matures.

Liquidity

The ability to quickly and easily convert your investments into cash, with little or no loss in value.

Default Risk

The risk that a borrower goes bust and fails to repay their debt.

Term Risk

The risk that arises when there is uncertainty about future interest rates over the duration of a loan.

Liquidity Risk

The risk that arises when your bond or asset will be hard to sell quickly for a good price.

Treasuries

Bonds issued by the U.S. government, recognized as the safest and most heavily traded bonds in the world.

Stock

A security that represents partial ownership in a firm; also referred to as a share.

Dividends

A share of profits that a company pays out directly to its shareholders.

Initial Public Offering (IPO)

An occasion when a company first sells stock directly to the public.

Stock Market

The market where people buy and sell existing, pre-owned stocks.

Ticker

The official nickname or abbreviation assigned to identify a stock on an exchange.

Market Capitalization

The total market value of a firm, calculated as: $\text{Number of shares} \times \text{Stock price}$.

Dividend Yield

A metric that measures the annual return from holding a stock, calculated as: $\frac{\text{Dividends}}{\text{Stock price}}$.

Price-Earnings Ratio (P/E Ratio)

The ratio of a firm's stock price to its annual profit per share, calculated as: $\frac{\text{Price per share}}{\text{Earnings per share}}$.

Fundamental Value

The present value of the future profits that a company will earn.

Fundamental Analysis

An approach used to value financial assets by forecasting future profits, discounting them, summing them up, and assessing whether a stock's price is below its fundamental value.

Relative Valuation

An assessment of the value of an asset by comparing it to similar assets, typically using financial ratios like price-to-book and price-to-earnings.

Book Value Per Share

A measure of a business's net assets per share, calculated as total assets less liabilities divided by total shares.

Price-to-Book Ratio

A ratio that measures a firm's stock price relative to its net assets per share, calculated as: $\frac{\text{Price per share}}{\text{Book value per share}}$.

Efficient Market Hypothesis

The theory that, at any point in time, stock prices reflect all publicly available information.

Random Walk

A pattern where a financial price follows an unpredictable path because forward-looking traders eliminate all predictable price changes.

Mutual Fund

A pooled fund that buys a portfolio of stocks, and sometimes bonds, on your behalf.

Actively Managed Mutual Fund

A fund managed by professional stock pickers seeking to beat the market, typically charging higher fees.

Index Fund

A mutual fund that automatically tracks and purchases every stock in a broad market index, such as the S&P 500, with low fees.

Speculative Bubble

A situation when the price of an asset rises above what appears to be its fundamental value and inflates until it bursts.

“Greater Fool” Theory

The idea that people buy an asset because they expect other people to buy it from them later at a higher price.