ECON 2035 Rakitan Exam 1

financial assets

an asset that represents a claim on someone else for a payment

types of financial assets

money, stocks, bonds, currency/foreign exchange, securitized loans

financial institutions

connects borrowers with lenders

financial intermediaries

a firm that borrows from savers and lends to spenders ; indirect = funds aggregated through a financial intermediary ; direct = funds given directly to the borrower

financial regulators

Federal Reserve System, Securities and exchange commission, federal deposit insurance corporation, office of the controller of the currency

US Federal Reserve System (The FED)

the "bankers' bank" = loans to banks ; lender of last resort ; deals with interest rates and money supply

Securities Exchange Commission (SEC)

financial markets regulator

Federal Deposit Insurance Corporation (FDIC)

Bank deposit insurance

Office of the Controller of the Currency

regulates federally chartered banks (but not state or other banks)

medium of exchange

anything that is used to determine value during the exchange of goods and services

unit of account

a means for comparing the values of goods and services

store of value

an item that people can use to transfer purchasing power from the present to the future

standard of deferred payment

money must also be acceptable to make purchases today that will be paid in the future

security

a financial asset that can be bought/sold on a financial market

consumption

real GDP @ the national level

money

the currency that facilitates exchanges/transactions

income

earnings/payment for a specific (often short) time period

wealth

the sum of incomes over many time periods

money aggregates

overall measures of the money supply ; M1 and M2

M1

cash + checking deposits

M2

M1 + less-liquid assets

return on investment

R = payment/(Po) + ΔP/Po

payment

any coupon, dividend, or other income paid by the investment during the period under consideration

Po

the purchase price of the investment

ΔP

the change in price of the asset during the period

expected value

E[R] = Pr[success] x Success + (Pr[fail]) x Rfail ; where Pr[fail] + Pr[success] = 1

variance

average squared deviation from expected value

variance equation

Pr[success] x (Rsuccess - E[R[)^2 + Pr[fail] x (Rfail - E[R])^2

what happens when two investments have the same expected value

higher variance = greater risk

monetary theory

the equation of exchange ; M x V = P x Y ⇒ M/P = Y ; M = money aggregate (money supply) ; V = velocity of money ; P = price level ; Y = rGDP

real interest rate

r = i - pi, where pi is the rate of inflation

present value

PV = future value/(1+r)^t

t-year coupon bond price

P = C/1+i + C/1+i^2 + C/1+i^3 ....

yield to maturity

interest rate (iy), that sets bond price equal to future stream of payoffs

maturity

time until face value payoff of a bond

present value formula (1 period)

PV = FV/1+r

financial liability

financial claim owed by a person or a firm

commercial banks

most important financial intermediaries ; takes deposits and invests them

investment banks

Doesn't take deposits but provides advice to firms about issuing stocks and bonds or considering mergers with other firms

mutual funds and EFTs

obtains money by selling shares to investors

hedge funds

accepts money from investors and uses the funds to buy portfolio assets

primary market

financial market where stocks bonds and other securities are sold for the first time

secondary market

financial market where investors buy and sell existing securities

transaction costs

the costs in time or other resources of marking a trade or exchange

checks

promises to pay on demand when money is deposited into a bank or another financial institution

velocity of money

PY/M

future value

the value at some future date of an investment made today

time value of money

the way that the value of a payment changes depending on when the payment is received

coupon bond

make interest payments in the form of coupons at regular intervals and repay the face value at maturity

capital gain

if the market price of an asset increases

capital loss

the market price of the asset decreases

rate of return

coupon + capital gain/purchase price

nominal interest rates

rates that are not adjusted for changes in purchasing power caused by changes in price level

real interest rates

adjusted interest rates

fisher effect

the nominal interest rate rises or falls point-for-point with changes in the expected inflation rate

Current yield

The expected annual coupon divided by the bond's purchase price

stock

A share of ownership in a corporation.

Bond

a formal contract to repay borrowed money with interest at fixed intervals

MxV=PxY

Relationship between the average turnover rate of individual units of currency in our economy

Insurance companies as financial intermediaries

Invest the premium payments from insurance buyers to earn a financial return,

then use this to pay out claims rather than rely on the saved premium payments

alone

Equation of exchange

%Δ𝑀 + %Δ𝑉= %Δ𝑃 + %Δ𝑌

Are stock market indexes adjusted for inflation

No

commodity money

objects that have intrinsic value -- value independent of its use as money

aggregate demand

the amount of goods and services in the economy that will be purchased at all possible price levels

risk-sharing

chance that asset value falls (negative capital gains)

consumption expenditure equation

Y = C̄ + mpc(Y-T) + I(r) + G + (X - M) ; C̄ + mpc(Y-T) = consumption expenditure ; I(r) = (real) interest rate ; G = gov. spending (fiscal policy) ; (X - M) = net exports

aggregate supply

total quantity of output or real GDP at a given price level