FI 301 EXAM I

financial market

a market in which tradeable financial assets, such as stocks and bonds, can be purchased or sold

surplus units

those who have excess funds

deficit units

those who needs funds

How do corporations and governments raise capital to finance spending/investment ?

issue securities

securities can be classified as

debt and equity securities

debt securities are composed of

bonds + money market securities

equity securities consist of

stocks

money market securities

debt securities that have a maturity if one year or less

capital market securities

equity or debt securities whose maturity, is greater than one year

stocks

represent partial ownership in the corporations that issued them

bonds

long-term debt securities

mortgages

long-term debt obligations created to finance the purchase of real estate

mortgage-backed securities

debt obligations representing claims on a package of mortgages

financial derivatives

financial contracts whose values are derives from the values of under

The 3 Types of derivatives

futures, options, and swaps

Futures

contracts to buy or sell an asset at a predetermined price on a specific future date

Options

contracts giving the buyer the right, but not the obligation on, to buy (call options) or sell (put options) an asset at a specific price before or on a specific date

Swaps

agreements to exchange cash flows between two parties over time

Primary markets

facilitate the issuance of new securities

Secondary markets

facilitate the trading of existing securities, which allows for a change in the ownership of the securities

T-bill

sold by one investor to another

market efficiency

degree to which securities are rationally priced

asymmetric info

information about a firm’s financial condition/ prospects that is not available to all investors

behavorial finance

irrational optimism/ fear can contribute to mispricing

Securities act of 1933

required complete and accurate disclosure of financial information on publicly offered securities

Securities Exchange Art of 1934

extended the disclosure requirements to secondary market issues

Sarbanes-Oxley Act of 2002

required that firms provide more complete and accurate financial information

depository institutions include:

• commercial banks

• savings institutions

• credit unions

source of capital

customer deposits are an important source of capital for depository institutions

use of capital

depository institutions make loans and purchase securities

savings institutions

concentrated on residential mortgage loans

credit unions

non profit organizations, restricts business to members with a common bond

Nonbanks include:

• Investment banks / securities firms

• Finance companies

• Mutual funds

• Insurance companies

• Pension funds

Investment banking activities:

underwriting, advisory

underwriting

place (find buyers for) newly issued securities

advisory

mergers, capital restructuring

Interest rates are both:

• rates borrowers pay when borrowing

• raters earned by creditors who lend

• think of an interest rate as a price

• prices are determined by supply + demand

As interest rates increase, borrowing becomes more

expensive

Interest rates affects the following securities:

Bonds, money market securities, mortgages, and stocks

Loanable Funds Theory

interest rate is determined by supply and demand for loanable funds

demand

borrowers wanting to borrow

supply

surplus units willing to provide capital in exchange for returns

Loanable funds demand coms from

households, businesses, government, and foreign countries

Who is the largest supplier of loanable funds ?

households

economic expansion includes

increased demand for loanable funds and more business investment due to higher CFs from projects

economic slowdown includes

reduced demand for loanable funds and fewer profitable investment opportunities for businesses

When inflation were expected to rise, borrowers would want to make purchases now before prices

increase

monetary policy

federal reserve adjusts money supply to change interest rates

When taxes on interest income increase, household will save

less

When foreign interest rates are low,

foreign investors will look to invest in other countries

crowding-out effect

excessive government demand for loanable funds tends to “crowd out” the private demand for funds

Federal funds rate

the interest rate that the Fed seeks to influence directly

The Fed has 5 major components:

1. Federal Reserve District Banks

2. Member banks

3. Board of Governors

4. Advisory committees

5. Federal Open Market Committee (FOMC)

How many federeal reserve district banks are there ?

12

The fed requires all commercial banks w/ national charter to be

members of the fed

The board of governors consists of

7 members

The federal reserve chairman sits for a term of how long ?

4 year term

Who sets the margin requirement ?

The board of governors

Open Market Operations consist of

the fed purchase of securities and therefore supply of loanable funds increases

Federal sale of securities

sells government securities, buyers pay money for securities, decreasing their bank deposits

Reserve requirement

the proportion of bank deposit accounts that must be held as required reserved or funds in reserve

Higher reserve ratio

less funds available to be loaned out

Lower supply of loanable funds typically mean higher

interest rates

Global monetary policy

each country has its own central bank that controls the money supply and monetary policy

The FOMC is responsible for determining

monetary policy

The Fed’s Goals are to:

achieve a low level of inflation and full employment

Primary indicators of economic growth:

GDP, National Income, and Unemployment rate

GDP

measures the total value of goods and services produces during a specific period

National Income

the total income earned by firms and individual employees during a specific period

Unemployment rate

maintain a low unemployment rate in the U.S.

Primary indicators of Inflation

CPI, PPI

Consumer Price Index (CPI)

tracks prices paid by consumers

Producer Price Index (PPI)

tracks prices paid by produces

Demand-pull inflation

when excess spending drives up prices

The Fed implements what kind of monetary pollicy ?

stimulative

The stimulative monetary policy that the Fed implements is intended to fight

high unemployment

recognition lag

the delay between the time a problem arises and the time it is recognized

implementation lag

the difference between the time a serious problem is recognized and the time the Fed implements a policy to resolve that problem

impact lag

until the policy has its full impact on the economy

strong economic conditions

low unemployment, but inflation tends to increase

weak economic conditions

high unemployment, but inflation tends to be low

A weak dollar can stimulate the economy by u.s. exports T/F

True

Economic problems can be fixed immediately T/F

False

The advisory committees consist of

federal advisory council, and community depository institution advisory council,

The current federal reserve chairman is

Kevin Warsh

Which bank is the most important of the Federal reserve district banks

NYC

Fisher effect

i = E (INF) + i^r (i = nominal rate of interest, E(INF) = expected rate of interest, i^r = real interest rate)