Money and Banking Exam Review

Economies of Scope

Saving money by offering multiple products or services together

Adverse Selection

BEFORE a transaction, people with higher risk are more likely to seek a transaction

Moral Hazard

AFTER a transaction, occurs when someone takes on more risk because they don’t bear the full cost of their actions

Asymmetric Information

When one person in a transaction knows more info than the other person

Liquidity Services

FI’s help people access their money when they need it

Why do FI’s reduce transaction costs?

To make transactions easier, faster, and less expensive for people

Risk Sharing

Instead of investing all of your money in one company’s stock, it is pooled and invested in many different companies to balance any loss

Mutual Fund

an investment that pools money from many investors to buy stock, bonds, assets

Asset Transformation

bank lends money from many depositors to different borrowers, spreading risk across multiple loans

Diversified

Assets are spread across different investments instead of all in one (spreading risk)

Eurobond

Bond sold in a foreign country and denominated in a currency different from that country’s currency

Eurodollars

U.S. dollars deposited in banks outside the U.S.

Foreign Bonds

a bond sold in a foreign country and denominated in another country’s currency

Foreign Exchange

The exchange of one country’s currency for another country’s currency

The Fed

the central banking system of the United States

Monetary Policy

actions taken by the Fed to influence interest rates and the money supply

Money Market

market for short-term debt instruments with maturities <1 year

Capital Market

market for long-term debt instruments and equities and maturities of >1 year

Debt Instrument

Financial contracts where a borrower agrees to repay borrowed money with interest (bonds and loans)

Cash Flow

the money you receive and when you receive it

Treasury Bills (T-bills)

The government borrows money from investors

Mortgage

borrow money to buy a house, which you repay over time

Loan Principal

The amount originally borrowed

Maturity Date

The date the loan must be repaid

Loan Term

The time from when the loan begins to its maturity

Simple Loan

A loan must be repaid with one payment covering the principal and interest

Fixed Payment Loans

A loan repaid through multiple payments that cover principal and interest

Installment Loan

A loan must be repaid in regular payments (car loans & home mortgages)

Demand for Bonds

How willing are investors to buy bonds

Fisher Effect

When expected inflation increases, nominal interest rates increase similarly

Nominal Interest Rate

not adjusted for inflation

Real Interest Rates

adjusted for inflation

Federal Funds

Short-term funds transferred (loaned/borrowed) between financial institutions for one day

• Used by banks to meet short-term needs and meet Fed requirements

Repurchase Agreements (Repos)

A short-term borrowing agreement in which a borrower sells securities to a lender and agrees to buy them back later at a higher price

• The higher price is effectively the interest payment

Negotiable Certificates of Deposits (CD’s)

A short-term deposit issued by a bank that pays interest and can be sold to another investor before it matures

Commercial Paper

Short-term, unsecured debt issued by large companies to borrow money

• A company borrows money from investors to pay its bills until customers pay them back

Bankers’ Acceptance (BA’s)

A short-term debt instrument in which a bank guarantees payment of a future amount

• Used in international trade

Direct Finance

When borrowers get funds directly from lenders by selling securities, such as stocks or bonds, without using a financial intermediary to make the loan

Indirect Finance

When funds move from lenders to borrowers through a financial intermediary, such as a bank or mutual fund

Equity Market

Investors buy and sell ownership shares (stocks) in companies

Primary Market

The market where new securities are sold for the first time to raise money for the company or government issuing them

• The company or issuer receives the funds

Secondary Market

The market where existing securities are bought and sold between investors after they have already been issued

• The investor selling the security receives the funds, not the company

Brokers

Agents who help buyers and sellers trade securities and earn a commission or fee for arranging the transaction

Dealers

Individuals or firms who buy and sell securities for their own accounts, earning money from the difference between buying and selling prices

Exchanges

Trades conducted in central locations (EX: New York Stock Exchange)

Over-the-Counter (OTC) Markets

Dealers are different locations buy/sell (market for treasury securities)

Examples of Money Market

Treasury Bills, Certificates of Deposit (CDs), Repurchase Agreements (repos)

Examples of Capital Market

Stocks, corporate bonds, and government bonds

Eurocurrency Market

A market where currencies are deposited and lent outside their home country

World Stock Markets

Stock markets around the world, where investors buy and sell companies

Dow Jones

An index of the 30 largest publicly traded corporations in the United States

S&P 500

An index of 500 of the largest companies traded in the United States maintained by Standard & Poor’s.

NASDAQ Composite

Where most of the technology stocks in the United States are traded

Relative decline of U.S. Capital Markets

• New technology in foreign exchanges

• 9/11 made U.S. regulations tighter

• Greater risk of lawsuits in the U.S.

• SOX has increased the cost of being a U.S. listed public company

SOX (Sarbanes-Oxley Act)

A law passed in 2002 to improve the accuracy of companies’ financial reporting and prevent accounting fraud

Depository Institutions

Commercial banks, savings and loans, mutual savings banks, credit union

Contractual Savings Institutions

Life insurance, fire & casualty insurance, pension funds, retirement funds

Investment Intermediaries

Finance companies, mutual funds, money market mutual funds

Thrifts

Financial institutions that mainly take savings deposits and use that money to make loans, especially home mortgages

(there’s three types)

Savings and Loan Associations (S&Ls)

Accept deposits and primarily make home mortgage loans (a type of thrift)

Mutual Savings Banks

Accept deposits and use them to make loans, especially mortgages. They are owned collectively by their depositors

Credit Unions

Accept deposits and make loans to their members, who often share a connection, such as working for the same company

Hedge Funds

Investment funds that pool money from investors and use more complex, flexible, and often riskier strategies to try to earn high returns

Securities and Exchange Commission (SEC)

Regulates securities markets and protects investors

Commodities Futures Trading Commission (CFTC)

Regulates futures and derivatives markets

Office of the Comptroller

Regulates national banks

National Credit Union Administration (NCUA)

regulates credit unions and insures their deposits

State Banking and Insurance Commissions

Regulate banks and insurance companies at the state level

Federal Deposit Insurance Corporation (FDIC)

Insures bank deposits

Coupon Bond

Pays regular interest and repays face value at maturity.

Discount Bond

Sold below face value and pays face value at maturity (ex: Treasury bills)

Rate of Return

Total gain or loss on an investment over a period

• (gain or loss)/initial investment x 100

Reinvestment Risk

Risk that future payments must be reinvested at a lower interest rate than expected

Duration

Measures how sensitive a bond’s price is to changes in interest rates

• Higher interest rate risk = higher duration

Standard Deviation

Measures how much returns vary from the expected returns

• Higher SD, higher risk

When bond is at par…

yield = coupon rate

Negative Return

When an investment loses value, meaning you lose money instead of earning money

Risk Premium

The extra return an investor expects for taking on more risk

Interest-Rate Ceilings

Government-imposed limits on the interest rates banks could pay depositors historically

Restrictions on Entry

Rules about who can start a financial institution, like a bank

Disclosure

Requiring financial institutions to provide accurate information about their finances

Restrictions on Assets & Activities

Limits on what financial institutions can invest in or do

Deposit Insurance

Protects depositors’ money up to a certain limit if their bank falls

Limits on Competition

Eules that limit competition between financial institutions to maintain stability

Restrictions on Interest Rates

Rules that limit the IR banks can charge borrowers or pay depositors

Zero-Coupon Bonds

Bonds that pay no regular interest but are sold at a discount and pay their full face value at maturity

FINRA

regulates brokerage firms and brokers

CFPB

protects consumers using financial products and services

SEC

regulates securities markets and protects investors

CFTC

regulates futures and derivatives markets

OCC

supervises federally chartered banks

NCUA

regulates and insures eligible federal credit unions

FDIC

insures bank deposits and supervises insured banks

Credit Union

A financial institution owned by its members that accepts deposits and makes loans, usually offering lower fees and better interest rates than banks

Sovereign Governments

governments that issue bonds, like Treasury Bonds

Government agencies, municipalities, and local govs

organizations that issue bonds to fund projects and services

Supranational Authorities

International organizations and authorities formed by multiple countries that issue bonds to fund projects

Corporations

businesses that issue bonds to raise money for business expenses or expansions

Callable Bond

A bond that allows the issuer to pay back the investor early, before the maturity date

Zero-Coupon Bond

A bond that pays no regular interest is sold at a discount and pays its full FV at maturity