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What are 3 types of economic units?
- household
- business firm
- Government
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Define financial market.
Structures through which funds flow.
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Define primary market.
Markets in which users of funds raise funds through new issues of financial instruments, such as stocks and bonds.
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Income> expenditures= surplus
Surplus spending unit (SSU); investor/ lender
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Income < expenditures= deficit
Deficit spending unit (DSU); borrower (user of financial securities)
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Define IOU.
A written promise to pay a specific sum of money (the principal) plus a fee (an interest rate) for the privilege of borrowing the money over a period of time (maturity of the loan.)
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What is the function of financial systems?
To channel funds from SSU to DSU. A financial claim, financial security, or financial instrument is exchanged for the financial resources.
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Define marketability/ liquidity
How many people want to buy it for that price/ profit made from sale.
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What are the 2 channels of funds?
Direct and indirect
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Define direct financing.
SSU deals directly with DSU via financial market.
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Define private placement.
DSU sells the entire issue of financial securities to one or a few SSU
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Define indirect financing.
Financial intermediaries like banks bring the DSU & SSU together by issuing financial securities to SSU in the form of deposit (indirect securities) & use the funds to purchase financial securities issued by DSU --> receive deposits from SSU & loans to DSU
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Define brokers/ dealers.
Middle mean that bring SSU & DSU together. Broker gets commission. Dealer gets profits- may lose $$.
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Define disintermediation.
SSUs take their funds out of financial institutions and invest in direct claims in the direct financial markets.
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What is one thing all financial intermediaries have in common?
They purchase financial claims with one set of characteristics from DSUs and sell financial claims with different characteristics to SSUs.
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The largest financial intermediaries in the US economy are commercial banks, but the fastest growing intermediaries are private pension funds and state and local government pension funds.
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List types of intermediaries.
- Deposit- type institutions
- Contractual savings institutions
- Investment funds
- Other financial institutions.
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What is the major regulatory difference between credit unions and other depository institutions?
The common bond requirement, the restriction that most loans are to consumers, and their exemption from federal income tax because of their cooperative nature.
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Define a money market.
A mutual fund that invests in money market securities, which are short term securities with low default risk. These securities sell in denominations of $1 million or more, so most investors are unable to purchase them.
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What are the 3 basic types of finance companies?
- Consumer finance companies specializing in installment loans to households.
- Business finance companies specializing in loans and leases to businesses.
- Sales finance companies that finance the products sold by retail dealers.
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Where are financial claims initially sold by DSUs?
Primary financial markets. A
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Define secondary financial markets.
Financial market in which participants buy or sell previously issued financial claims.
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Define a futures market.
A market in which people trade contracts for future delivery of securities (such as government bonds), commodities (such as a kilo of gold or a barrel of oil), or the value of securities (such as the value of the Standard & Poor's 500 stock index) sold in the cash market.
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Define money markets.
Markets in which commercial banks and other businesses adjust their liquidity position by borrowing, lending, or investing for short periods of time. Typically have short maturities, are highly liquid, and have low risk of default.
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Define treasury bills.
Direct obligations of the US government and thus are considered to have no default risk. They are sold weekly and have maturities that range from 3 months to 1 year.
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Define negotiable CODS.
Large- denomination time deposits of the nation's largest commercial banks. Unlike other time deposits of most commercial banks, NCDs may be sold in the secondary market before their maturity.
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Define commerical paper
The unsecured promissory note of a large business.
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Define federal funds.
Bank deposits held with the Federal Reserve bank. Banks with deposits in excess of required reserves may lend those excess reserves to other banks.
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Define capital markets.
Capital goods are financed with stock or long- term debt instruments.
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Define common stock.
Represents an ownership claim on a firm's assets
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Define corporate bonds.
Long-term IOUs that represent a claim against the firm's assets. Unlike equity holder's returns, bondholder's returns are fixed; they receive only the amount of interest that is promised plus the repayment of the principal at the end of the loan contract.
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Define munipal bonds
The long-term debt obligations of state and local governments. Coupon income is exempt from federal income taxes. Most have limited secondary markets and, thus, are not considered liquid investments.
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Define mortgages.
Long-term loans secured by real estate. They are the largest segment in the capital markets in terms of the amount of outstanding. Mortgages by themselves do not have good secondary markets. However, a large number of mortgages can be pooled together to form new securities called mortgaged- backed securities, which have an active secondary market.
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What are the 5 basic risks that financial institutions must manage and balance?
- Credit risk
- Interest rate risk
- Liquidity risk
- Foreign exchange risk
- political risk
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