Chapter 1

Question 1

LIBOR (London Interbank Offered Rate)

Answer 1

Rate that most creditworthy banks charge on another for large loans of Eurodollars in the London market.

Question 2

Financial Investment

Answer 2

The investment of capital in financial instruments and assets, rather than in real, physical goods (real investment).

Question 3

Real Investment

Answer 3

The investment of capital in physical goods, such as equipment or plant, resulting in expansion of the productive base of the economy.

Question 4

Real assets

Answer 4

Land, buildings, and equipment used to produce goods and services. See also financial assets.

Question 5

Financial assets

Answer 5

Claims to the income generated by real assets or claims on income from the government. See also real assets.

Question 6

Informational role

Answer 6

Role played by financial assets that enables the efficient allocation of capital to real assets by establishing prices that convey information about the value of those assets.

Question 7

Consumption timing

Answer 7

The decision of individuals who use funds for investment or consumption in different periods of their lives, generally entailing investing in financial assets at the beginning and later selling those assets for the consumption needs.

Question 8

Separation of ownership and management

Answer 8

The division in a corporate between the owners or stockholders of a firm and their agents who are the managers hired to direct the firm.

Question 9

Agency problem

Answer 9

The conflict of interest between stockholders, bondholders and managers and the resultant suboptimal decisions.

Question 10

Asset allocation

Answer 10

The choice made by investors between broad asset classes, in particular cash, stocks and bonds, as well as other assets such as commodities.

Question 11

Security selection

Answer 11

The choice made by investors of which particular securities to hold within an asset class.

Question 12

Security analysis

Answer 12

Determining the correct value of a security in the marketplace.

Question 13

Financial intermediaries

Answer 13

Institutions such as banks, mutual funds, investment companies, or insurance companies that serve to connect the household and business sectors so households can invest and businesses can finance production.

Question 14

Investment Companies

Answer 14

Firms managing funds for investors. An investment company may manage several mutual funds.

Question 15

Investment bankers

Answer 15

Firms specializing in the sale of new securities to the public, typically by underwriting the issue. Also known in Canada as investment dealers.

Question 16

P:rimary market

Answer 16

A market in which issues of securities are offered to the public.

Question 17

Secondary market

Answer 17

Already existing securities are bought and sold on the exchanges or in the OTC market.

Question 18

Globalization

Answer 18

Tendency toward a worldwide investment environment, and the integration of national capital markets.

Question 19

American Depository Receipts (ADR)

Answer 19

The instrument traded on the NYSE which represents and equity interest in a (foreign) company; ADRs are equivalent to a number of shares in the company, as traded in that company’s home market, and are entitled to proportional payments of dividends.

Question 20

Financial engineering

Answer 20

Innovative security design and repackaging of investments.

Question 21

Unbundling

Answer 21

Creation of securities either by combining primitive and derivative securities into one hybrid or by separating returns on an asset into classes.

Question 22

Bundling

Answer 22

Creation of securities either by combining primitive and derivative securities into one hybrid or by separating returns on an asset into classes.

Question 23

Portfolio insurance

Answer 23

The practice of using options or dynamic hedging strategies to provide protection against investment losses while maintaining upside potential.

Question 24

Securitization

Answer 24

Pooling loans for various purposes into standardized securities backed by those loans, which can then be traded like any other security.

Question 25

Mortgage backed security (MBS)

Answer 25

Ownership claim in a pool of mortgages or an obligation that is secured by such a pool also called a pass through security, because payments are passed along from the mortgage originator to the purchaser of the mortgage backed security.

Question 26

Pass through securities

Answer 26

Pools of loans (such as home mortgage loans) sold in one package. Owners of pass-throughs receive all principal and interest payments made by the borrowers.

Question 27

Collateralized mortgage obligations (CMOs)

Answer 27

Mortgage pass-through securities that partition cash flows from underlying mortgages into successive maturity groups called tranches, that receive principal payments according to different maturities.

Question 28

Agency theory

Answer 28

The study of conflicts of interest between stockholders, bondholders and managers of a firm.

Question 29

Risk return tradeoff

Answer 29

If an investor is willing to take on risk, there is the reward of higher expected returns.

Question 30

Passive management

Answer 30

Buying a sell diversified portfolio to represent a broad based market index without attempting to search out mispriced securities.

Question 31

Active management

Answer 31

Attempts to achieve portfolio returns more than commensurate with risk, either by forecasting broad market trends or by identifying particular mispriced sectors of a market or securities in a market.