Chapter 2 Flashcards
(176 cards)
1
Q
Lender-Savers are
List different examples of lender-savers
A
- Households
- Business firms
- Government
- Foreigners
2
Q
Borrower-Spenders are
A
- Business firms
- Government
- Households
- Foreigners
3
Q
Lender-Savers ==> financial intermediaries ==> borrower-Spenders is an example of
A
Indirect finance
4
Q
Define Direct finance
A
Borrowers borrow funds directly from lenders in financial markets by selling them securities.
5
Q
How direct finance perform the essential function of channelling funds
A
By channelling funds from economic players that have saved surplus funds to those who have shortage of funds
6
Q
How direct finance promote economic efficiency
A
By producing an efficient allocation of capital which increases production and efficiency for the overall economy
7
Q
Structure of financial markets
List the type of financial markets
A
- Debt and equity market
- Primary and secondary market
- Exchanges and over-the-counter market
- Money and capital market
8
Q
Firms can obtain funds in a Debit and equity markets in two ways
A
- The issuance of a debt instruments such as bond or mortgage
- The issuance of equities such as common stock
9
Q
Define a bond
A
A bond is a debt security that promises to make payments periodically for a specified period of time
10
Q
Define a mortgage
A
Is a contractual agreement by the borrower to pay the holder of the instrument fixed money amount at regular intervals until a specified date when a final payment is made
11
Q
Define Maturity
A
Is the number of years until the expiration date of the instrument
12
Q
If maturity term is less than a year then it is
A
Short-term
13
Q
If maturity term is 10 years or longer then it is
A
Long-term
14
Q
If maturity term is between one and 10 years then it is
A
Intermediate term
15
Q
Define common stock
A
Are claims to share in the net income and assets of the business
16
Q
Periodic payments of equities are referred as
A
Dividends
17
Q
___________ are Long term securities that have no maturity date
A
Common stock
18
Q
For bonds the principal payment is at ____________
A
Maturity date
19
Q
Equities that give the holder a portion of the firm and the right to vote on important issues of the firm and elect directors is often referred to as
A
Common stock
20
Q
Define primary market
A
The financial market in which new issues of security are sold to initial buyers by the corporation or government agency borrowing to the funds.
21
Q
Which bank helps the issuer by underwriting securities
A
The investment bank
22
Q
Define underwriting
A
To guarantee price and sells them
23
Q
Define Secondary market
A
The financial market in which securities that have been previously issued can be resold
24
Q
Who are Brokers
A
Are agents of investors who match buyers and sellers
25
Who are Dealers
Link buyers and sellers by buying and selling securities at stated price
26
Examples of secondary markets are
1. Foreign exchange markets
2. Future markets
3. Options market
27
Which market makes financial instruments more **liquid**
Secondary market
28
How secondary market affects the prices of securities in primary market
Investors who buy securities in the primary market will pay the issuing corporation no more than the price they think the secondary market will set for that security.
29
Secondary markets are classified to
1. Exchange market
2. over-the-counter market
30
Define an Exchange market
Where sellers and buyers of securities meet in the one central location to conduct trades
31
Example of exchange markets
| The 3 main examples of Exchange markets
1. NYSE for stocks
2. Chicago Board of Trade for commodities
3. Egyptian Exchange (EGX)
32
Define **Over-the-counter-market** (OTC)
OTC market dealers are in computer contact and have an inventory of securities stand ready to buy and sell securities to anyone who is willing to accept their prices
33
**Over-the-counter-market** (OTC) example
US government bond market
34
Define **Money market**
Is a financial market in which only short term debt instruments are traded
35
Why do corporations and banks actively use money market
To earn interest on surplus funds because money market securities are safer
36
Why money market securities are safer?
They have smaller fluctuations in prices than longer term securities and more **liquid**.
37
Define Capital market
Is the market in which the longer term debt are traded and equity instruments are traded
38
Capital market securities are often held by ___________
Financial intermediaries
39
What are the US treasury bills?
These are short term instruments issued in (1/3/6) month maturities to finance the federal government
40
Money market instruments are
1. Us treasury bills
2. Negotiable bank certificates of deposits
3. Commercial papers
4. Repurchase agreements
5. Federal funds
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Which money market instrument pay a set amount at maturity and have no interest payments although they effectively pay interest by initially selling at discount
US treasury bills
42
Which money market instrument is the most liquid because it's actively traded
TB
| Treasury bond
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Which money market instrument is the safest and why?
TB, since there is almost no possibility of default, as government can issue currency or raise taxes to meet obligations
44
Define default
When the issuer of the instrument is unable to pay interest payments or pay off the value of the instrument when it matures
45
Negotiable bank certificates of deposits are
Debt instruments sold by a bank to depositors which pay annual interest of a given amount and at maturity pays back the original price.
46
Which Money market instrument is important source of funds for commercial banks
Negotiable bank certificates
47
Negotiable CD are sold in
| Negotiable bank certificates
Secondary markets
48
Define commercial paper
Is a short term debt instrument issued by **large banks** and well know corporations
49
Define **Repurchase Agreements**
Repurchase agreements (repos) are effectively short term loans (with maturity less than 2 weeks), for which treasury bills serve as collateral
50
What is a **collateral**?
is an asset that the lender receives if the borrower does not pay back the loan
51
The following example is an example of :
"A large corporation like Microsoft may have idle funds ($ 1 million), it buys US TB for one week. After a week the bank will repurchase the TB at a price slightly above ($1 million)"
Repurchase agreements
52
Which Money Market insrument is an important source of bank funds?
Repurchase agreement
53
Federal Funds are
Overnight loans between banks of their deposits at the Federal Reserve
| Fedral reserve refers to **(Central Bank)**
54
___________ funds are loans by banks to other banks ( interbank loans)
Federal
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The Interest on federal funds is called
"The federal fund rate"
| (interbank rate)
56
If the interbank rate is high this denotes that __________
banks are strapped for funds.
57
If the interbank rate is low this denotes that __________
the credit needs of banks are low
58
CAPITAL MARKET INSTRUMENTS includes
1. Stocks
2. mortgages and Mortgages-Backed Securities
3. Corporate bonds
4. US government securities
5. US government agency securities
6. State and local government bonds
7. Consumer and bank commercial
loans
59
Define a **stock**
Is an equity claim on the net income and assets of a corporation
60
Which Capital market instrument makes periodic payments (dividends) and the holder owns a portion of the firm and gives him the right to vote on important issues of the firm
Stocks
61
Stocks are long-term securities because
they have no maturity date
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Mortgages and Mortgages-Backed
Securities are
loans to households or firms to purchase land, housing , or other real structures in which the structure or land itself serves as collateral for the loans.
63
_______________ are long term bonds issued by corporations with very strong credit rating.
Corporate bonds
64
Which type of bond sends the holder an interest payment twice a year and pays off the face value when the bond matures
Typical corporate bond
65
Convertible bond
Allows the bondholder to convert bonds into a specified number of shares of stock at anytime up to
the maturity date.
66
The main holders of corporate bonds are
1. life insurance companies
2. Pension funds
3. Households
67
US government securities are
long term instruments are issued by the US treasury to finance the deficits of the federal government
68
What is the most liquid security traded in the capital market
US government securities
69
US government securities are held by
1.Federal Reserve
2.banks
3.households
4.foreigners
70
US government agency securities are
long-term bonds are issued by government agencies to finance mortgages, farm loans, and power generating equipment.
71
US government agency securities are guaranteed by
The federal government
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US government agency securities are held by
the same parities who held the government bonds
73
State and local government
bonds are called
municipal bonds
74
Define the following:
Long term debt instruments issued by state and local government to finance expenditure on schools, roads, and other large programs.
State and local government
bonds
75
What is the most important feature of State and local government
bonds
Their interest payments are exempt from income tax and generally from state taxes in the issuing state.
76
The biggest buyers of State and local government bonds
Commercial banks
77
Consumer and bank commercial
loans are
Loans to consumers and businesses are made principally by bank.
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Apart from the bank, consumer loans can be financed by
Finance companies
79
The extraordinary growth of foreign financial markets has been the result of :
1.Large increases in the pool of savings in foreign countries.
2.The deregulation of foreign financial markets which has enabled foreign markets to expand their activities.
80
Foreign bonds are
Sold in a foreign country and denominated in that country's currency
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Eurobond
bond denominated in a currency other than that of the country in which it is sold
82
Eurocurrencies
foreign currencies deposited in banks outside the home country
83
Eurodollars
U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. banks
84
What are the advantages of channeling funds through financial intermediaries
1.Lower transaction costs
2.Reduce the exposure of investor to risk
3.Deal with asymmetric information problems
4.Economies of scope
85
Transaction cost is
The time and money spent in carrying out financial transactions
86
Financial intermediaries reduce transaction costs because
They developed expertise in lowering them and because their large size allows them to take advantage of economies of scale
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Banks provide the customers with___________ , that make it easier for customers to conduct transactions
Liquidity services
88
Example of liquidity services
Banks provide depositors with checking accounts that enables them to pay their bills easily
89
Risk is defined as
The uncertainty about the returns investors will earn on assets
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Financial intermediaries reduce the exposure of investors to risk by
1.Risk sharing through diversification
2.Asset transformation
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Risk sharing through diversification is done by
investing in a collection assets whose returns do not always move together, then the overall risk is lower than for individual assets
92
Asset transformation is
Where risky assets are transferred into safer assets for investors
93
How can financial intermediaries earn profit
By the spread between the returns they earn on risky assets and the payments they make on the assets they have sold
94
Asymmetric information involves
One party does not know enough about the other party to make accurate decisions
95
Examples of asymmetric information problems are
1.Adverse selection
2.Moral hazard
96
Adverse selection is the problem created by asymmetric information _______ the transactions occurs.
Before
97
Adverse selection in financial markets occurs because
Lenders usually do not know all information about borrowers
98
Adverse selection occurs when
The potential borrowers who are the most likely to produce an adverse outcome are the ones who most actively seek out loan and are the most likely to be selected
99
How intermediaries deal with Asymmetric information
They try to avoid selecting the risky borrower by gathering information about them
100
Moral hazard is the problem created by asymmetric information ___________ the transaction occurs
After
101
Moral hazard in financial markets occurs after the debt contract starts because
Because the lender such as a bank may not have the same information that is available for the other part (borrower)
102
Moral hazard is
The risk that the borrower might engage in activities that are immoral from the point of view of the lender. It lowers the probability that the loan will be repaid
103
How intermediaries deal with Moral hazard
1.Intermediaries ensure borrower will not engage in activities that will prevent him to repay the loan
2. Sign a contract with restrictive covenants
104
Economies of scope is
The ability to use one resource to provide many products and services
105
Economies of scope involves
Reduction in the cost of information production for each service by applying one information resource to many different services
106
How banks achieve economies of scope
Through offering multiple financial services to their customers
107
How economies of scope can cause potential costs for financial intermediaries
Conflict of interests
108
What is conflict of interests
It is a type of moral hazard problem arising when a person or institution has a multiple objectives some of which conflict with each other.
109
Potentially competing interests may lead the firm to
Conceal information or disseminate misleading information leading to less efficient financial markets
110
Types of financial intermediaries
| List the 3 types of financial intermediaries
1. Depository institutions
2. Contractual savings institutions
3. Investment intermediaries
111
Types of Depository institutions
| List the 2 most known depository institutions
1. Commercial banks
2. Credit unions
112
Types of Contractual Saving institutions
| List the 3 most known contractual saving institutions
1. Life insurance companies
2. Life and causality insurance companies
3. Pension funds and government retirement funds
113
Types of Investment
intermediaries
| The 4 types of financial intermediaries
1. Finance companies
2. Mutual Funds
3. Money market Mutual funds
4. Hedge funds
114
**Depository institutions** are
are financial intermediaries that accept deposits from
individuals and institutions and make loans
115
The study of money and banking focuses on depository institutions because
| An important component of money supply
They are involved in the creation of deposits
116
Commercial banks raise funds by
issuing three types of deposits
| 1.Checkable deposits
2.Savings deposits
3.Time deposits
117
Checkable deposits are
| issued by commercial banks
deposits on which checks can be written
118
Savings deposits
| issued by commercial banks
deposits that are payable on demand but do not allow their owner to write checks
119
Time deposits are
| issued by commercial banks
deposits with fixed terms to maturity
120
Commercial banks use funds to
| Funds raised from deposits e.g Saving deposits
make commercial, consumer, and mortgage loans and to buy government securities and municipal bonds.
121
Which is the largest financial intermediary that have the most diversified portfolios of assets.
Commercial Banks
122
**Savings and loan associations and mutual banks** are financial intermediaries that
raise funds by issuing checkable deposits, savings deposits, and time deposits.
123
Which institutions were constrained
in making mortgages loans for housing in the past
savings and loan associations and mutual savings banks
124
Credit Unions are
very small cooperative lending institutions organized around a particular group.
| Such as union members and employees of a particular firm
125
Credit unions acquire funds from deposits called
shares and make consumer loans
126
Contractual Savings
Institutions are
Financial intermediaries that acquire funds at periodic intervals on a contractual basis
127
Why contractual saving institutions do not worry about losing funds quickly as much as depository institutions
As they can predict how much they will have to pay out in benefits in the coming years
128
Contactual saving institutions can predict how much they will have to pay out in benefits in the coming years accordingly they tend to invest in
Long term securities such as corporate bonds, stocks and mortgage
129
Types of Contractual Savings
Institutions
1. Life insurance companies
2. Fire and casulty insurance companies
3. Pension funds and government retirement funds
130
Life insurance companies insure people against
Financial hazards following a death
131
Life insurance companies acquire funds from
Premiums
| Payments to keep their polices in force
132
Life insurance companies use funds to
Buy corporate bonds, mortgages and stocks
133
Fire and Casuality Insurance Companies insure people against
Loss from theft, fire, and accidents
134
Fire and Causality Insurance Companies aquire funds from
Premiums
135
Fire and casuality Insurance companies use funds to
Buy municipal bonds and corporate bonds
136
Why Fire and casuality Insurance companies use their funds to buy **more liquid assets** than life insurance companies do
They have greater possibility of loss of funds if major disasters occur
137
Pension Funds and Government Retirement Funds provide
Retirement income in the form of annuities to employees who are covered by a pension plan
138
How pension and government retirement funds aquire funds
By contributions from employers and from employees, who either have a contribution automatically deducted from their paychecks or contribute voluntarily
139
Pension Funds and Government Retirement Funds use funds to purchase
Purchase corporate bonds and stocks
140
Types of Investment intermediaries
1. Finance companies
2. Mutual Funds
3. Money market Mutual Funds
4. Hedge Funds
5. Investment bank
141
Finance Companies raise funds by
Selling commercial papers and by issuing stocks and bonds
142
Finance Companies lend funds to
consumers, who use them to purchase furniture , automobiles, home improvements and small businesses
143
Some finance companies are organised by a parent company to
Help sell its products
144
Mutual funds aquire funds by
Selling shares to many individuals
145
Mutual funds use the proceeds to
purchase diversified portfolio of stocks and bonds
146
Why Mutual funds allow shareholders to pool their resources
so that they can take advantages of lower transaction costs
147
Shareholders can sell their shares at any
time, but the value of these shares are determined by
demand and supply in the market
148
Mutual funds can be risky because
shares are determined by
demand and supply in the market
149
Money market Mutual funds are
financial institutions that have the same characteristics of mutual funds but also function to some extent as depository institutions
150
Why it is said that Money Market Mutual Funds function to some extent as depository
institutions
because they offer deposit- type accounts
151
Like most mutual funds, Money Market Mutual Funds aquire funds by
Selling shares
152
Money Market Mutual Funds use funds aquired to
buy money market instruments that are both safe and liquid
153
shareholders in money market mutual funds can
1. Get the interest on their shares
2. Write checks against the value of their shareholdings
154
Shares in Money market mutual funds function like
checking account deposits that pay
interest of commercial banks
155
Hedge funds are
a type of mutual funds with special
characteristics
156
Which type of funds are organized as limited partnerships
Hedge funds
157
Which type of funds are subject to much weaker regulations
Hedge Funds
158
Hedge funds invest in many types of assets, these may include:
* Stocks
* Bonds
* Foreign Currencies
159
Investment banks is not a bank because
It does not accept
deposits and make loans
160
Which type of investment intermediary help a corporation issue securities?
Investment bank
161
How does the investment bank helps a corporation issue securities
1. It first advises the corporation on which type of
securities to issue (stocks or bonds)
2. It helps sell (underwrite) the securities by
purchasing them from the corporation at a predetermined price and reselling them
162
Which Financial intermediary acts as deal maker and earns enormous fees by helping corporations acquire other companies through mergers or acquisitions
Investment banks
163
The government regulates financial markets and financial intermediaries for two main reasons:
1. Increase the information available to investors
2. To ensure the soundness of financial intermediaries
164
Increasing the information available to investors will
| Regulation of the Financial System
* Reduce adverse selection and moral hazard problems and enhance the efficiency of the markets
* Reduce insider trading (trading by largest stockholders in corporations)
165
Why it is important to ensure the soundness of financial intermediaries
To avoid financial panic
| The collapse of financial intermediaries
166
Governments implement several types of regulations in the financial systems
| List the regualtions implemented to avoid financial panic
* Restrictions on entry
* Disclosure of information
* Restrictions on Assets and Activities
* Deposit Insurance
* Limits on Competition
167
Restrictions on entry are
Tight regulations governing who is allowed to set up a financial intermediary
168
Disclosure of information is
Reporting requirements for financial intermediaries are stringent. The bookkeeping must follow strict principles, the books are subject to periodic inspection and they must make certain information available to the public
169
Which type of regulation control holding of risky assets and restricting financial intermediaries from engaging in certain risky activities
Restrictions on Assets and Activities
170
Deposit Insurance
avoid bank runs
171
Limits on Competition
* Branching
* Restrictions on Interest rates
172
In Egypt, banks are under the supervision of the
CBE
173
Which institution supervises and regulates all non-banking financial markets and instruments, including capital markets, insurance activities, mortgage finance & financial leasing in Egypt
EFSA
| Egyptian Financial Supervisory Authority
174
Which type of institutions usually invest in CDs
Corporations, charitable institutions, mutual funds and government agencies.
175
The sources of funds for commercial banks comes from
Corporations, charitable institutions, mutual funds and government agencies.
176
Lender-Savers ==> financial markets ==> Borrower-Spenders is an example of
Direct finance
