Final Exam Flashcards
(92 cards)
What is the EMU?
Economic and Monetary Union of the European Union
EMU Characteristics
Harmonized policies across countries.
Fixed exchange rates or a shared currency (like the Euro).
Shared monetary policy.
Partial pooling of foreign exchange reserves.
Possible financial transfers between states to correct economic imbalances.
EMU Choices
- Requires surrendering of sovereignty in certain areas of policy making
- Politicians need to undertake necessary structural reforms
- Restrain public spending
UK Concerns for EMU
Creation of a European Banking Union. (The creation of the European Banking Union threatened the UK’s interests by shifting financial regulation toward Eurozone priorities, risking London’s status as Europe’s top financial center.)
The ECB, not the European Banking Authority, would act as the main supervisor.
Banking regulation would focus on Eurozone stability, hurting the UK’s interests as a non-Eurozone EU member.
Concern that the UK would lose status as a major financial center.
What are the requirements for the EU to be an Optimal Currency Area?
L: High labor mobility and flexible wages.
A: No major asymmetric shocks across member states, similar business cycles. (EX: Greece has an economic crisis while Germany is booming)
F: Centralized fiscal policy to support struggling countries.
Eurozone Debt Crisis
The Eurozone debt crisis was a financial crisis that hit several European countries starting around 2009, when it became clear that some members of the eurozone had high levels of government debt and were struggling to repay or refinance it without help.
Trigger: The crisis began after the 2008 global financial crisis, which exposed weaknesses in the economies and fiscal policies of some eurozone countries.
Affected Countries: Often referred to as the “PIIGS”—Portugal, Ireland, Italy, Greece, and Spain—these countries had:
Large budget deficits
High levels of sovereign debt
Weak economic growth
Impacts: economic contraction and high unemployment, political instability and the rise of populist movements, long-lasting debate over austerity vs. stimulus in crisis response
What is a financial Instrument?
A financial instrument is a legal contract that represents a monetary value and can be traded. It’s essentially any asset that can be bought, sold, or used for investment purposes.
Uses of Financial Instruments
- Means of payment (like money)
- Stores of value (like money)
- Transfer of risk (unlike money)
What are 3 key features (not types) of financial instruments (stocks, bonds, loans, futures, etc…)? Essentially, what do they do?
Standardized to lower costs despite complexity. (→ Example: Corporate bonds are standardized contracts (fixed terms like maturity date, coupon rate) so they can be easily traded without needing to renegotiate every deal.)
Reduce problems from asymmetric information. (→ Example: Financial statements that public companies must file (like 10-K reports) give detailed information about their earnings, debts, and risks — helping investors avoid being at an informational disadvantage compared to the company.)
Provide investors with information about the issuer. (→ Example: Stock prospectuses (documents companies must publish when issuing shares) disclose financial statements, management details, and risks to help investors make informed decisions.)
Types of Financial Instruments
- Underlying Instruments (stocks, bonds, loans): used to directly transfer funds from savers to borrowers
- Derivative Instruments (futures, options, swaps): derive value from underlying assets, primarily used to shift or manage risk
Valuation Factors for Financial Instruments
- Size of payment (larger = more valuable)
- Timing (payment is sooner = more valuable)
- Likelihood payment is made (more likely to be made = more valuable)
- Conditions under with payment is made (made when we need them = more valuable)
What is leveraging?
Borrowing to invest; amplifies risk and reward
What is deleveraging?
Selling assets to reduce risk (common in crises)
What are financial markets?
Places where financial instruments are bought and sold, helping allocate resources efficiently
What are the 3 main functions of financial markets?
- Provide liquidity
- Pool and communicate information
- Enable risk sharing
What is the difference between primary and secondary markets?
Primary Market: new securities are issued to raise capital (EX: IPO, US Treasury issues new bonds to raise money)
Secondary Market: Existing securities are traded between investors (EX: investor buys Apple stock on the NASDAQ from another investor, bondholder sells a corporate bond to someone else on the market)
What is a centralized exchange?
A physical place where buyers and sellers meet to trade in a central, physical location (EX: NYSE)
What is an over-the-counter (OTC) market?
A decentralized market where dealers trade directly, often electronically
What is an ECN (Electronic Communication Network)?
A fully electronic system matching buyers and sellers without brokers or dealers (EX: NASDAQ)
How are financial markets categorized by instrument?
- Debt markets: loans, bonds, mortgages
- Equity markets: Stocks
- Derivative markets: Futures, options, swaps
What is the difference between money markets and bond markets?
Money markets: trade short-term debt (<1 year)
Bond markets: trade long-term debt (>1 year)
What is high-frequency trading (HFT)?
Algorithm-based trading that executes thousands of trades in seconds
Why is HFT controversial?
- Can disrupt markets (can create flash high and lows)
- Increased risk of errors
- Reduces role of traditional market makers, takes out human decision-makers
- May lead to unfair advantages (I.e. front running - someone, like a broker or trader, has advance knowledge of a pending order or future transaction that will affect an asset’s price, and they trade that asset for their benefit gain before the transaction is executed)
What is a derivative?
A financial contract whose value is based on the price of an underlying asset, such as a stock, bond, commodity, or index. In simple terms, a derivative derives its value from something else.
EX: Futures Contract (agreement to buy or sell an asset (like oil, gold, or agricultural products) at a predetermined price at a specific time in the future)
