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COMM 220 > Midterm #2 > Flashcards

Midterm #2 Flashcards

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1
Q

opportunity cost of leisure

A
  • the cost of spending time not working

- what you would have earned

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2
Q

substitution effect

A

demand for leisure decreases if wage rates increase

-workers want to work more because they earn more per hour

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3
Q

income effect

A

demand for leisure increases if wage rates increase

-workers want to work less because they earn more per hour

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4
Q

Utility

A

measure of overall happiness

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5
Q

preference for leisure

A

defined by the amount of utility that one gains from leisure and income
-shown on indifference curve

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6
Q

indifference curve

A

curve showing each combination of leisure and income that would yield the same amount of utility
steep indifference curve= high value placed on leisure
flatter indifference curve= low value placed on leisure

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7
Q

budget constraint

A

line showing every possible combination of leisure and income possible with specific amount of hours and wages
-utility is maximizing point where the budget constraint is tangent to the indifference curve

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8
Q

4 principles of indifference curve

A

1) utility curves cannot intersect
2) they are negatively sloped
3) utility are convex
4) everyone’s utility curve is different

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9
Q

worker’s reservation wage is

A

the lowest wage the person would accept to offer his labour services

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10
Q

expected utility

A

utility that the consumer would expect to receive on average

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11
Q

risk averse

A
  • prefers certain income over risky income of equal value
  • more worried about losing investment, do not like investing in riskier products
  • more likely buy insurance products
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12
Q

risk neutral

A
  • indifferent between certain income and risky income of equal value
  • slope is constant
  • marginal utility is constant at all income levels
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13
Q

risk loving

A
  • some who loves risk

- slope is always increasing

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14
Q

risk premium

A

amount of money a risk averse person will pay to avoid taking risk
risk averse- amount they would have to give up to eliminate risk
risk lover- amount they would have to be paid to eliminate risk

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15
Q

reference point

A

point of view from which you make a decision or an opinion

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16
Q

endowment effect

A

when people value a good more because they own it

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17
Q

loss aversion

A

its when we have something but don’t want to lose it

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18
Q

anchoring

A

being influenced into a decision based on a certain piece of info

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19
Q

framing

A

relying on a context in which a choice is presented when making a decision

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20
Q

the law of small numbers

A

overstate the probability that something will happen when faced with relatively little info

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21
Q

what type of risk is avoidable with proper diversification

A

unsystematic risk

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22
Q

How does the diversification of an​ investor’s portfolio avoid​ risk?

A

buying stocks that are negatively correlated, as the number of stock held increases, the overall variance of the portfolio decreases

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23
Q

What is a financial market?

A

channel from those who have a surplus of funds to those that have a shortage
saved money= lenders
shortage= borrowers

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24
Q

Direct vs indirect finance

A

direct finance- borrowers borrow the funds directly from the lenders in financial markets by selling them securities
indirect finance- financial intermediaries borrow the funds from the lenders and lend them to the borrowers

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25
3 ways to diminish risk
1) diversification 2) insurance 3) gain more info
26
debt
contractual agreements between the borrower and the lender | ex) bonds, mortgages, and other loans
27
borrower
- sells fraction of ownership to the lender in exchange for funds - doesn't get money back ex) common shares and preferred shares
28
Primary market vs secondary
primary- where securities are issued for the first time, the investor is buying securities directly from the issuer secondary- securities are previously issued are resold or traded to other investors
29
exchanges
where buyers, sellers, brokers, and agents meet to conduct trades ex) Toronto stock exchange
30
over-the-counter markets (OTC)
decentralized exchange where parties buy and sell financial instruments to each other -various locations
31
Money market | Capital market
- short term debt and other instruments (maturity is less than one year) are traded in this market - long term debt and other instruments (maturity is one year or more) are traded in this market
32
Money market instruments are
- short term debt instruments - little fluctuation in price - least risky - lower expected returns
33
Treasury bills (t-bills)
short term debt issued by government of Canada with maturity of less than a year -risk free
34
Certificates of deposit (CD)
- debt instruments sold by banks to depositors - pays annual interest ex) bearer deposit notes, term deposit receipts and common names certificates of deposits
35
commercial paper
- unsecured short term debt instrument issued by bank and corporations - interest rate depends on the risk
36
repurchase agreements (repos)
short term loan maturity is less than 2 weeks | -t bills held are collateral
37
overnight funds
overnight loans between banks | interest rate= overnight interest rate
38
capital market instruments are
1) longer-term instruments 2) wider price fluctuation 3) more risky 4) higher expected return
39
stocks
represent fractional ownership in a corporation
40
mortgages
-loans to purchase real estate
41
corporate bonds
- long term bonds issued by corporations | - corporation pays semi annual interest payments to the investor
42
government of Canada bonds
- intermediate term bonds (1-10 years) issued by the government of canada - used to finance the government's deficit
43
canada savings bond
- non marketable government bonds | - do not change in value
44
provincial and municipal government bonds
used to finance local expenditures like schools, road, and other programs
45
government agency securities
-long term bonds issued by various government agencies
46
consumer and bank commercial loans
loans made to consumers and business by banks
47
International bond market
1) bonds can be traded internationally | 2) type of bond depends on issuer and currency
48
foreign bond
- bonds sold in foreign country | - same currency as foreign country
49
eurobond
- bond is not in the same currency as the country it was issued in ex) issued in Japan but in US dollars
50
eurocurrency
foreign currency deposited in banks outside of the home country
51
transactional costs
- costs related to financial market transactions - includes commissions, brokerage fees - higher costs when smaller amounts are invested
52
economies of scale
financial institutions can decrease transaction costs by bundling the funds of many investors
53
expertise
financial institutions can decrease transaction costs by using expertise they have developed
54
asymmetric information
when one party does not have enough info about the other to make an accurate decision
55
adverse selection
- happens BEFORE the transaction because of asymmetric info | - one party has more info than the other party, causing the party with less info to try to mitigate risk
56
moral hazard
- happens AFTER the transaction due to asymmetric info | - when one party behaves in a certain way because they are not responsible for the risk
57
lemons problem
- result of asymmetric info | - investor does not have enough info to differentiate good and bad firms
58
Tools to solve adverse selection problems
1) private production and sale of info- does not completely solve the problem due to the free rider effect - people using info to their advantage 2) government regulations- prevent misleading investors 3) financial intermediation 4) collateral and net worth- property promised to the lender if the borrower defaults
59
principal-agent problem
principal- owner of the business agent- managers of the business in charge of representing the owners -when the interests of the agents are not aligned with the principals -form of moral hazard
60
Tools to solve the principal-agent problem
1) monitoring- auditing 2) government regulation 3) financial intermediation 4) debt contracts reduce moral hazard 5) lending the firm more money
61
tools to solve moral hazard in debt contracts (loans)
1) net worth and collateral 2) monitoring 3) restrictive convenants 4) financial intermediation
62
function of financial intermediaries- indirect finance
-lower transaction costs ex) economies of scale -reduce investors risk exposure ex) diversification -solve asymmetric info problems adverse selection- gather info about potential borrowers moral hazard- sign a contract with restrictive covenants
63
financial capital flows ex)
currency market transactions
64
Deep integration
trade agreements which do not only contain rules on tariffs and conventional non-tariff trade restrictions, but which also regulate the business environment in a more general sense
65
financial intermediares are
- transform assets - borrow from one group of people and lend to another - include life insurance companies
66
mortgage backed security
bone like debt instrusments
67
government regulates financial markets for 2 main reasons
1) to increase info available to investors | 2) to ensure soundness of financial intermediaries
68
Secondary markets DON'T
match lenders (savers) with borrowers in need of funds
69
intermediate-term
Canada bond with maturity 5-10 years
70
chartered bank
These financial intermediaries raise funds primarily by issuing chequable​ deposits, savings​ deposits, and term deposits.
71
free rider problem
someone who benefits from resources, goods, or services without paying for the cost of the benefit
72
what is a bond?
issued by corporations and governments to raise capital for various activities
73
Coupon rate > YTM Coupon rate < YTM Coupon rate = YTM
- bond is sold at a premium - bond is sold at a discount - sold at par
74
zero coupon bonds and T-Bills
also known as discount bond doesn't pay coupons bought at a price less than FV
75
4 types of credit market instruments
1) simple loan- repay principle with interest 2) fixed payment loan- Pay fixed amount every period throughout loan 3) coupon bond- pay a fixed interest payment every year until maturity date and repay face value - perpetuity/console bond- no maturity date, pay coupon payments forever 4) discount bond- sells at a price below its FV
76
real interest rate
adjusted for changes in the price level (inflation)
77
Prices and returns for long term bonds are
more volatile (fluctuations in prices) than those for shorter term bonds
78
the concept on time value of money assumes that
money loses value with time
79
the current yield is a good approximation to yield to maturity when
- the bond price is very close to par | - the maturity of bond occurs over 10 year period
80
determinants of asset demand (4)
1) wealth 2) expected return 3) risk 4) liquidity- the ease with which the asset can be converted to cash relative to others
81
the fisher effect with bonds
1) when inflation decreases Bs increases and Bd decreases 2) Inflation decreases the value of future payments good for bond issuers= payments are less bad for bond holders= income is less
82
changes to equilibrium caused by higher inflation
interest rates rise bond prices fall bond quantity can either rise or fall
83
economic expansion
supply and demand for bond both shift to the right interest rates can rise, fall or stay the same quantity of bonds rise
84
supply and demand for money
determines the equilibrium interest rate in terms of the supply and demand for money all wealth is stored in two places- bonds and money
85
effects of increasing money supply
1) decreases interest rates initially- liquidity effect | 2) interest rate increases over time because of income,, price level, and expected inflation effect
86
income effect
higher money supply= increases wealth in economy people spend more money=increase in demand for money increase in demand for money= increase in interest rates
87
price level effect
higher money supply= more money purchasing the same assets asset prices increase=people need more money increase in demand for money=increase in interest rates
88
expected inflation effect
higher money supply= increases inflation | expectation for more inflation in the future= higher interest rates
89
``` Takes action when liquidity effect income effect price level effect expected inflation effect ```
1) immediately 2) slowly 3) slowly 4) fast or slow
90
why does the liquidity effect dominate the other effects
rates fall immediately increase slowly over time new interest rate is lower than intial
91
what is NOT function of secondary markets
matching lenders with borrower in need of funds

COMM 220 (3 decks)

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