Primary Markets
•Used by corporations andgovernments•Used to issue new financialinstruments•Stocks•Bonds
Secondary Markets
•Benefit investors and issuers•Securities traded after issue•Provide liquidity and diversificationbenefits for investors•Security valuation information forissuers
Money Markets
trade debt securities or instruments with maturities of one year or less
Capital Markets
trade stocks and longterm debt with maturities greater than one year
Foreign Exchange Markets
•Trade currency for immediate delivery (spot) or for some future delivery•Subject to foreign exchange risk due to currency fluctuations
Derivitaves
• Highly leveraged financial securities linked to underlying security•Potentially high-risk• Used for hedging and speculating
4 Most Common Financial Institutions
• Banks• Thrifts• Insurance companies• Mutual funds
4 Functions of Financial Institutions
• Perform economic functions• Monitor costs• Provide liquidity• Price risk
What is the most often quoted interest rate?
Nominal Rate
5 Factors Affecting Nominal Interest Rate
• Inflation• Real interest rate• Default and liquidity risk•Provisions of security issuer•Term to maturity
Inflation
Percentage increase in cost of goods or services over given period of time
Default/Credit Risk
Risk that issuer fails to pay promised interest and principal
As interest rates rise...
investment portfolios values fall
Unbiased Expectations Theory
long-term interest rates contain a prediction of future short-term interest rates. You would earn the same amount of interest by investing in a one-year bond today and rolling that investment into a new one-year bond a year later compared to buying a two-year bond today.
Market Segmentation Theory
Says that the yield curve is determined by supply and demand for debt instruments of different maturities.
Liquidity Premium Theory Explained
The risk premium is the liquidity premium that increases with the term of the bond. Hence, the yield curve slopes upward, even if future interest rates are expected to remain flat or even decline a little, and so the liquidity premium theory of the term structure of interest rates explains the generally upward sloping yield curve for bonds of different maturities.
Forward Rate
An implied rate on a short-term security that will originate sometime in the future.
Investment Banks
These arrange most primary market transactions for businesses
Trading Volume
the number of shares of a security that are simultaneously bought and sold during a given period
OTC Trading
Markets that do not operate in a specific location. Most transactions are over the phone, internet, or wire transactions.
Bankers Acceptance
Bank guaranteed time drafts payable to a vendor of goods
Mortgage-Backed Securities
Long-term debt securities that offer expected principal and interest payments as collateral. They are gathered into a pool and supported by promised principal and interest cash flows.
Thrifts
Depository institutions including savings associations, savings banks, and credit unions.
In a world without financial institutions, we would have _____ transfers of funds from fund suppliers to fund users.
Direct
Delegated Monitor
An economic agent appointed to act on behalf of smaller investors in collecting info and/or investing funds.
Asset Transforming
Financial institutions issue financial claims more attractive than those offered by a corporation.
Real Interest Rate
Interest rate adjusted for inflation. It's typically lower than the nominal interest rate.This is the rate that would exist on a default-free security if no inflation were expected.
The relationship between inflation and interest rates is ____. (Positive or negative)
Positive
The Fisher effect theorizes that nominal interest rates that we observe in financial markets (e.g., the 1-year Treasury bill rate) must compensate investors for...
Any inflation-related reduction in purchasing power lost on funds lent or principal due.An additional premium above the expected rate of inflation for forgoing present consumption (which reflects the real interest rate issue discussed above).