ECON 311 1st EditionExam # 1 Study Guide Chapters: 1 – 5Chapter 1:Bond: a debt instrument that promises to make payments periodically for a specified period of time Common stock (stock): represents a share of ownership in a corporation. It is a security claim on the earnings and assets of the corporationFinancial markets: funds are transferred from people who have an excess of available funds to people who have a shortageInterest rate: the cost of borrowing or the price paid for the rental of funds (usually expressed as a percentage of the rental of &100/year, determined by bond marketForeign exchange market: where the conversion of currencies takes placeForeign exchange rate: the price of one country’s currency in terms of anotherWhen the value of the dollar drops, Americans decrease their purchases of foreign goods and increase their consumption of domestic goods ( such as travel in the U.S. or buying American made wine)A weaker dollar leads to more expensive foreign goods, making vacationing abroad more expensive and raises the cost of foreign goodsA strong dollar means that the U.S. goods exported abroad will cost more in foreign countries and hence foreigners will buy fewer of them A strong dollar benefits American consumers by making foreign goods cheaperA strong dollar hurts American businesses and eliminates jobs by cutting domestic and foreign sales of their productsThere is a strong positive association between inflation and growth rate of money over long periods of time.As the money growth rate rose in the 1960s and 1970, the long-term bond rate rose with it. However, the relationship between money growth and interest rates has been less clear-cut since 1980.Chapter 2Direct finance: borrowers borrow funds directly from the lenders in the financial markets by selling themsecurities These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.Ex: you lend funds to a neighbor, corp. needs to borrow funds to pay for a new factory so it sells bonds to savers and promises to make periodic payments for a specified time, corp. sells stock to savers to finance new factory Indirect finance: lenders lend their funds to financial intermediaries so that they may forward them to borrowers Ex. You deposit $100 in a bank, you use a broker to buy stock, you use a dealer to buy stockAsymmetric information: one party often does not know enough about the other party to make accuratedecisionsAdverse selection: the problem created by asymmetric information BEFORE the transaction occursEx. People with poor health are likely to buy medical insuranceMoral Hazard: the problem created by asymmetric information AFTER the transaction occursEx. A corp. uses the funds raised from selling bonds to fund corporate expansion to pay for cruises for employeesChapter 3M1 = Currency+ Travelers checks+ Demand deposits+ Other checkable depositsTotal M1M2 = M1+ Small-denomination time deposits+ Savings deposits and money market deposit accounts+ Money market mutual fund shares (retail)Total M2Functions of Money: Medium of exchange: used to pay for goods and servicesNeed: Time to searchDouble coincidence of wantEx. Using a debit card at the grocery storeCriteria of a good medium of exchange:Easily standardized, widely accepted, is divisible (make change), is easy to carry Unit of account: used to measure value in the economy, prices are quoted in terms of moneyEx. A coke costs $1.50Store of Value: used to save purchasing power from the time income is received until the time it is spent Ex. Saving your money to buy a houseLiquidity: the relative ease and speed with which an asset can be converted into a medium of exchangeChapter 4: Financial Instruments: Simple LoanLender provides the borrower with funds which must be repaid at the maturity dateEx. If Peter borrows $100 from the bank and next year the back asks $110 back, what is the interest rate, i?Fixed Payment LoanThe same payment every period throughout the life of the loan Ex. You need a $100,000 mortgage. You take out a loan and the bank charges 7%interest. What is your yearly payment to the bank if you pay it back over 20 years?Coupon BondBond pays the owner a fixed interest payment every year until the maturity date, when aspecific final amount is repaid Ex. Find the price of a 10% coupon bond with the face value of $1,000, a 12.15% yield to maturity, and eight years to maturity Discount BondBought at a price below its face value and the face value is repaid at the maturity dateRate of Return (not equal to the interest rate)Fisher EquationTrue/ False:Chapter 5: Determinants of Asset Demand:Wealth, the total resource owned by the individual, including all assets An increase in wealth raises the quantity demanded of an asset Expected Return (the return expected over the next period): on one asset relative to alternative assetsAn increase in an asset’s expected return relative to that of another alternative asset raises the quantity demanded of that asset Risk (the degree of uncertainty associated with the return) on one asset relative to alternative assetsIf an asset’s risk rises relative to that of alternative assets, its quantity demanded will fallLiquidity (the ease and speed with which an asset can be turned into cash) relative to alternativeassets The more liquid an asset is relative to alternative assets the more desirable it is, and the greater will be the quantity demandedShifts in demand of bondsWealth Expected returns on bonds relative to alternative assets Shifts in the supply of bondsExpected Profitability of investment opportunitiesExpected inflationGovernment budget