Chapter 1: introducing money and the financial system-Asset- anything of value owned by a person or firm- Financial asset- an asset that represents a claim on someone else for a payment- Security- a financial asset that can be bought and sold in a financial market- Financial market- a place or channel for buying or selling stocks, bonds, and othersecurities-Money- anything that is generally accepted in payment for goods and services or to pay off debts - Money supply- the total quantity of money in the economy -Stock- financial securities that represent partial ownership of a firm; also called equities- Dividend- a payment that a corporation makes to its shareholders-Bond- a financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money- Interest rate- the cost of borrowing funds, usually expressed as a percentage of themoney borrowed-Foreign Exchange- units of foreign currency -Securitization- the process of converting loans and other financial assets that are not tradable into securities- Banks have created financial markets to buy and sell loans-Financial liability- A financial claim owed by a person or firm-Financial intermediary (3 party system)- A financial firm, such as a bank, that borrows funds from savers and lends them to borrowers- Commercial bank- a financial firm that serves as a financial intermediary by taking in deposits and using them to make loans - Mutual funds, hedge funds, investment banks etc..-nonbank financial intermediaries- Insurance companies- collect premiums from policy holders and invest them- Mutual funds- sells shares to group investors and then invest funds in a portfolio; savers reduce the cost they would incur if buying shares individually- Pension funds- invest contributions from workers to earn necessary to pay pension benefit payments during retirement - Hedge funds- like a mutual fund but has no more than 99 investors who are all wealthy; investments are more risky; and management fee is larger - Investment banks- don’t take in depots. Usually don’t give loans to households but only companies-portfolio- a collection of assets, such as stocks and bonds-Financial markets- places or channels for buying and selling stocks, bonds, and other securities- Primary market- a financial market in which stocks, bonds, and other securities are sold for the first time- Secondary market- a financial market in which investors buy and sell existing securities Financial System Purpose: provide channels for transferring funds between lenders and borrowers- Savers: supply funds; Borrowers: demand funds- 3 MAIN GOVERNMENT REGULATORS: FED, SEC, FDIC-Federal Reserve- the central bank of the United States; often called “the fed”- Monetary policy- actions the federal reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives - Lender of last resort- Federal funds rate- the interest rate that banks charge each other on short term loans-Securities & Exchange Commission (SEC): Regulates the financial markets-Federal Deposit Insurance Corporation (FDIC): Insures deposits in commercial banks-Diversification splitting- wealth among many different assets to reduce risk- Risk sharing- a service the financial system provides that allows savers to spread and transfer risk- Liquidity- the ease with which an asset can be exchanged for money at a reasonable price- Information- facts about borrowers and about expectations of returns on financial assets -Bubble- an unsustainable increase in the price of a class of assets Chapter 2; Interest Rates and rates of return-Future Value- the value at some future time of an investment made today-Compounding- the process of earning interest on interest as saving accumulates over time-Present Value- the value today of funds that will be received in the future- Further away payment is expected to be received, the lower the present value- The higher the interest rate used to discount payments, the lower the present value-Time value of money- the way that the value of a payment changes depending on when the payment is received-Discounting- the process of finding the present value of funds that will be received in the Debt vehicles Equity vehiclesCurrent Income: Interest DividendsCapital gains (loss): Yes Yes-Interest: the cost of money-Dividend: payment that may be made by a firm to its shareholders• Capital gains (loss): an increase in the market value of an asset- Realized gains (loss): asset must be sold- Paper gains (loss): asset is heldTotal Returns: current income + capital gain (loss)-Required Return: the rate of return that fully compensates an investor for taking risk- The minimum expected return an investor will accept to invest- Compensates for inflation, lost opportunities, and chance of not getting expected return-government issues debt and not equity3- month Treasury bill is the risk-free rate’ (Rf)- Real world proxy for the return the market will accept for a risk-free investment. -Insolvent- term used to describe bank if the value of the banks investments fall below the money owed to depositors -Most financial transactions include future payments- Interest rates are link to financial present and financial future-principal- amount of your investmentChapter 3: -Transaction costs- the cost of a trade or exchange- Ex: commission paid to real estate agent to sell house- Banks find people who need your money and they lend it to them for interest-Information cost- the costs that savers incur to determine the creditworthiness of borrowers and to monitor how they use the funds acquired.-Economies of scale- the reduction in average cost that results from an increase in the volume of a good or service produced. - Intermediaries- lower transaction costs with economies of scale-Asymmetric information- the situation in which one party to an economic transaction has better information than does the other party.- Adverse selection- the problem investors experience in distinguishing low risk borrowers from high risk borrowers before making an investment; in insurance, the problem that most likely to buy insurance are also most likely to file claims - Adverse selection leads to credit rationing in bond market, makes it difficult except for large firms to sell stock, and causes bad cars to push good cars through the market- When investors have difficulty obtaining information
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