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Exam 1 Outline - FIN3244Chapter 3:Borrowers: demanders of funds for consumer durables, houses, or business plant and equipment, promising to repay funds based on their expectation of having higher in-comes in the future. These promises are financial liabilities for the borrower (a source of funds and a claim against the borrower's future income.)Savers: (or lenders) are suppliers of funds in the future.The promises, or IOUs, are financial assets (both a use of funds and a claim on the bor-rower's future income.Ex: your car loan is an asset (use of funds) for the banks and a liability (source of funds)for you. If you buy a house, the mortgage is your liability and your lender's asset. If your uncle buys treasury bonds for his retirement account, the bonds are assets for him and liabilities for the U.S. government. Financial Markets: Places or channels for buying and selling newly issued or existing bonds, stocks, foreign exchange contracts, and other financial instruments.Such as the stock market or the bond market, issue claims on individual borrowers di-rectly to savers.Financial Institutions: (or intermediaries) such as banks, mutual funds, and insurance companies, act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers. Diversification: Splitting wealth among many different assets to reduce risk.As long as the individual returns do not vary in the same way, the risk of severe fluctua-tions in a portfolio's value will be reducedRisk Sharing: Services provided by the financial system wherein savers and borrowers spread and transfer risk.Liquidity: The ease with which one can exchange assets for cash, other assets, or goods and services.Dollar bill and checks are super liquid. Selling your car however, takes more time be-cause personal property is not very liquid. By holding financial claims (such as stocks and bonds) on a factory, individual investors have more liquid savings than they would ifthey owned the machines in the factory.Information: Facts about borrowers and about expectations of returns on financial as-sets.asymmetric information: borrowers posses information about their opportunities or activ-ities that they dont diclose to lenders or creditors and can take advantage of this infor-mation. Primary Markets: Financial markets in which newly issued debt or equity claims are soldto initial buyers by private borrowers to raise funds for durable-goods purchases or new ventures and by governments to finance budget deficits. Secondary Markets: Financial markets in which claims that have already been issued are sold by one investor to another. Capital Markets: Financial markets for trading debt instruments with a maturity greater than one year and equity institutionsBorrowers seeking funds for long-term investments in housing or business investment issue long-term financial instruments in capital markets.- Some financial institutions, such as pension funds and insurance companies, are will-ing to hold assets for a long time and risk price fluctuations in capital markets.Money Markets: Financial markets that trade assets used as the medium of exchange, such as currency or shorter-term instruments with a maturity of less than one year. When the government or well-known corporations need funds to finance inventories or to meet short-term needs, they issue money market instruments.- Short term instruments have relatively small increases or decreases in price, so they are less risky as investments than long-term instruments are. As a result, financial insti-tutions and corporations typically invest short-term surplus funds in money markets. - Money market instruments are generally more liquid than capital market instruments because their trading volume is greater and the cost of buying and selling is low. Thus, households and businesses can invest their funds for a short period of time relatively cheaply. - Information costs are lower for money market instruments because the borrowers are well known and the length of time for which funds are loaned is relatively short. Financial Innovation: Alterations in the operation of financial markets and institutions caused by changes in costs of providing risk-sharing, liquidity, or information services, or changes in demand for these services. Financial innovation can benefit everyone. FInancial markets and institutions that have survived and thrived are those that combine low operation costs with high demand. Shifts in the cost of and demand for financial services can also alter the competitive bal-ance among markets and institutions in the financial system. Questions from Chapter 3:Q: As a saver, what sort of claims might you hold?A: You can hold claims on many borrowers. Your checking account is a claim on your bank. If you have savings bonds, you own a claim on the U.S. government. Money market accounts with Fidelity, Merrill Lynch, or any of their competitors are claims on a portfolio of assets held by the brokerage firm. If your aunt left you a Disney bond, you own a claim against the firm. Q: Using the categories describing financial markets, how would you characterize a transaction in which you buy 100 shares of Growthco from someone through a dealer?A: Debt or equity: shares of stock are equity. Primary or Secondary Market: The stock is already outstanding, so the transaction takes place in a secondary market. MOney orcapital market: The equities have no fixed maturity and so are traded in a capital mar-ket. Auction or over-the-counter market: The transaction takes place through a dealer rather than through an exchange, so it is conducted in an over-the-counter market. Cash or derivative market: you pay money to the dealer and receive the stock now, so the transaction takes place in a cash market. Q: Why might you be willing to buy a bond issued by IBM but prefer to lend to the local computer store through a bank?A: Your preference results from differences in information costs. Information about IBM is readily available, but you would have to incur significant costs to investigate the cred-itworthiness of the computer store. A bank can collect information on behalf of many small savers, reducing the cost of lending to the computer store and reducing the chance that you will invest your savings in a losing proposition. Q: Why do you think many experts have encouraged emerging market economies in Eastern Europe to develop financial intermediaries


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FSU FIN 3244 - Exam 1

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