10 5 12 10 42 AM CHAPTER 1 Financial markets markets in which funds are transferred from people who have an excess of available funds to people who have a shortage Security also called a financial instrument is a claim on the issuer s future income or assets Assets and financial claim or piece of property that is subject to ownership Bond debt security that promises to make payments periodically for a specified period of time Interest rate is the cost of borrowing or the price paid for the rental of funds Common stock represents a share of ownership in a corporation Financial intermediaries institutions that borrow funds from people who have saved and in turn make loans to others Financial crises major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms Banks financial institutions that accept deposits and make loans Financial innovation the development of new financial products and services E finance ability to deliver financial services electronically Money defined as anything that is generally accepted in payment for goods or services or in the repayment of debts Aggregate output total production of goods and services Unemployment rate the percentage of the available labor force unemployed Business cycles upward and downward movement of aggregate output produced in the economy Recession periods of declining aggregate output Monetary theory the theory that relates the quantity of money and monetary policy to changes in aggregate economic activity and inflation Aggregate price level average price of goods and services Inflation continual increase in the price level affects individuals businesses and the government Inflation rate the rate of change of the price level usually measured as a percentage change per year Monetary policy management of money and interest rates Central bank organization responsible for the conduct of a nation s monetary policy Federal reserve system the United States central bank Fiscal policy involves decisions about government spending and taxation Budget deficit excess of government expenditures over tax revenues for a particular time period typically a year Budget surplus arises when tax revenues exceed government expenditures Foreign exchange market funds converted from one currency into another instrumental in moving funds between countries Foreign exchange rate the price of one s country s currency in terms of another Gross domestic product is the market value of all final goods and services produced in a country during the course of a year Aggregate income the total income of factors of production from producing goods and services in the economy during the course of the year What role do financial markets play in the economy They transfer funds from people who have excess funds to those who have a shortage Financial markets are crucial to promoting greater economic efficiency by channeling funds from those who do not have a use for them to those who do Well functioning markets are a key factor in producing high economic growth The structure of a balance sheet Assets liabilities plus equity Assets are things you own liabilities are things you owe and equity is net worth What is the interpretation of the movement of interest rates depicted in Figure 1 The interest rates tend to move together over time but there is a spread between them that has to do with risk From figure 2 explain the sharp rise in the DJIA between 1990 2000 the steep declines in 2001 and 2007 Tech boom in the late 80 s Dow Jones increased dot Com bust in late 99 plus 9 11 dropped Rose again until 2007 housing bubble burst and it dropped again Before the tech boom we didn t have info in real time everything was done more slowly Volatility might be an occurrence because we know so much at such a fast pace that it is easily more volatile What is the key piece of information regarding M2 growth and recessions as conveyed by Figure 3 Close correlation between sharp declines in contraction of money supply and recessions You cannot have a high supply of money and low price levels 2 We discussed the crossover of M2 and the GDP deflator depicted in Figure 4 Be able to explain this Money supply and price level are both increasing at the same rate until mid 1980 when the money supply began increasing faster than the price level This is due to the technology boom things became more efficient and the price of labor dropped significantly How would you calculate any growth rate How would you calculate the real rate of economic growth from one period to the next How would you inflate an historic value to a current value Rate of change formula change x2 x1 x1 x 100 X2 is the more recent value X1 is the historic value What metric is most widely used to evaluate the US stock market s performance Dow Jones Industrial Average CHAPTER 2 Liabilities Direct finance borrowers borrow funds directly from lenders in financial markets by selling them securities Capital wealth either financial or physical that is employed to produce more wealth Maturity number of years until that instruments expiration date Short term if maturity of an instrument is less than a year Long term if maturity of an instrument is ten years or longer Intermediate term debt instruments with a maturity between one and ten years Equities claims to share in the next income and the assets of business Dividends when equities often make periodic payments to their holders and are considered long term securities because they have no maturity date Primary market financial market in which new issues of a security such as a bond or stock are sold to initial buyers by the corporation or government agency borrowing funds Secondary market is a financial market in which securities that have been previously issued can be resold Investment bank financial institution that assists in the initial sale of securities in the primary market Underwriting securities guarantees a price for a corporation s securities and then sells them to the public 3 Brokers are agents of investors who match buyers with sellers of securities Dealers link buyers and sellers by buying and selling securities at state prices Liquid how quickly something can be converted to cash Exchanges where buyers and sellers of securities meet in one location to conduct trades Over the counter OTC market in which dealers at different locations who have an inventory of securities stand ready to