FI 301 1nd EditionExam # 1 Study Guide Lectures: 1 - 8Chapter 1Surplus Unit- person that has money to give aka an investorDeficit unit- borrower needs moneyName of a company/individual helps deficit units get money from surplus units- Intermediary, financial institutions, help flow of funds, do these in financial marketsMoney market- short terms a year or less, examples: CD, derivative securityCapital market- a year or more long-term debt examples: bonds, stocks, mortgages, Bonds- investment in a debtStock- share/equity in a companyMortgage- real estate investmentInvestments and debtsDerivative security- short term investment with an asset backing speculators and hedger invest in theseSpeculator- uses derivative to bet or gamble if prices are going up and downHedging- foreigners and banks they are trying to reduce riskDifference between primary and secondary marketPrimary- buys investment initially or borrows money initiallySecondary- 2 investors trade with each other Commercial bank- main job is to make short-term loansCredit union different than a bank, credit unions do business with their members and banks will make a loan with anyone. Credit unions make better deals most of the timeFinance company- makes high interest loans for people with bad creditSecurities- mutual funds, treasuries, stocks, bills and bonds, CDs, mortgages, Financial asset- piece of paper that gives you a claim to its asset that backs it. Piece of paper that gives us a return. something that gives us a value and a return on your investment Financial institution- bank, insurance company, investment brokerage, they transfer capital (invest for us) facilitate the flow of fundsPhysical assets- farm commodities, real estate deals with land and buildingsLiquidity- financial assets are more liquidReal estate assets generally take longer to sell and transferInsurance markets- guaranteed a certain payback with insurances, not guaranteed with bonds and stocksDerivative securities- futurist, swap contracts- short term and long term securities where they have physical asset underlying them and its not always real estate ex. Corn, soybeans, rice contract, or it can be an interest rate, another form of security that has an asset behind it, invented for two type of people (farmers and the banks) they use derivatives to hedge risk. Speculation- trying to make big returnsRisk management and hedging- don’t care if they loose as long as they don’t loose bigHedge and risk- banks and farmers want to avoid disaster so they take out contracts and they note going in that they may loose money (futurist contract) but they don’t care because they are trying to avoid disaster ex if interest rates move too fast they cant pay off their liabilitiesChapter 2 5 types of demand household- provide by investing in debt, largest supplier of money that’s demanded, federal government- interest inelastic, interest rates don’t affect their demand they will borrow money no matter the interest rates because they can print money to pay it back if they have tomunicipal government- cant print money, issue bonds or raise taxes to pay back debt, they are tax free businesses/corporations-foreign investors-when do corporations decide to buy money and affect interest rates- they want to expand, they are expecting to make more profit/higher cash flows, interest rates change when they expect more cash flowinterest rate- risk free rate +risk premiumrisk premium- default risk, liquidity risk, inflation, return risk, tax default risk- risk you will not pay it backliquidity risk - cant sell the asset quickly to make a profitreturn risktaxinterest makes up the yield curve- shows interest rates on vertical size and maturity on horizontal side shows expectations in the economyupward slope- economy is going to get better , interest rates should risedownward slope- expecting recession, interest rates should lowerflat or hump shaped tells us that there is uncertainty*** examples in chapter 2 economic conditionseconomy expected to grow, demand is going to INCREASE, interest rates are going to RISEIf inflation is expected to start rising, 2 to 4% inflation, demand is going to go UP right now for money because price is going to go up want to buy it now while it is cheaper, interest rates are going to go UPBudget surplus- demand for money is low; interest rates are going to fall because banks need people to borrow moneyForeign investors supply goes down – interest rates are going to increaseThe Loanable Funds Theory suggests that the market interest rate is determined by the factors that control supply of and demand for loanable funds.Lower interest rate the betterIf we didn’t care what the interest rate was, it was an absolute emergency, there is still gonna bea lot more money at 2% then 6% because there’s less interest money to pay back, it is more attractive, more people can afford the 2 percent than the 6 percent. Foreign countries want to borrow money from us or we want to borrow from them. We borrow money in a foreign country instead of our own because they have a lower interest rate. Each country has different interest rates. Risk- currency risk- our dollar is worth more or less in other placesBenchmark interest ratesUS- 0.25%China- 6%Brazil- 11%Japan- 0%Australia- 2.5%Mexico-3%Tells you higher percentage the higher likely they are to default foreign investors in that country not government itself They have high inflation (high interest rates like brazil and china) they are trying to slow down their economyWe want foreign investors to borrow from us (low interest rates) same with JapanChapter 3 Liquidity- how quickly turn investment into cash without loosing valueAffects interest rate you pay higher interest rate if less liquid 3. People can control their tax status Different tax bracketsExample-municipal bond and a corporate bond municipal bonds can pay out less lower interest rate where a corporate is higher municipal bond you don’t have to pay taxes on they can give you less for returns. Tax effects what interest rates are Equivalent before tax Yield= )1( Tbtat = )1( TatbtExample Questions:• Suppose our household income is approximately $100,000. Due to few tax deductions, we are in the 35% tax bracket. What is our after-tax yield on our holdings if we made 4.40% before-tax yield on dividends on our Public Storage stock holdings? • Now what is our before-tax yield if we made a 1.56% after-tax return on our