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ECON 311: EXAM 1
Financial System links.. |
investors and savors |
Financial system provides |
productive uses for nations savings, leading to economic growth (savers give money to investors for a fee) |
financial markets |
stock and bond markets (direct financing) |
financial intermediaries |
banks
pool funds from savers and lend it to investors indirectly |
Financial System channels |
funds from savers, who have a surplus of funds but lack a productive use for those funds, to investors, who face a shortage of funds but have a productive use for them. |
direct finance |
individual savers hold claims issued directly by an individual borrower |
indirect finance |
financial intermediaries pool funds from individual savers and lend to borrowers |
monetary theory |
examines the effects of money on the overall economy |
money is like fuel... |
add money, it is going to heat up but have inflation problems
take money, it is going to slow down |
monetary policy |
use of money and interest rates to effect the level of economic activity |
role of financial system |
speculation
insuring against risk
storing, protecting and providing profitable uses for excess capital
provides capital to do things to today that other people could not afford
|
structure of financial markets |
debt and equity markets
primary adn secondary markets
exchanges and over the counter markets
money and capital markets |
debt securities |
promises to repay principal and interest at specified dates. they are the primary source of direct finance (loan) |
debt security maturity describes |
the length of time until the final payment on the debt is made |
short term debt maturity |
less than a year |
intermediate term debt |
between 1 and 10 years |
long term debt maturity |
more than 10 years |
equity securities |
represent ownership of a corporation and entitle the stockholder to a firms earnings and assets (stock) |
primary market |
newly issued debt or equity securities are sold to their initial buyers - corporate hands out new shares |
secondary markets |
financial markets where previously issued securities are bought or sold (stk mkt went up or down today) |
short term debt securities are traded in |
money markets |
equity and longer term securities are traded |
capital markets |
repurchase agreements |
the sale of securities with simultaneous agreement to repurchase the security at an agreed upon future price and date
ex/ pawn shop of securities - need to take gf out, pawn watch, go on date, buy back watch |
financial intermediation |
the process of indirect finance using financial intermediaries |
types of financial intermediaries |
banks
savings and loans
credit unions
mutual funds |
financial intermediaries provide |
the primary route for moving funds from saver/lenders to investor/borrower because they reduce transaction costs and information costs |
transaction costs |
time and money spent carrying out financial transactions
they reduce transaction costs through economies of sale |
asymmetrical information |
2 parties in a transaction - seller/buyer - one has more info than the other |
adverse selection |
occurs before transaction - seller has more info than buyer |
moral hazard |
occurs after transaction
business borrows to reinvest and chooses risky project to invest in
second party takes more rise than the original intended
insured person takes more risk, because if injured or sick insurance company has to pay for it
extra credit bc you would study less than optimal amount |
regulation of financial system goals |
increased info available to savers/lenders
ensure the soundness of financial intermediaries
improve the control of monetary policy |
interest |
the amount lenders receive for extending credit, or the amount borrowers pay for obtaining credit |
interest rate |
reflects the amount of interest paid in relation to the amount of lent or borrowed |
interest rates reflect |
the trade off between present and future consumption
and reflect the price of capital |
yield to maturity |
the interest rate that equates the price of an asset today with the present value of all future payments associated with that asset |
4 credit market instruments |
simple loan
discount bond
coupon bond
fixed payment loan |
simple loan |
borrower receives principal and repays rpinciapl plus interest at maturity |
discount bond |
borrower repays face value of the bond at maturity, but intially receives less than face value |
coupon bond |
borrower intially receives the face value of the bond then makes payments of interest at regular intervals and repays the face value at maturity |
fixed payment loan |
borrower makes regular period payments of equal size. each payment includes both principal and interest |
bond prices and interest rates are... |
negatively related |
YTM = Rate of Return |
if a bonds maturity and holding period are the same |
changes in interest rates result in... |
rates of return that differ from YTM if holding period is less than maturity |
the longer the bonds maturity... |
the more sensitive its price to changes in interest rates |
bond returns |
can be negative |
real interest rates |
the nominal interest rate minus the rate of inflation |
2 approaches to the determination of interest rates |
bond market framework
liquidity preference framework
both approaches rely on the theory of asset demand |
how will a change in any of the following affect ones decision to buy a particular asset |
wealth
the assets expected return relative to other assets
the assets risk relative to ther assets
the liquidity of an asset relative to other assets |
the demand for asset X will INCREASE, as a result of |
an increase in wealth
an increase in expected return of asset X relative to the return on other assets
decrease in risiness of asset X relative ot the riskiness of other assets
increase in the liquidity of asset X relative to the liquididty of other assets |
if expected demand return for stocks goes down... |
then demand for bonds goes up |
the market for bonds |
assume there is only one tyhpe of bond and one interest rate in the economy |
bond demand |
there is a negative realtionship between bond prices and the quantity of bonds demanded |
bond supply |
there is a positive relationship between bond prices and the quantity of bonds supplied |
factors that increase demand for bonds |
increase in wealth
decrease in expected future interest rates
decrease in expected future inglation
decrease in riskiness of bonds realtive to riskiness of other assets
increase in liquidity of bonds relative to the liquidity of other assets |
factors that incrase the supply for bonds |
increase in expected profitibility of business investments
increase in expected inflation
incrase in government budget deficit |
Fisher effect |
what happens to interest rates when expected inflation incrases. goes up |