Ch. 3 Financial Instruments, Financial Markets, and Financial Institutions
role of financial markets
1. Market Liquidity - ensure owners can buy and sell financial instruments cheaply 2. Information - pool and communicate information about issuers of financial instruments 3. Risk Sharing - provide individuals a place to buy and sell risk
3 functions of financial instruments
1. act as a means of payment (like money), employees take stock options as payment for working 2. act as stores of value (like money), can be used to transfer purchasing power into the future 3. allow for the transfer of risk (unlike money), futures and insurance contracts allow for this
portfolio
A collection of financial assets
centralized exchange
A financial market in which financial instruments are traded in a single physical location.
Asset-backed security
A security whose cash flows come from an underlying pool of financial securities that "back" it.
broker
a wholesaler who does not take title to goods and whose function is to bring buyers and sellers together and assist in negotiation
dealer
an agent who buys and sells securities from inventory
future contract
an agreement to buy or sell at a specific date in the future at a predetermined price
direct finance
borrowers sell securities directly to lenders in the financial markets
over-the-counter markets
decentralized secondary markets where dealers stand ready to buy and sell securities electronically
electronic communication networks
electronic market bringing buyers/sellers together without the use of a broker or dealer
intermediary
financial institution
indirect finance
financial intermediaries/institutions stands between lender and borrower
equity market
financial market where stocks are bought and sold
financial institutions
firms that provide access to the financial markets, both to savers who wish to purchase financial instruments directly and to borrowers who want to issue them
money markets
include short-term, highly liquid, and relatively low-risk debt instruments
derivative instrument
instruments where their value and payoffs are 'derived' from the behavior of the underlying instruments
debt market
is the markets for loans, mortgages, and bonds
primary financial market
market in which a borrower obtains funds from a lender by selling newly issued securities
secondary financial market
markets where people can buy and sell existing securities
Government Sponsored Enterprises
organizations such as FANNIE MAE and FREDDIE MAC, which are authorized and supported by the US government to operate a secondary mortgage market for residential loans
financial markets
perform the essential function of channeling funds from economic players that have saved surplus funds to those that have a shortage of funds
counterparty
person or institution on the other side of a contract
collateral
something pledged as security for repayment of a loan, to be forfeited in the event of a default.
bond market
the collective buying and selling of bonds; most bond trading is done over the counter, rather than in organized exchanges
leverage
the use of borrowed money to supplement existing funds for purposes of investment
financial instrument
the written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under specified conditions
underlying instrument
used by savers/lenders to transfer resources directly to investors/borrowers
liability
Anything for which a person or firm is legally bound or responsible.
asset
Anything of value that is owned
mortgage-backed securities
Bonds that represent claims to all or part of the monthly mortgage payments from the pools of mortgage loans made by leaders to borrowers to help them purchase residential property.
capital markets
Markets that trade debt (bonds) and equity (stock) instruments with maturities of more than one year