Chapter 17 and Appendix C Financial Markets Microeconomics

Dividend

A direct payment from a firm to its shareholders

Bond

A financial contract through which a borrower like a corporation, a city or state, or the federal government agrees to repay the amount that was borrowed and also a rate of interest over a period of time in the future

Capital gain

A financial gain from buying an asset, like a share of stock or a house, and later selling it at a higher price

Private company

A firm owned by the people who run it on a day-to-day basis

Public company

A firm that has sold stock to the public, which in turn can be bought and sold by investors

Risk

A measure of the uncertainty of that project's profitability

Certificate of deposit (CD)

A mechanism for a saver to deposit funds at a bank and promise to leave them at the bank for a time, in exchange for a higher rate of interest

Index fund

A mutual fund that seeks only to mimic the overall performance of the market

Financial intermediary

An institution, like a bank, that receives money from savers and provides funds to borrowers

Compound interest

An interest rate calculation on the principal plus the accumulated interest

Simple interest

An interest rate calculation only on the principal amount

Venture capital

Financial investments in new companies that are still relatively small in size, but that have potential to grow substantially

NASDAQ

Founded in 1971 as an electronic stock market, allowing people to buy or sell from many physical locations.

Mutual funds

Funds that buy a range of stocks or bonds from different companies, thus allowing an investor an easy way to diversify

Liquidity

Refers to how easily money or financial assets can be exchanged for a good or service

Bondholder

Someone who owns bonds and receives the interest payments

A corporation is a business that "incorporates"—that is owned by _____ that have limited liability for the debt of the company but share in its profits (and losses). Corporations may be private or public, and may or may not have stock that is publicly traded. They may raise funds to finance their operations or new investments by raising capital through the sale of stock or the issuance of bonds.

shareholders

The sharp rise in housing prices was driven by a high level of demand for housing. Interest rates were low, so people were encouraged to borrow money to buy a house. Banks became much more flexible in their lending, making what were called "_____" loans. Banks loaned money with low, or sometimes no, down payment.

subprime

In financial markets, households are on the _____.

supply side

default risk

the risk that a borrower fails to pay back a bond

Sole proprietorship

A company run by an individual as opposed to a group

Debit card

A card that lets the person make purchases, and the cost is immediately deducted from that person's checking account

Stock

A claim on partial ownership of a specific firm

Partnership

A company run by a group as opposed to an individual

notes

10-year U.S. Treasury Bonds

Savings account

A bank account that pays an interest rate, but withdrawing money typically requires a trip to the bank or an automatic teller machine

Checking account

A bank account that typically pays little or no interest, but that gives easy access to money, either by writing a check or by using a debit card

Municipal bonds

A bond issued by cities that wish to borrow

Corporate bond

A bond issued by firms that wish to borrow

Treasury bond

A bond issued by the federal government through the U.S. Department of the Treasury

Present value

A bond's current price at a given time

Corporation

A business owned by shareholders who have limited liability for the company's debt yet a share of the company's profits; may be private or public and may or may not have publicly-traded stock

_____ borrowing is more customized than issuing bonds, so it often works better for relatively small firms.

Bank

Dow Jones Industrial Average

Based on 30 large companies from a diverse set of representative industries, chosen by analysts at Dow Jones andCompany. The index was started in 1896.

Standard & Poor's 500

Based on 500 large U.S. firms, chosen by analysts to represent the economy as a whole

High yield bonds

Bonds that offer relatively high interest rates to compensate for their relatively high chance of default

Shareholders

People who own at least some shares of stock in a firm

Expected rate of return

How much a project or an investment is expected to return to the investor, either in future interest payments, capital gains, or increased profitability

Wilshire 5000

Includes essentially all U.S. companies with stock ownership

FTSE

Includes the 100 largest companies on the London Stock Exchange

Nikkei

Index includes the 225 largest and most actively traded stocks on the Tokyo Stock Exchange.

Diversification

Investing in a wide range of companies to reduce the level of risk

Face value

The amount that the bond issuer or borrower agrees to pay the investor

Maturity date

The date that a bond must be repaid

Initial public offering (IPO)

The first sale of shares of stock by a firm to outside investors

Coupon rate

The interest rate paid on a bond; can be annual or semi-annual

Equity

The monetary value a homeowner would have after selling the house and repaying any outstanding bank loans used to buy the house

Corporate governance

The name economists give to the institutions that are supposed to watch over top executives in companies owned by shareholders

New York Stock Exchange

The oldest and largest U.S. stock market, dating back to 1792.

Bond yield

The rate of return a bond is expected to pay at the time of purchase

Shares

The stock of a firm, divided into individual portions

Actual rate of return

The total rate of return, including capital gains and interest paid on an investment at the end of a period of time

DAX

Tracks 30 of the largest companies on the Frankfurt, Germany, stock exchange

When a firm has a record of at least earning significant revenues, and better still of earning profits, the firm can make a credible promise to pay interest, and so it becomes possible for the firm to borrow money. Firms have two main methods of borrowing: _____.

banks and bonds

In theory, the _____ help(s) to ensure that the firm is run in the interests of the true owners—the shareholders.

board of directors

If a firm issues bonds and fails to make the promised interest payments, the _____ can take the firm to court and require it to pay, even if the firm needs to raise the money by selling buildings or equipment. However, there is no guarantee the firm will have sufficient assets to pay off the bonds.

bondholders

With a _____, you agree to deposit a certain amount of money, often measured in thousands of dollars, in the account for a stated period of time, typically ranging from a few months to several years. In exchange, the bank agrees to pay a higher interest rate than for a regular savings account.

certificate of deposit

interest rate risk

danger of buying a bond before the interest rate rises, meaning you could have made a higher return

A saver who _____ is following the old proverb: "Don't put all your eggs in one basket." In any broad group of companies, some firms will do better than expected and some will do worse—but the extremes have a tendency to cancel out extreme increases and decreases in value.

diversifies

Investment in a house is tangibly different from bank accounts, stocks, and bonds because a house offers both _____ returns.

financial and nonfinancial

Firms can raise _____ in four main ways: (1) from early-stage investors; (2) by reinvesting profits; (3) by borrowing through banks or bonds; and (4) by selling stock.

financial capital

Identify tangible assets

gold - collectibles

The bottom line on investing in the stock market is that both the rate of return over time and the risks are _____.

high

total future amount

principal + interest

simple interest

principal x rate x time

Because stock prices will shift in response to unpredictable future news, these prices will tend to follow what mathematicians call a "_____"

random walk with a trend.

Any young startup firm is a _____; indeed, some startup firms are only a little more than an idea on paper. The firm's founders inevitably have better information about how hard they are willing to work, and whether the firm is likely to succeed, than anyone else. When the founders put their own money into the firm, they demonstrate a belief in its prospects. At this early stage, angel investors and venture capitalists try to overcome the imperfect information, at least in part, by knowing the managers and their business plan personally and by giving them advice.

risk