Econ 330 Exam 1
advantages of commodity money
-has intrinsic value -universally accepted -not easy to abuse
Depository Institutions
-traditional banks -accepts deposits -make loans
types of credit market instruments
1. simple loan 2. fixed payment loan 3. coupon bond 4. discount bond
Factors that cause a shift in the demand for bonds
1. wealth 2. expected returns on bonds relative to alternative assets 3. risk of bonds relative to alt assets 4. liquidity of bonds relative to alt assets
Eurodollars
US dollars deposited in foreign banks outside the US or in foreign branches of US banks ex: dollar-denominated checking account at a bank in Italy
1. medium of exchange 2. store of value 3. unit of account
3 functions money must fulfill
exchanges (secondary markets)
NYSE, Chicago Board of Trade -buyers and sellers meet at a location and time to exchange
security
a claim on the issuer's future income or assets
Debt
a contract that specifies how much you give me now and when and how much I give you in the future -borrowing/a promise ex: bond or loan
Discount bond
a credit market instrument that is bought at a price below its face value and is repaid at the maturity date; it does not make any interest payments
Coupon Bond
a credit market instrument that pays the owner a fixed interest payment every year until the maturity date, at which a specified final amount is repaid
simple loan
a credit market instrument that provides the borrower with a number of funds that must be repaid to the lender at the maturity date, along with additional payment
Fixed Payment Loan
a credit market instrument that provides the borrower with an amount of money that is repaid through fixed periodic (usually monthly) payments over a set number of years
Bond
a debt security that promises to make periodic payments to the holder for a specified period of time
Indirect Finance
a financial intermediary borrows funds from lender-savers and then uses these funds to make loans to borrower-spenders ex: I have a checking account at Bank of America ex: I have a bank account credit card
Interest (for bonds)
a measure of how much extra I pay you back
store of value
a repository of purchasing power over time
Face value
a specified final amount paid to the owner of a coupon bond at the maturity date
Theory of Portfolio Choice
a theory that outlines how much of an asset people will want to hold in their portfolios, as determined by wealth, expected returns, risk, and liquidity
positively
according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to its expected return relative to other assts
positively
according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to its liquidity relative to alternative assets
negatively
according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to the risk of its returns to alternative assets
positively
according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to wealth
Moral Hazard happens...
after the transaction
Brokers
agents for investors who match buyers with sellers
Central Bank
an institution in charge of monetary policy -controls the money supply
unit of account
anything used to measure value in an economy
medium of exchange
anything used to pay for goods and services -liquid
examples of financial intermediaries
bank, insurance company, stockbrokers, investment banks, mutual fund company
Adverse Selection happens...
before the transaction
lenders are the
bond demanders
savers are the
bond demanders as well
borrowers are the
bond suppliers
Eurobond
bonds denominated in a currency other than that of the country in which it is sold ex: airbus bond sold in US but denominated in Euros
Direct Finance
borrowers borrow funds directly from lenders in financial markets by selling the lenders securities ex: i own shares of apple ex: i own a US government bond
Secondary Market
buy/sell equity or debt that already exists -much larger than other market
Primary Market
buy/sell new equity shares or new bonds
stock brokers as financial intermediaries
buyers of stock to sellers of stock
Disadvantages of commodity money
can't control supply debasement
Nominal Interest Rate
change in how much money I have by waiting
Inflation rate
change in price of goods and services -cost in goods from borrowing
Real interest rate
change in what i can consume by waiting
owning common stock
commercial banks and other depository institutions are prohibited from
Fiscal Policy
control of government spending and taxes to affect the macroeconomy
Monetary Policy
control of the supply of money, interest rates, and price
what financial intermediaries can do
create economies of scale provide liquidity services risk share allow for diversification
M1
currency + traveler's checks + demand deposits + other checkable deposits -most liquid assets
Monetary Base (MB)
currency and reserves (money in a bank's vault)
banks role as financial intermediaries
depositors to borrowers
advantages of fiat money
easy to control supply
Moral Hazard
ensure borrower will not engage in activities that will prevent him/her to repay the loan
Examples of secondary markets
exchanges over the counter markets money markets capital markets
Euro currencies
foreign currencies deposited in banks outside the home country ex: a bank of America checking deposit denominated in Euros
Over the counter markets (secondary markets)
foreign exchange -ongoing decentralized electronic market
Investment Banks
get funds from virtually anywhere (except deposits in the traditional sense) and do virtually anything with the funds
Stock
gives ownership to a portion of a firm and have the right to vote on issues important to the firm and to elect its director
examples of commodity money
gold coins, silver, cigarettes
Solution to fiat money
independent central banks
Financial Intermediaries
institutions that borrow funds from people who have money saved and then make loans to others -a person/company that connects savers with borrowers
Contractual Savings Instituions
insurance company and pension company -get funds from premiums or contributions -lend those funds
Equity
is ownership of an asset and thus claims on income generated by that asset
Finance Company (GMAC)
issue stock shares to raise funds -use funds to make loans (often for a specific product)
argument for financial regulation
it protects individuals and the economy as a whole from the unknowns in the financial sector (individuals) as well as the risk to the entire economy posed by systemic risk
argument against financial regulation
it puts a burden on financial intermediaries that discourages innovation, raises costs, and thus reduces the supply of financial services -it is not needed because the market will discipline financial intermediaries
Liquidity Services
make it easier for customers to conduct transactions
Financial Markets
markets in which funds are transferred from people and firms who have an excess of available funds to people and firms who have a need of funds -where funds are exchanged
Commodity Money
money made up of precious metals or another valuable commodity
Financial Innovation
the development of new financial products and services
Liquidity
the ease and speed with which an asset can be turned into cash relative to alternative assets
Yield to maturity
the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
Monetary aggregates
the measures of the money supply (M1 and M2) used by the federal reserve
Coupon rate
the money amount of the yearly coupon payment expressed as a percentage of the face value of a coupon bond
Interest Rate Risk
the possible reduction in returns associated with changes in interest rates
expected return
the return expected over the next period on one asset relative to alternative assets
Interest Rate
the reward for waiting or the cost of having something now
disadvantages of fiat money
the temptation to print money to pay bills -worth nothing except as a medium of exchange
GDP
the value of all final goods and services produced in the economy during the course of the year -the most comprehensive measure of aggregate output
wealth
the value of all your assets
interest rate risk
there is no __________ for any bond whose time to maturity matches the holding period
Adverse Selection
try to avoid selecting the risky borrower by gathering information about them
bond/loan and stocks
types of security
what affects your desire to hold an asset
wealth expected return risk liquidity
economies of scale liquidity services
what are the advantages of financial intermediaries
Maturity (for bonds)
when you are paid back
Types of Financial Intermediaries
Depository Institutions Contractual Savings Institutions Finance Company (GMAC) Mutual Fund Investment Banks
M2
M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares
risk
the degree of uncertainty associated with the return on one asset relative to alternative assets
Dealers
People who link buyers with sellers by buying and selling securities at stated prices
Money
one of those assets one has -used to buy goods and services
Capital Markets (secondary markets)
only longer term debt and equity instruments are traded
Money Markets (secondary markets)
only short term debt instruments are traded
Fiat Money
paper currency decreed by a government as a legal tender but not convertible into coins or precious metals
currency
paper money and coins
Mutual Fund
pool savings to buy a diversified group of stocks or bonds
systemic risk asymmetric information
regulation of financial intermediaries are necessary because
insurance company as financial intermediaries
savers for accidents to borrowers
mutual fund company as financial intermediaries
small savers to large borrowers or investors
Foreign Bonds
sold in a foreign country and denominated in that country's currency ex: airbus sold in US denominated in dollars
Saver
someone who consumes less than their income
investor
someone who purchases physical/human capital
