Finance Chapter 2

Which of the following statements describes a primary market transaction? One financial institution buys 200,000 shares of BP stock from another institution. An investment banker arranges the transaction. Microsoft sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years. You sell 200 shares of Kroger stock on the NYSE through your broker. Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker. You buy 200 shares of Honda stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock.

Facebook issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

The acronym IPO stands for "independent public offering." True False

False

Physical Location Exchanges

Formal organizations having tangible physical locations that conduct auction markets in designated ("listed") securities.

hedge funds

Lightly regulated investment funds that have fewer restrictions than mutual funds pertaining to investment choices.

Money Market Funds

Mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts

Which of the following is an example of a capital market instrument? Money market mutual funds. Banker's acceptances. Commercial paper. U.S. Treasury bills. Preferred stock.

Preferred stock

Commercial Banks

Privately owned financial institutions that accept demand deposits and make loans and provide other services for the public

Which of the following is an example of securities traded in money markets? Consumer automobile loans. Foreign currencies. Common stocks. Short-term debt securities such as Treasury bills and commercial paper. Long-term bonds.

Short-term debt securities such as Treasury bills and commercial paper.

Credit Default Swap

Suppose a bank wants to protect itself from one of its borrowers. The bank could enter into a credit default swap where is agrees to make regular payments to another financial institution. In return, that financial institution agrees to insure the bank against losses that would occur if the borrower defaulted.

Financial Asset Markets

deal with stocks, bonds, notes, and mortgages

Indexed Funds

designed to simply replicate the performance of a specific market index

Physical Asset Markets

for products such as wheat, autos, real estate, computers, and machinery

Dealer Markets

include all facilities that are needed to conduct security transactions not conducted on the physical location exchanges

Money Markets

include short-term, highly liquid, and relatively low-risk debt instruments

Financial Service Corporations

large conglomerates that combine many different financial institutions within a single corporation

Short Term

less than a year

Capital Markets

markets for intermediate or long term debt and corporate stocks

Primary Markets

markets in which corporations raise new capital by issuing new securities

Secondary Markets

markets in which existing, already outstanding securities are traded among investors

Long Term

more than 10 years

Stock markets

most active secondary market, where the prices of firms' stocks are established.

Intermediate Term

1-10 years

Mutual funds

A pool of money used by a company to purchase a variety of stocks, bonds or money market instruments. Provides diversification and professional management for investors.

Three years ago you purchased 500 shares in the Kellogg Company, but yesterday you sold 200 those shares through your broker. This is: A primary market transaction. A money market transaction. A secondary market transaction. An over-the-counter market transaction. A futures market transaction.

A secondary market transaction.

Pension Funds

Amounts of money put aside by corporations, nonprofit organizations, or unions to cover part of the financial needs of members when they retire

Of the following statements, which is CORRECT? If you purchase 100 shares of Facebook stock from your friend Sam, this is an example of a primary market transaction. Only institutions, and not individuals, can engage in derivative market transactions. If H&R Block issues additional shares of common stock through an investment banker, this would be a secondary market transaction. The NYSE is an example of an over-the-counter market. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

Thinking about the financial markets, which of the following statements is CORRECT? Money market transactions only involve securities denominated in U.S. dollars. Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year. If General Electric were to issue new stock this year, this would be considered a secondary market transaction as the company already has stock outstanding. Capital market transactions involve only preferred stock or common stock.

Both NASDAQ dealers and specialists on the NYSE hold inventories of stocks.

One of the following statements about issuing and owning securities is incorrect. Which statement is NOT CORRECT? The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself. When a corporation's shares are owned by a few individuals, we say that the firm is closely, or privately, held. When stock in a closely held corporation is offered to the public for the first time, the transaction is called going public, or an IPO, and the market for such stock is called the new issue, or IPO, market. Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Going public establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Which of the following statements about hedge funds is CORRECT? Hedge funds are extremely popular in Europe and Asia, but they are rarely used or made available in the United States. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. Hedge funds have more in common with commercial banks than with any other type of financial institution. Hedge funds have more in common with investment banks than with any other type of financial institution.

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only the wealthiest investors invest in hedge funds, and they understand the risks.

Investment Banks

Helping corporations design securities with features that are currently attractive to investors Buying these securities from the corporation Reselling them to savers

Which of the following statements about IPOs is CORRECT? The term "IPO" stands for Individual Purchase Order, and it is the price at which individual shares of a new company are offered for purchase. IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day that the stock is offered to the public. Sometimes, a company is forced to issue more shares than it wants to sell in an IPO because the share price is so low and demand is high. It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In this situation, the IPO is said to be oversubscribed. In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.

In a Dutch auction, investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.

financial intermediary

Intermediary that buys securities with funds that it obtains by issuing its own securities. An example is a common stock mutual fund that buys common stocks with funds obtained by issuing shares in the mutual fund.

Primary Market Transaction

The Company sells its stock or bonds to the investment bank, which then sells these same securities to savers.

Which of the following statements about financial institutions and securities is CORRECT? While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. A liquid security is a security whose value is derived from the price of some other "underlying" asset. Money markets are markets for long-term debt and common stocks. The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.

The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.

Which of the following statements about financial markets is CORRECT? While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. Capital markets deal only with common stocks and other equity securities. The New York Stock Exchange is an auction market, and it has a physical location. If an investor sells shares of stock through a broker, then it would be a primary market transaction. Home mortgage loans are traded in the money market.

The New York Stock Exchange is an auction market, and it has a physical location.

Going Public

The act of selling stock to the public at large by a closely held corporation or its principal stockholders.

initial public offering

The first time a corporation issues stock to the public

Spot Markets

The markets in which assets are bought or sold for "on-the-spot" delivery.

Brokerage Department

They purchase seats on the exchanges and designate one or more of their officers as members.

You recently sold 100 shares of Facebook stock to your uncle. You had the certificates and gave them to him. In exchange, he wrote you a check. Which of the following best describes this transaction? This is an example of a money market transaction. This is an example of a derivative market transaction. This is an example of a primary market transaction. This is an example of a direct transfer of capital. This is an example of an exchange of physical assets.

This is an example of a direct transfer of capital.

A corporation is said to be publicly owned if its shares are held by the investing public, which may include individuals, other corporations, and institutional investors. True False

True

A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. One example is a commercial bank, which takes in demand deposits and then uses that money to make long-term mortgage loans. True False

True

A stock is considered to be closely held if the corporation's shares are owned by a few individuals who are associated with the firm's management. True False

True

A stock's return can be broken out into its dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). These returns can be calculated for all of the stocks in the S&P 500. You can find an indicator of the "return on the market" by calculating the weighted average of those returns, using each stock's total market value. True False

True

Data from the Dow Jones Industrial Average, the S&P 500 Index, and the NASDAQ Composite Index give information about past stock returns. True False

True

Financial institutions are more diversified today than they were in the past, when federal separated investment banks, commercial banks, insurance companies, and other financial companies. Today, large financial services corporations offer services that they could not in the past. True False

True

Hedge funds are similar to mutual funds except that they are less regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions. True False

True

The equation used to find the annual rate of return on any given stock is the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price. When applied to a large portfolio of stocks, like those in the S&P 500, the average of the returns on each stock can be used to find stock market returns for the year in question. True False

True

To find the annual rate of return on any given stock, add the stock's dividend for the year plus the change in the stock's price during the year, then divide by its beginning-of-year price. True False

True

Publicly Owned Cooperating

a corporation that is own by a relativity large numbers of individuals who are not actively involved in the firms

over the counter market

a large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities.

Credit Unions

a nonprofit-making money cooperative whose members can borrow from pooled deposits at low interest rates.

Financial Industry Regulatory Authority (FINRA)

a private, nonprofit organization that regulates firms selling securities in the United States

Closely held

an organization that is owned by only a few people

Derivatives

any financial asset whose value is derived from the value of some other "underlying" asset

Efficient Market Hypothesis

asset prices always embody all publicly available information (intrinsic)

technology Influence

buy and sell securities often at speeds less than a second don't use cash anymore crowdfunding

Exchange Traded Funds

collections of stocks, bonds, and other investments that are traded on exchanges but are traded more like individual stocks than like mutual funds

Direct Transferring

occur when a business sells its stock or bonds directly to savers, without going through any type of financial institution.

Private Equity Companies

organizations that operate much like hedge funds; but rather than purchasing some of the stock of a firm, private equity players buy and then manage entire firms.

Crowdfunding

raising money for a project or venture by obtaining many small amounts of money from many people

Hedge

reduce the risk faced by both individuals

Derivative Securities

securities whose value is derived from the value of other assets

Public Markets

standardized contracts are traded on organized exchanges common stock and corporate bonds

Life Insurance

take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties.

Dutch Auction

the actual transaction price is set at the highest price (the clearing price) that causes all of the offered shares to be sold

oversubscribed

the demand for shares at the offering price exceeds the number of shares issued

bid-ask spread

the difference between the bid price and the asked price

Future Markets

the markets in which participants agree today to buy or sell an asset at some future date

Arbitrage

the purchase of securities in one market for immediate resale in another to profit from a price discrepancy

Private Markets

transactions are negotiated directly between two parties bank loans

Actively Managed Funds

try to outperform the overall markets

Underwriters

underwriters purchase securities from the issuing company and resell them to the public