Financial Institutions Exam 1
Financial institutions are required to maintain a deposit insurance cap of _____ per person per bank.
$250,000
The daily volume of electronic payments processed through the Fedwire and CHIPS systems is approximately
$4.5 trillion.
Risks that financial institutions face
-Credit Risk -Denomination intermediation -Price Risk -Liquidity Risk -Maturity intermediation -Interest Rate Risk (change) -Operational Risk -Technology Risk -Off balance sheet Risk -Foreign Exchange Risk
The 3 major reasons that suppliers of funds would not want to directly purchase securities
1. Monitoring Risk 2. Liquidity Risk 3. Price Risk
Delegated Monitor
An economic agent appointed to act on behalf of smaller investors in collecting information and investing funds on their behalf
Depository institutions include:
Banks and thrifts
Why monetary policy is transmitted through the banking system?
Because deposits are a significant component of the money supply, which in turn directly impacts the rate of economic growth
The two payment services
Check-clearing and wire transfer services
Capital Market instruments
Corporate stocks, mortgages, treasury securities, and corporate bonds
Depository institutions (DIs) play an important role in the transmission of monetary policy from the Federal Reserve to the rest of the economy because:
DI deposits are a major portion of the money supply
What is the riskiest market?
Derivative Security Markets
The passage of the Securities Act of 1933 stated that the main emphasis of SEC regulations should be focused on
Detecting and prosecuting insider trading
Investors in Secondary Markets
Economic agents
A financial institution's average cost of monitoring is lower than the individual investor's due to
Economies of scale
Maturity Intermediation
FIs can better bear the risk of mismatching the maturities of their assets and liabilities
Financial intermediaries (FIs) can offer savers a safer, more liquid investment than a capital market security, even though the intermediary invests in risky illiquid instruments because:
FIs can diversify away some of their risk and closely monitor the riskiness of their assets
Denomination Intermediation
FIs such as mutual funds allow small investors to overcome constraints to buying assets imposed by large minimum denomination size
T or F: Asset transformation by financial intermediaries involves increasing the risk attributes of securities such as mortgages, bonds, and stocks.
False
T or F: Corporate security issuers are always directly involved in funds transfers in the secondary market.
False
T or F: Secondary markets are markets used by corporations to raise cash by issuing securities for a short time period.
False
T or F: There are three types of major financial markets today: primary, secondary, and derivatives markets. The NYSE and NASDAQ are both examples of derivatives markets.
False
Major suppliers of funds for capital market securities
Households
Secondary markets help support primary markets because secondary markets: I. offer primary market purchasers liquidity for their holdings. II. update the price or value of the primary market claims. III. reduce the cost of trading the primary market claims.
I,II, and III
right, left
Inflation causes the demand curve for loanable funds to shift to the _____ and causes the supply curve to shift to the _____.
Money to be used to proved for children in the event of death
Insurer
Type of financial institutions in Primary Markets?
Investment Banks
Primary Markets
Markets in which corporations raise funds through new issues of financial instruments
Secondary Markets
Markets that trade financial instruments once they are issued
What delegated monitoring function FIs perform?
Monitoring Costs
Vary
Nominal interest rates tend to _________ over time.
Money to provide supplemental retirement income
Pension fund
Treasury Bills
Short-term obligations issued by the U.S. government
False
T or F: According to the liquidity premium theory, investors preferring long-term bonds over short-term bonds would require lower liquidity premium.
True
T or F: According to the market segmentation theory, short-term investors will not normally switch to intermediate- or long-term investments.
True
T or F: An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households.
False
T or F: An increase in the perceived riskiness of investments would cause a movement up along the supply curve.
True
T or F: An investor earned a 5 percent nominal risk-free rate over the year. However, over the year, prices increased by 2 percent. The investor's real risk-free rate was less than his nominal rate of return.
True
T or F: Convertible bonds will normally have lower promised yields than straight bonds of similar terms and quality.
True
T or F: Given all other factors are unchanged, households generally supply more funds to the markets as their income and wealth increase.
False
T or F: If you earn 0.5 percent a month in your bank account, this would be the same as earning a 6 percent annual interest rate with annual compounding.
True
T or F: The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.
True
T or F: The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk.
True
T or F: The term structure of interest rates is the relationship between interest rates on bonds that are similar in all terms except for maturity.
False
T or F: The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.
True
T or F: When the quantity of a financial security supplied or demanded changes at every given interest rate in response to a change in a factor, this causes a shift in the supply or demand curve.
suppliers, demanders
The loanable funds theory categorizes all market participants (consumers, businesses, governments, and foreign participants) as net Blank______ or Blank______ of funds.
Which of the following statements is true regarding derivative securities?
Their value is linked to the value of another previously issued security
T or F: Financial intermediaries rather than financial systems are the most common agents to channel funds from the suppliers to the users of funds.
True
T or F: Money markets are the markets for securities with an original maturity of one year or less.
True
T or F: Primary markets are markets in which users of funds raise cash by selling securities to funds suppliers.
True
T or F: The NYSE is an example of a secondary market.
True
IBM creates and sells additional stock to the investment banker Morgan Stanley. Morgan Stanley then resells the issue to the U.S. public through its mutual funds. This transaction is an example of a(n): a) primary market transaction b) asset transformation by Morgan Stanley c) money market transaction d) foreign exchange transaction
a
Derivative securtities
a financial security whose payoff is linked to another, previously issued security such as a security traded in capital or foreign exchange markets
Price Risk
a risk that the price of the security will change when interest rates change
Monitoring costs
aggregation of funds in an FI provides greater incentive to collect a firm's information and monitor actions
Repurchase Agreements
agreements involving the sale of securities by one party to another with a promise by the seller to repurchase the same securities from the buyer at a specified date and price
Financial Institutions (Asset Transformers)
are institutions that perform the essential function of channeling funds from those with surplus funds to those with shortage of funds
Financial Markets
are structures through which funds flow
negotiable CD
bank-issued time deposits that specify an interest rate and maturity date and are negotiable
Ex. of economic agents
consumers, businesses, and governments
Major suppliers of capital market securities
corporations and governments
In primary markets, the users of funds are frequently
corporations needing funds for new projects
Money likely to be needed within six months
depository institutions
A primary conduit through which monetary policy actions of the Federal Reserve are transmitted to the economy are
depository institutions.
Financial intermediaries' ability to reduce the average cost of collecting information because of their efficient operations allows them to take advantage of:
economies of scale
Indirect flow of funds
financial institutions being a middleman
Ex. of derivative securities
futures contract, option contract, swap contract, mortgage-back security
Traditional depository institutions find it difficult to compete with other financial institutions due to
higher costs due to regulation
Maturity intermediation may expose financial institutions to
interest rate risk
In the "originate and hold" model, financial institutions are exposed to risks, including which of the following?
interest rate risk, liquidity risk, and credit risk
A financial institution's average cost of monitoring fund users is _________ than the individual investor's cost.
lower
Foreign Exchange Markets
markets in which cash flows from the sale of products or assets denominated in a foreign currency are transacted
Derivative Security Markets
markets in which derivative securities trade
Over-the-counter (OTC) Market
markets that do not operate in a specific fixed location
Money Markets
markets that trade debt securities or instruments with maturities of one year or less
Capital Markets
markets that trade equity and debt instruments with maturities of more than one year
Services Benefiting the Overall Economy
money supply transmission, credit allocation, intergenerational wealth transfers, payment services
Services benefiting suppliers of funds
monitoring costs, liquidity and price risk, transaction cost services, maturity intermediation, denomination intermediation
Financial institutions reduce individual investor's monitoring costs by
pooling their funds and hiring employees to monitor the fund users.
IPO's are issued on the ____________ and facilitated by ____________.
primary market; investment banks
In the U.S., savings banks and savings associations have been directed to provide financing primarily for
residential mortgages
Commerical Paper (CP)
short term unsecured promissory notes issued by a company to raise short-term cash
Federal Funds
short-term funds transferred between financial institutions usually for no more than one day
Financial instruments in Primary Markets
stocks and bonds
Money to be set aside for college in 10 years
stocks or bonds
What kind of transactions are in over-the-counter markets?
telephones, wire transfers, and computer trading
Liquidity risk at a financial intermediary (FI) is the risk:
that a sudden surge in liability withdrawals may require an FI to liquidate assets quickly at fire sale prices
The Act of Congress that overturned Glass-Steagall and made the creation of Financial Services Holding Companies possible was
the Financial Services Modernization Act of 1999.
If foreign currency depreciates relative to the US dollar....
the dollar value of cash flows received will fall
Securities and Exchange Commission (SEC)
the main regulator of securities markets since the passage of the Securities Act of 1934-- as well as the exchanges on which the instruments are traded
Two factors that effect the relative size of the capital market value
the number of securities issued and their market prices
What does the fund user save in purchasing in the Primary Markets?
the risk and cost of creating a market for its securities on its own
What do economic agents save in Secondary Markets?
the search and other costs of seeking buyers or sellers on their own
Direct flow of funds
the transfer of money between just the two parties (loan and interest)
Banker's Acceptance
time drafts payable to a seller of goods, with payment guaranteed by a bank
The service that financial institutions provide to those who want to save for their future or for future generations is called
time intermediation
Money Market Securities
treasury bills, federal funds and repurchase agreements, commercial paper, negotiable certificates of deposit, banker's acceptances
