Money and Banking Chapter 3
Capital market
A market in which longer-term debt (generally those with original maturity of one year or greater) and equity instruments are traded.
Debt market
A market where bonds or mortgages, which are contractual agreements by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date when a final payment is made, are traded.
Asymmetric information
A situation where one party often does not know enough about the other party to make accurate decisions.
Moral hazard
A situation where the borrower might engage in activities that are undesirable from the lender's point of view, because they make it less likely that the loan will be paid back.
What are the functions of secondary markets?
Determining the price of the security that the issuing firm sells in the primary market; Providing information to borrowers and lenders about expectations and attitudes of the economic climate; Providing liquidity to owners of existing financial instruments
Federal Reserve
Examines the books of commercial banks that are members of the Federal Reserve System and sets reserve requirements for all banks.
Office of Thrift Supervision
Examines the books of savings and loan associations and imposes restrictions on assets they can hold.
How do conflicts of interest make the asymmetric information problem worse?
Competing interests may lead a financial institution to conceal information or disseminate misleading information, which prevents financial markets from channeling funds into the most productive investment opportunities.
What is the difference between a mortgage and a mortgage-backed security?
Mortgages are loans, whereas mortgage-backed securities are bond-like debt instruments.
Why would a life insurance company be concerned about the financial stability of major corporations or the health of the housing market?
Most life insurance companies hold large amounts of corporate bonds and mortgage assets.
Adverse selection
Occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcomelong dash—the bad credit riskslong dash—are the ones who most actively seek out a loan and are thus most likely to be selected.
Stocks
These are equity claims on the net income and assets of a corporation.
Mortgages
These are loans to households or firms to purchase housing, land, or other real structures, where the structure or land itself serves as collateral for the loans.
Savings and Loan
These depository institutions obtain funds primarily through savings deposits (often called shares) and time and checkable deposits. In the past, these institutions were constrained in their activities and mostly made mortgage loans for residential housing.
Credit Union
These financial institutions are very small cooperative lending institutions organized around a particular group: union members, employees of a firm, and so forth. They acquire funds from deposits called shares and primarily make consumer loans.
Mutual Fund
These financial intermediaries acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds.
Commercial Bank
These financial intermediaries raise funds primarily by issuing checkable deposits, savings deposits, and time deposits. They then use these funds to make commercial, consumer, and mortgage loans and to buy U.S. government securities and municipal bonds.
Corporate Bonds
These long-term bonds are issued by corporations with very strong credit ratings.
Agency Securities
These long-term bonds are issued by institutions such as Ginnie Mae, the Federal Farm Credit Bank, and the TVA. Many of these securities are guaranteed by the federal government.
Government Security
These long-term debt instruments are issued by the U.S. Treasury to finance the deficits of the federal government.
How do financial intermediaries benefit by providing risk-sharing services?
They are able to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold
Eurodollars
US dollars deposited in foreign banks outside the United States or in foreign branches of US banks.
Financial intermediaries have a role to play in matching savers and borrowers for all of the following reasons
risk sharing; minimizing transaction costs; economies of scale
Money market
A financial market in which only short-term debt instruments (generally those with original maturity of less than one year) are traded.
Secondary market
A financial market in which securities that have been previously issued can be resold.
Eurobonds
A bond denominated in a currency other than that of the country in which it is soldlong dash—for example, a bond denominated in US dollars sold in London.
Primary market
A financial market in which new issues of a security, such as a bond or a stock, are sold to initial buyers by the corporation or government agency borrowing the funds.
Foreign bonds
Bonds sold in a foreign country and denominated in that country's currency.
Comptroller of the Currency
Charters and examines the books of federally chartered commercial banks and imposes restrictions on assets they can hold.
Eurocurrency
Foreign currencies deposited in banks outside the home country.
FDIC
Provides insurance of at $250,000 for each depositor at a bank, examines the books of insured banks, and imposes restrictions on assets they can hold.
SEC
Requires disclosure of information of financial instruments traded in organized exchanges.
