Chapter 2

Risk in Mortgage-backed securities

A primary risk associated with mortgage-back securities is that homeowners may not be able to, or may choose not to, repay their loans.

Tax-Deductible Expenses

In calculating taxes, corporations may deduct operating expenses and interest expense but not dividends paid.

Largest stock market in the world?

NYSE Euronext

Long term securities

Take place in the Capital Market

Short term marketable securities

Take place in the money market

How are firms intermediares?

They channel the savings of individuals, businesses, and governments into loans or investments.

Foreign bond market

a market for bonds issued by a foreign corporation or government that is denominated in the investor's home currency and sold in the investor's home market

Capital market

a market that enables suppliers and demanders of long-term funds to make transactions

Efficient market

allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value.

Gramm-Leach-Bliley Act

allows business combinations (e.g. mergers) between commercial banks, investment banks, and insurance companies, and thus permits these institutions to compete in markets that prior regulations prohibited them from entering

International equity market

allows corporations to sell blocks of shares to investors in a number of different countries simultaneously

Glass-Steagall Act

an act of Congress in 1933 that created the federal deposit insurance program and separated the activities of commercial and investment banks. It was repealed it 1999 by Congress

Behavioral finance

an emerging field that blends ideas from finance and psychology, argue that stock prices and prices of other securities can deviate from their true values for extended periods.

Investment Banks

are institutions that: assist companies in raising capital advise firms on major transactions such as mergers or financial restructurings engage in trading and market making activities

Commerical Banks

are institutions that: provide savers with a secure place to invest their funds offer loans to individual and business borrowers

key capital market securities

bonds (long-term debts) and common and preferred stocks (equity, or ownership)

Eurobond market

corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the United States

Money market

created by a financial relationship between suppliers and demanders of short-term funds

Shadow banking system

describes a group of institutions that: engage in lending activities, much like traditional banks but do not accept deposits are not subject to the same regulations as traditional banks

ordinary income

earned through the sale of good or services (includes interest received)

Secondary market

financial markets in which preowned securities (those that are not new issues) are traded

Financial markets

forums in which suppliers of funds and demanders of funds can transact business directly.

Private placement

involves the sale of a new security directly to an investor or group of investors

Bonds

long-term debt instruments used by businesses and gov. to raise large sums of money

Double taxation

occurs when after-tax corporate earnings are distributed as cash dividends to stockholders, who then must pay personal taxes on the dividend amount

Securitization

process of pooling mortgages or other types of loans and then selling claims or securities against that pool in a secondary market

Glass-Steagall Act 1933

prohibited institutions that took deposits from engaging in activities such as securities underwriting and trading, thereby effectively separating commercial banks from investment banks.

Federal Deposit Insurance Corporation (FDIC)

provides insurance for deposits at banks and monitors banks to ensure their safety and soundness.

Securities Act of 1933

regulates the sale of securities to the public via the primary market.

Securities Act of 1934

regulates the trading of securities such as stocks and bonds in the secondary market

Mortgage-backed securities

represent claims on the cash flows generated by a pool of mortgages and can be purchased by individual investors, pension funds, mutual funds, or virtually any other investor

Broker markets

securities exchanges on which the two sides of a transaction, the buyer and seller, are brought together to trade securities

Marketable securities

short-term debt instruments, such as: U.S. Treasury bills issues by the federal government commercial paper issued by businesses negotiable certificates of deposit issued by financial institutions (least risky investments)

Preferred stock

special form of ownership w features of bond and common stock

Dealer markets

such as Nasdaq, are markets in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that "make markets" in the given security

Capital gain

the amount by which the sale price of an asset exceeds the asset's purchase price

Primary market

the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction

Average tax rate

the firm's taxes divided by taxable income.

Eurocurrency market

the international equivalent of the domestic (U.S.) money market

Marginal tax rate

the rate at which additional income is taxed.

How Can firms obtain funds?

through a financial institution through financial markets through private placements

Role of capital markets (firm)

to be a liquid market where firms can interact with investors in order to obtain valuable external financing resources

Role of capital markets (investor)

to be an efficient market that allocates funds to their most productive uses

Common stock

units of ownership interest or equity in a corporation

Public offering

which is the sale of either bonds or stocks to the general public.