Chapter 3

which of the following is true about financial instruments? A) They are legally enforceable B) They require payment to be made immediately C) They are usually oral contracts as opposed to being written D) They allow one party to transfer something of value to another, but they do not obligate that party to make the transfer

A) They are legally enforceable

indirect finance

An institution like a bank stands between the lender and the borrower, borrowing from the lender and providing the funds to the borrower

financial instrument

The written legal obligation of one party to transfer something of value (usually money) to another party at some future date, under specified conditions.

underlying instruments (primitive securities)

a financial instrument used by savers/lenders to transfer resources directly to investors/borrowers

derivative instrument

a financial instrument, such as a futures contract or an option, whose value and payoff are "derived from" the behavior of underlying instruments

items of value that you own are called ___________; something you owe to others is called ___________.

assets; a liability

direct finance

borrowers sell securities directly to lenders

We say that a firm, homeowner, or economy is highly leveraged when it does a great deal of _____________.

borrowing

The two fundamental classes of financial instruments are: ___________

derivative instruments and underlying instruments

when a borrower sells securities to a lender with no bank acting as an intermediary this is an example of ____________ finance.

direct

most common examples of derivatives

futures; options ;swaps

financial institutions such as banks lend to consumers via ______________

indirect finance

functions of financial instruments

means of payment; stores of values; transfer of risk

assets

something of value that can be owned; a financial claim or property that serves as a store of value

liability

something you owe

primary examples of underlying securities

stocks and bonds that offer payments based solely on the issuer's status

relationship between promises payments and financial instruments

the bigger the promised payment the more valuable the financial instrument

relationship between time of payment and value

the sooner the payment is made the more valuable is the promise to make it

leverage

the use of borrowing to finance part of an investment

primary use of derivatives

to shift risk among investors

Which of the following is NOT an example of a financial instrument? A) a car loan B) a credit union C) a share of stock D) an insurance policy

B) a credit union

Which of the following does NOT correctly describe financial instruments? A) A share of stock sold to one person is the same as a share sold to another B) They are written in specialized language that varies from contract to contract C) They help buyers and sellers of financial instruments avoid the costs of complexity D) They assist with asymmetric information problems

B)They are written in specialized language that varies from contract to contract

of the economic entities listed, which tends to be most highly leveraged? A) private households B) Government agencies C) financial institutions D) firms

C) financial institutions