Chapter 2 & 6: FIN 350

publicly owned corporation

A corporation that is owned by a relatively large number of individuals who are not actively involved in the firm's management.

Financial services corporation

A firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking.

Over-the-counter (OTC) market

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

Inflation premium

IP

Scenario: There is an increase in the perceived marketability of a company's bonds, so the liquidity premium decreases

Impact on yield: decreases Cost of borrowing money from bond markets is... less expensive

This is the premium added to the real risk-free rate to compensate for a decrease in purchasing power over time.

Inflation Premium

Short-term rates are greater than long-term rates

Inverted yield curve

Liquidity risk premium

LP

maturity risk premium

MRP

Money Market Funds

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

Upward sloping is a ______ yield curve

Normal

The yield curve exhibits an upward-sloping path

Normal yield curve

The use of ______-term financing over _____-term financing for a long-term project will increase the risk of the firm

Short;long

If inflation is expected to decrease in the future and the real rate is expected to remain steady, then the Treasury yield curve is downward sloping (Assume MRP=0)

TRUE

The yield on a bond with a longer maturity will be higher than the yield on a bond with a shorter maturity

TRUE

Capital Markets

The financial markets for stocks and for intermediate- or long-term debt (one year or longer).

Money Markets

The financial markets in which funds are borrowed or loaned for short periods (less than one year)

Spot Markets

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

Futures Markets

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

During recessions, short-term interest rates decline more sharply than long-term interest rates

True

The Federal Reserve Board has a significant influence over the level of economic activity, inflation, interest rates in the US

True

The yield curve for a BBB-rated corporate bond is expected to be above the U.S. Treasury bond yield curve

True

When the Fed increases the money supply, short-term interest rates tend to decline

True

Yield curves of highly liquid assets will be lower than yield curves of relatively illiquid assets

True

Dealer markets

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

This is the premium added to the equilibrium interest rate on a security that cannot be bought or sold quickly enough to prevent or minimize loss

liquidity risk premium

Primary Markets

markets in which corporations raise capital by issuing new securities

Secondary Markets

markets in which securities and other financial assets are traded among investors after they have been issued by corporations

Public markets

markets in which standardized contracts are traded on organized exchanges

Private Markets

markets in which transactions are worked out directly between two parties

this is the premium that reflects the risk associated with changes in interest rates for a long-term security

maturity risk premium

This is the rate for a risk-less security that is exposed to changes in inflation

nominal risk-free rate

Mutual Funds

organizations that pool investor funds to purchase financial instruments and thus reduce risks through diversification

Multiply coupon interest rate by ____ ________ to get dollar payment of interest

par value

Nominal Risk Free Rate

r(little RF)

real risk-free rate

r*

represents the "real" risk-free rate of interest like a T-bill rate, if there was no inflation.

r*

it changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people's time preferences for consumption

real risk-free rate

coupon interest rate

stated interest rate (generally fixed) paid by issuer

Par Value

the amount that is repaid when a bond matures

Commercial bank

the traditional department store of finance serving a variety of savers and borrowers

Issue date

when the bond was issued

Maturity date

years until the bond must be repaid

Default risk premium

DRP

This is the premium added as a compensation for the risk that an investor will not get paid in full

Default risk premium

Actions that lower short-term interest rates will always lower long-term interest rates

False

All else equal, the yield on new bonds issued by a leveraged firm will be less than the yield on the new bonds issued by an unleveraged firm

False

The yield curve exhibits a zero slope

Flat yield curve

Physical location exchanges

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

Short-term and long-term (for example, 1-year and 30-year) rates are significantly less than intermediate-term (for example, 10-year) rates.

Humped Yield Curve

Closely held corporation

a corporation that is owned by a few individuals who are typically associated with the firm's management

Investment Bank

an organization that underwrites and distributes new investment securities and helps businesses obtain financing

Derivatives

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