FIN Ch 2 HW

_____ are markets in which corporations raise capital by issuing new securities

*Primary markets* are markets in which corporations raise capital by issuing new securities

____ are the markets in which corporations raise new capital.

*Primary markets* are the markets in which corporations raise new capital. If GE were to sell a new issue of common stock to raise capital, a primary market transaction would take place. The corporation selling the newly created stock, GE, receives the proceeds from the sale in a primary market transaction.

____ are markets in which transactions are worked out directly between two parties.

*Private markets* are markets in which transactions are worked out directly between two parties. Bank loans and private debt placements with insurance companies are examples of private market transactions. Because these transactions are private, they may be structured in any manner to which the two parties agree.

____ are markets in which standardized contracts are traded on organized exchanges.

*Public markets* are markets in which standardized contracts are traded on organized exchanges. securities that are traded in public markets (for example, common stock and corporate bonds) are held by a large number of individuals. These securities must have fairly standardized contractual features because public investors do not generally have the time and expertise to negotiate unique, nonstandardized contracts. Broad ownership and standardization result in publicly traded securities being more liquid than tailor-made, uniquely negotiated securities.

Differentiate between private and public markets.

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Distinguish between money markets and capital markets.

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Distinguish between physical asset markets and financial asset markets.

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What's the difference between primary markets and secondary markets?

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What's the difference between spot markets and futures markets?

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____ funds try to outperform the overall markets, whereas ____ are designed to simply replicate the performance of a specific market index.

*Actively managed funds* try to outperform the overall markets, whereas *indexed funds* are designed to simply replicate the performance of a specific market index. For example, the portfolio manager of an actively managed stock fund uses his or her expertise to select what he or she thinks will be the best-performing stocks over a given time period. By contrast, an index fund that tracks the S&P 500 index will simply hold the basket of stocks that comprise the S&P 500. Both types of funds provide investors with valuable diversification, but actively managed funds typically have much higher fees— in large part, because of the extra costs involved in trying to select stocks that will (hopefully) outperform the market. In any given year, the very best actively managed funds will outperform the market index, but many will do worse than the overall market—even before taking into account their higher fees. Furthermore, it is extremely difficult to predict which actively managed funds will beat the market in a particular year. For this reason, many academics and practitioners have encouraged investors to rely more heavily on indexed funds.

____ are the markets for intermediate- or long-term debt and corporate stocks.

*Capital markets* are the markets for intermediate- or long-term debt and corporate stocks.

____ are the traditional "department store of finance" because they serve a variety of savers and borrowers.

*Commercial Banks* are the traditional "department store of finance" because they serve a variety of savers and borrowers.

____ are cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm. Members' savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages. These are often the cheapest source of funds available to individual borrowers

*Credit unions* are cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm. Members' savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages. Credit unions are often the cheapest source of funds available to individual borrowers

____ of money and securities occur when a business sells its stocks or bonds directly to savers, without going through any type of financial institution. The business delivers its securities to savers, who, in turn, give the firm the money it needs. This procedure is used mainly by small firms, and relatively little capital is raised by direct transfers.

*Direct Transfers* of money and securities occur when a business sells its stocks or bonds directly to savers, without going through any type of financial institution. The business delivers its securities to savers, who, in turn, give the firm the money it needs. This procedure is used mainly by small firms, and relatively little capital is raised by direct transfers.

____ markets deal with stocks, bonds, notes, and mortgages. Financial markets also deal with derivative securities whose values are derived from changes in the prices of other assets.

*Financial asset markets* deal with stocks, bonds, notes, and mortgages. These markets also deal with derivative securities whose values are derived from changes in the prices of other assets. A share of Ford stock is a "pure financial asset," while an option to buy Ford shares is a derivative security whose value depends on the price of Ford stock.

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

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

____ take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties.

*Life insurance companies* take savings in the form of annual premiums; invest these funds in stocks, bonds, real estate, and mortgages; and make payments to the beneficiaries of the insured parties.

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

*Money Market Funds* are mutual funds that invest in short-term, low-risk securities and allow investors to write checks against their accounts.

____ are the markets for short-term, highly liquid debt securities.

*Money markets* are the markets for short-term, highly liquid debt securities.

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

*Mutual funds* are organizations that pool investor funds to purchase financial instruments and thus reduce risks through diversification.

____ are retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies. These invest primarily in bonds, stocks, mortgages, and real estate

*Pension funds* are retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life insurance companies. Pension funds invest primarily in bonds, stocks, mortgages, and real estate

____ have formal organizations with tangible physical locations that conduct auction markets in designated ("listed") securities.

*Physical Location Exchanges* have formal organizations with tangible physical locations that conduct auction markets in designated ("listed") securities.

____ markets are for products such as wheat, autos, real estate, computers, and machinery.

*Physical asset markets* (also called "tangible" or "real" asset markets) are for products such as wheat, autos, real estate, computers, and machinery.

____ are markets in which existing, already outstanding securities are traded among investors.

*Secondary markets* are markets in which existing, already outstanding securities are traded among investors. The New York Stock Exchange is a secondary market because it deals in outstanding, as opposed to newly issued, stocks and bonds. Secondary markets also exist for mortgages, other types of loans, and other financial assets. The corporation whose securities are being traded is not involved in a secondary market transaction and thus does not receive funds from such a sale.

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

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

____ are markets in which assets are bought or sold for "on-the-spot" delivery (literally, within a few days).

*Spot markets* are markets in which assets are bought or sold for "on-the-spot" delivery (literally, within a few days).

____ is any security or financial asset whose value is derived from the price/value of some other "underlying" asset.

A *Derivative* is any security or financial asset whose value is derived from the price/value of some other "underlying" asset. An option to buy IBM stock is a derivative, as is a contract to buy Japanese yen six months from now. The value of the IBM option depends on the price of IBM's stock and the value of the Japanese yen "future" depends on the exchange rate between yen and dollars. The market for derivatives has grown faster than any other market in recent years, providing investors with new opportunities but also exposing them to new risks.

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

A *Financial Services Corporation* is a firm that offers a wide range of financial services, including investment banking, brokerage operations, insurance, and commercial banking

A _____ is an organization that underwrites and distributes new investment securities and helps businesses obtain financing and raise capital.

A *Investment Bank* is an organization that underwrites and distributes new investment securities and helps businesses obtain financing.

Is an initial public offering an example of a primary or a secondary market transaction? Explain.

An initial public offering is an example of a primary market transaction because the company is offering shares or common stock to the public for the first time and the primary market is the market for newly issued securities.

By far, the most active secondary market—and the most important one to financial managers—is the ____, where the prices of firms' stocks are established.

By far, the most active secondary market—and the most important one to financial managers—is the *stock market*, where the prices of firms' stocks are established.

Derivatives can be used to:

Derivatives can be used to *reduce risks or to speculate.* Example: Suppose a wheat processor's costs rise and its net income falls when the price of wheat rises. The processor could reduce its risk by purchasing derivatives—wheat futures—whose value increases when the price of wheat rises. This is a hedging operation, and its purpose is to reduce risk exposure. Speculation, on the other hand, is done in the hope of high returns; but it raises risk exposure. For example, several years ago Procter & Gamble disclosed that it lost $150 million on derivative investments. More recently, losses on mortgage-related derivatives helped contribute to the credit collapse in 2008.

*T/F* Derivative transactions are designed to increase risk and are used almost exclusively by speculators who are looking to capture high returns.

FALSE Derivatives can be used to *reduce risks* or to speculate. It is a kind of hedging operation whose purpose it to reduce risk exposure

*T/F* Hedge funds have traditionally been highly regulated.

FALSE Hedge funds are largely unregulated because they are marketed primarily to institutions and individuals having high net worths

*T/F* A larger bid-ask spread means that the dealer will realize a lower profit.

FALSE a larger bid-ask spread means that the dealer will realize a higher profit

*T/F* Large businesses in developed economies generally find it more efficient to use direct funds transfers when it comes time to raise capital.

FALSE Large businesses in developed economies generally find it *more efficient to enlist the services of a financial institution* when it comes time to raise capital.

Globalization has exposed the need for greater cooperation among regulators at the international level, but the task is not easy. Factors that complicate coordination include:

Globalization has exposed the need for greater cooperation among regulators at the international level, but the task is not easy. Factors that complicate coordination include: (1) the different structures in nations' banking and securities industries; (2) the trend toward financial services conglomerates, which obscures developments in various market segments; and (3) the reluctance of individual countries to give up control over their national monetary policies.

How do investment banks help companies raise capital?

Investment banks: (1) help corporations design securities with features that are currently attractive to investors, (2) buy these securities from the corporation, and (3) resell them to savers

*T/F* Hedge funds typically have large minimum investments and are marketed to institutions and individuals with high net worths.

TRUE Hedge funds take on the risks that are considerably than that of an average individual stock or mutual fund

*T/F* The New York Stock Exchange is an example of a stock exchange that has a physical location.

TRUE Physical location exchanges are tangible entities and the New York Stock Exchange is an example of physical local stock exchanges

Describe the different ways in which capital can be transferred from suppliers of capital to those who are demanding capital.

There are 3 ways in which capital is transferred from suppliers of capital to those who are demanding capital: *1. Direct Transfers:* in this there is direct transfer of capital from the supplier to the borrower and no intermediary is involved. It is a cost efficient method of capital transfer. *2. Indirect Transfers through Investment Bankers:* in this the bank acts as the intermediary between the supplier and the borrower. Suppliers transfer the capital to the banker and the banker to the borrower, and vice versa. *3. Indirect Transfers through a Financial Intermediary:* in these the financial intermediaries are like brokers. Dealers, insurance companies, closed and open ended mutual funds, venture capitalists, and finance houses, act as a middle man between the supplier and the borrower of capital

Transfers can also be made through a ____ such as a bank, an insurance company, or a mutual fund. Here the intermediary obtains funds from savers in exchange for its securities. The intermediary uses this money to buy and hold businesses' securities, and the savers hold the intermediary's securities. For example, a saver deposits dollars in a bank, receiving a certificate of deposit; then the bank lends the money to a business in the form of a mortgage loan. Thus, intermediaries literally create new forms of capital—in this case, certificates of deposit, which are safer and more liquid than mortgages and thus better for most savers to hold. The existence of intermediaries greatly increases the efficiency of money and capital markets.

Transfers can also be made through a *Financial Intermediary* such as a bank, an insurance company, or a mutual fund. Here the intermediary obtains funds from savers in exchange for its securities. The intermediary uses this money to buy and hold businesses' securities, and the savers hold the intermediary's securities. For example, a saver deposits dollars in a bank, receiving a certificate of deposit; then the bank lends the money to a business in the form of a mortgage loan. Thus, intermediaries literally create new forms of capital—in this case, certificates of deposit, which are safer and more liquid than mortgages and thus better for most savers to hold. The existence of intermediaries greatly increases the efficiency of money and capital markets.

Transfers may also go through an investment bank (iBank) such as Morgan Stanley, which underwrites the issue. An underwriter facilitates the issuance of securities. The company sells its stocks or bonds to the investment bank, which then sells these same securities to savers. The businesses' securities and the savers' money merely "pass through" the investment bank. However, because the investment bank buys and holds the securities for a period of time, it is taking a risk—it may not be able to resell the securities to savers for as much as it paid. Because new securities are involved and the corporation receives the sale proceeds, this transaction is called a ____.

Transfers may also go through an investment bank (iBank) such as Morgan Stanley, which underwrites the issue. An underwriter facilitates the issuance of securities. The company sells its stocks or bonds to the investment bank, which then sells these same securities to savers. The businesses' securities and the savers' money merely "pass through" the investment bank. However, because the investment bank buys and holds the securities for a period of time, it is taking a risk—it may not be able to resell the securities to savers for as much as it paid. Because new securities are involved and the corporation receives the sale proceeds, this transaction is called a *Primary Market Transaction* This is an indirect means of transferring capital through investment bankers