Chapter 2

In a well functioning economy, capital will flow efficiently from those who supply capital to those who demand it. This transfer of capital can take place in three different ways:

(1) direct transfer (2) primary market transfer (3) financial intermediary

Stocks are traded using a variety of market procedures, but there are two basic types:

(1) physical location exchanges (2) electronic dealer-based markets

Physical Asset Markets

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

Closely Held, Corporations

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

Publicly Owned Corporations

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

Financial Services Corporations

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.

Investment Banks

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

Indexed Funds

Are designed to simply replicate the performance of a specific market index.

Private Equity Companies

Are organizations that operate much like hedge funds; but rather than purchasing some of the stock of a firm, private equity players buy and then manage entire firms.

Hedge Funds

Are similar to mutual funds because they accept money from savers and use the funds to buy various securities. However, unlike mutual funds, these funds are unregulated.

Exchange Traded Funds (ETFs)

Are similar to regular mutual funds and are often operated by mutual fund companies, and buy a portfolio of stocks of a certain type

Direct Transfer

Business sells its stocks or bonds directly to savers, without going through any type of financial institution

Primary Market Transfer

Businesses use financial institutions as a middleman to sell securities to savers

Common stocks are examples of which type of market securities?

Capital Market Securities

Long-term corporate bonds are examples of which type of market securities?

Capital Market Securities

Preferred stocks are examples of which type of market securities?

Capital Market Securities

Credit Unions

Cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm.

In a _______ members' savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages.

Credit Union

What are often the cheapest source of funds available to individual borrowers?

Credit Unions

Financial Markets

Deal with stocks, bonds, notes, mortgages, and derivative securities.

If a stock trades infrequently and has above average volatility, we would expect it to have a smaller than average bid-ask spread. True or false?

False

Physical Location exchanges

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

What type of market is being used if a farmer enters into a futures contract in which he agrees today to sell 5,000 bushels of soybeans 6 months from now at a price of $13.75 a bushel

Future Market

Dealer Markets

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

Financial Intermediary

Intermediaries obtain funds from savers in exchange for their own securities. The intermediary uses this money to buy and hold businesses' securities, while the saver holds the intermediaries securities

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

Investment Banks

Initial Public Offering (IPO)

Is a stock issue in which privately held firms go public.

Primary Market

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

A U.S. Treasury bill is an example of which type of market security?

Money Market Security

Dealer commercial paper is an example of which type of security?

Money Market Security

Money Market Funds

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

Mutual Funds

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

An initial public offering (IPO) is an example of which type of market transaction?

Primary Market Transaction

What type of market transaction would take place if GE were to sell a new issue of common stock to raise capital and receives the proceeds from the sale ?

Primary Market Transaction

Bank loans and private debt placements with insurance companies are examples of which type of market transactions?

Private Market Transactions

Pension Funds

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.

If Jane Doe decided to buy 1,000 shares of GE stock, the purchase would occur in what type of market?

Secondary Market

Suppose you just purchased 10 shares of GE stock in the open market. Which of the following statements best describes the transaction?

Secondary Market Transaction

The most active secondary market where the prices of firms' stocks are established.

Stock Market

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.

Going Public

The act of selling stock to the public at large by a closely held corporation or its principal stockholders.

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 (literally within a couple of days)

Future Markets

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

How does a cost-efficient capital market help reduce the prices of goods and services?

The prices of goods and services must cover costs. Costs include: labor, materials, and capital. Capital costs to a borrower include a return to the saver who supplied the capital, plus a markup (called a "spread") for the financial intermediary that brings the saver and the borrower together. The more efficient the financial system, the lower the costs of intermediation, the lower the costs to the borrower, and, hence, the lower the prices of goods and services.

Commercial Banks

The traditional department store of finance serving a variety of savers and borrowers.

Derivatives are financial assets (such as options and futures) whose values are derived from the values of some other "underlying" assets. They can be used either to reduce risks or to speculate. True or false?

True

Financial intermediaries such as banks and mutual funds help transfer capital from those with a surplus of funds to those who need capital. True or false?

True

In Google's IPO, it conducted a Dutch auction where investors directly place bids for shares of stock. In a Dutch auction, the actual transaction price is set at the highest price that causes all of the offered shares to be purchased. Investors who submitted bids at or above this clearing price received shares of the company's stock. True or false?

True

While Nasdaq began as a system that simply provided quotations on stocks, it has grown to the point where it is an organized securities market with its own listing requirements. True or False?

True

Actively managed funds

Try to outperform the overall markets.

Derivative Securities

Values are derived from changes in the prices of other assets

An option to buy Ford shares, whose value depends on the price of Ford stock, is an example of

a derivative security

A share of Ford stock is an example of

a pure financial asset

Pension funds invest primarily in:

bonds, stocks, mortgages, and real estate.