Econ 330 Exam 1

advantages of commodity money

-has intrinsic value -universally accepted -not easy to abuse

Depository Institutions

-traditional banks -accepts deposits -make loans

types of credit market instruments

1. simple loan 2. fixed payment loan 3. coupon bond 4. discount bond

Factors that cause a shift in the demand for bonds

1. wealth 2. expected returns on bonds relative to alternative assets 3. risk of bonds relative to alt assets 4. liquidity of bonds relative to alt assets

Eurodollars

US dollars deposited in foreign banks outside the US or in foreign branches of US banks ex: dollar-denominated checking account at a bank in Italy

1. medium of exchange 2. store of value 3. unit of account

3 functions money must fulfill

exchanges (secondary markets)

NYSE, Chicago Board of Trade -buyers and sellers meet at a location and time to exchange

security

a claim on the issuer's future income or assets

Debt

a contract that specifies how much you give me now and when and how much I give you in the future -borrowing/a promise ex: bond or loan

Discount bond

a credit market instrument that is bought at a price below its face value and is repaid at the maturity date; it does not make any interest payments

Coupon Bond

a credit market instrument that pays the owner a fixed interest payment every year until the maturity date, at which a specified final amount is repaid

simple loan

a credit market instrument that provides the borrower with a number of funds that must be repaid to the lender at the maturity date, along with additional payment

Fixed Payment Loan

a credit market instrument that provides the borrower with an amount of money that is repaid through fixed periodic (usually monthly) payments over a set number of years

Bond

a debt security that promises to make periodic payments to the holder for a specified period of time

Indirect Finance

a financial intermediary borrows funds from lender-savers and then uses these funds to make loans to borrower-spenders ex: I have a checking account at Bank of America ex: I have a bank account credit card

Interest (for bonds)

a measure of how much extra I pay you back

store of value

a repository of purchasing power over time

Face value

a specified final amount paid to the owner of a coupon bond at the maturity date

Theory of Portfolio Choice

a theory that outlines how much of an asset people will want to hold in their portfolios, as determined by wealth, expected returns, risk, and liquidity

positively

according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to its expected return relative to other assts

positively

according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to its liquidity relative to alternative assets

negatively

according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to the risk of its returns to alternative assets

positively

according to the theory of portfolio choice... the quantity demanded of an asset is ____ related to wealth

Moral Hazard happens...

after the transaction

Brokers

agents for investors who match buyers with sellers

Central Bank

an institution in charge of monetary policy -controls the money supply

unit of account

anything used to measure value in an economy

medium of exchange

anything used to pay for goods and services -liquid

examples of financial intermediaries

bank, insurance company, stockbrokers, investment banks, mutual fund company

Adverse Selection happens...

before the transaction

lenders are the

bond demanders

savers are the

bond demanders as well

borrowers are the

bond suppliers

Eurobond

bonds denominated in a currency other than that of the country in which it is sold ex: airbus bond sold in US but denominated in Euros

Direct Finance

borrowers borrow funds directly from lenders in financial markets by selling the lenders securities ex: i own shares of apple ex: i own a US government bond

Secondary Market

buy/sell equity or debt that already exists -much larger than other market

Primary Market

buy/sell new equity shares or new bonds

stock brokers as financial intermediaries

buyers of stock to sellers of stock

Disadvantages of commodity money

can't control supply debasement

Nominal Interest Rate

change in how much money I have by waiting

Inflation rate

change in price of goods and services -cost in goods from borrowing

Real interest rate

change in what i can consume by waiting

owning common stock

commercial banks and other depository institutions are prohibited from

Fiscal Policy

control of government spending and taxes to affect the macroeconomy

Monetary Policy

control of the supply of money, interest rates, and price

what financial intermediaries can do

create economies of scale provide liquidity services risk share allow for diversification

M1

currency + traveler's checks + demand deposits + other checkable deposits -most liquid assets

Monetary Base (MB)

currency and reserves (money in a bank's vault)

banks role as financial intermediaries

depositors to borrowers

advantages of fiat money

easy to control supply

Moral Hazard

ensure borrower will not engage in activities that will prevent him/her to repay the loan

Examples of secondary markets

exchanges over the counter markets money markets capital markets

Euro currencies

foreign currencies deposited in banks outside the home country ex: a bank of America checking deposit denominated in Euros

Over the counter markets (secondary markets)

foreign exchange -ongoing decentralized electronic market

Investment Banks

get funds from virtually anywhere (except deposits in the traditional sense) and do virtually anything with the funds

Stock

gives ownership to a portion of a firm and have the right to vote on issues important to the firm and to elect its director

examples of commodity money

gold coins, silver, cigarettes

Solution to fiat money

independent central banks

Financial Intermediaries

institutions that borrow funds from people who have money saved and then make loans to others -a person/company that connects savers with borrowers

Contractual Savings Instituions

insurance company and pension company -get funds from premiums or contributions -lend those funds

Equity

is ownership of an asset and thus claims on income generated by that asset

Finance Company (GMAC)

issue stock shares to raise funds -use funds to make loans (often for a specific product)

argument for financial regulation

it protects individuals and the economy as a whole from the unknowns in the financial sector (individuals) as well as the risk to the entire economy posed by systemic risk

argument against financial regulation

it puts a burden on financial intermediaries that discourages innovation, raises costs, and thus reduces the supply of financial services -it is not needed because the market will discipline financial intermediaries

Liquidity Services

make it easier for customers to conduct transactions

Financial Markets

markets in which funds are transferred from people and firms who have an excess of available funds to people and firms who have a need of funds -where funds are exchanged

Commodity Money

money made up of precious metals or another valuable commodity

Financial Innovation

the development of new financial products and services

Liquidity

the ease and speed with which an asset can be turned into cash relative to alternative assets

Yield to maturity

the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today

Monetary aggregates

the measures of the money supply (M1 and M2) used by the federal reserve

Coupon rate

the money amount of the yearly coupon payment expressed as a percentage of the face value of a coupon bond

Interest Rate Risk

the possible reduction in returns associated with changes in interest rates

expected return

the return expected over the next period on one asset relative to alternative assets

Interest Rate

the reward for waiting or the cost of having something now

disadvantages of fiat money

the temptation to print money to pay bills -worth nothing except as a medium of exchange

GDP

the value of all final goods and services produced in the economy during the course of the year -the most comprehensive measure of aggregate output

wealth

the value of all your assets

interest rate risk

there is no __________ for any bond whose time to maturity matches the holding period

Adverse Selection

try to avoid selecting the risky borrower by gathering information about them

bond/loan and stocks

types of security

what affects your desire to hold an asset

wealth expected return risk liquidity

economies of scale liquidity services

what are the advantages of financial intermediaries

Maturity (for bonds)

when you are paid back

Types of Financial Intermediaries

Depository Institutions Contractual Savings Institutions Finance Company (GMAC) Mutual Fund Investment Banks

M2

M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares

risk

the degree of uncertainty associated with the return on one asset relative to alternative assets

Dealers

People who link buyers with sellers by buying and selling securities at stated prices

Money

one of those assets one has -used to buy goods and services

Capital Markets (secondary markets)

only longer term debt and equity instruments are traded

Money Markets (secondary markets)

only short term debt instruments are traded

Fiat Money

paper currency decreed by a government as a legal tender but not convertible into coins or precious metals

currency

paper money and coins

Mutual Fund

pool savings to buy a diversified group of stocks or bonds

systemic risk asymmetric information

regulation of financial intermediaries are necessary because

insurance company as financial intermediaries

savers for accidents to borrowers

mutual fund company as financial intermediaries

small savers to large borrowers or investors

Foreign Bonds

sold in a foreign country and denominated in that country's currency ex: airbus sold in US denominated in dollars

Saver

someone who consumes less than their income

investor

someone who purchases physical/human capital