Quiz 1
inflation (IP), real risk-free interest rate (RFR), default risk premium (DRP), liquidity risk (LRP), special provisions (SCP), term to maturity (MP)
determinants of interest rates for individual securities (6 things)
Board of Governors
Federal Reserve Banks operate under the general supervision of the __________________________.
1913
Federal Reserve was founded by Congress under the Federal Reserve Act in _______
Fedwire system, CHIPS
Federal reserve oversee _____________ and 47 large banks oversee international payments through __________.
transferring resources across time and space, pooling resources and sharing ownership, clearing and settling payments, managing risk, providing liquidity
Financial institutions mitigate transaction costs by ... (5 things)
expansionary policy
New York Fed purchases Treasury bills from primary dealer
contractionary policy
New York Fed sells Treasury bills to primary dealers
provide liquidity for investors, provide price for the security (true value)
Why are secondary markets important? (2 things)
inflation
________ arises when there is more money chasing the goods in the economy.
higher
_________ reserve ratios indirectly restrict lending
liability
currency is a ______ of the Fed: a promise to pay
t-bonds
debt obligations of the federal government with original maturities of one yr or more
federal agency debt
debt securities issued by some governmental agencies
corporate bonds
long-term debt issued by corporations typically paying semiannual coupons and returning the face value of the bond at maturity
disintermediation
many new technological innovations in the financial industry are displacing the role of financial intermediaries
transaction costs
matching borrowers and lenders, directly and/or indirectly
natural resources, physical capital, human capital, intellectual property, cultural captial
real assets (5 things)
FOMC
sets the target of the federal funds rate and corresponding reserve and discount rates
t-bills
short-term government securities issued at a discount from face value and returning the face amount at maturity
RP (repurchase agreement)
short-term sales of government securities with an agreement to repurchase the securities at a higher price
expectations hypothesis
theory that the shape of the yield curve is based upon investor expectations of future behavior of interest rates
liquidity preference theory
theory that the shape of the yield curve is based upon the difference in risk between short-term and long-term bonds
how people spend and save foreign demands changes such as ATMs, debit cards, etc
things that influence inflation that the Fed can't control
bank run
Happens when a large number of bank customers withdraw their deposits because they believe the bank is, or might become, insolvent.
money, debt, equity, derivatives, combos
financial assets (5 things)
O/N RRP (overnight reserve repurchase agreement
market involves "a wide-range of market participants" who can lend to FED through reverse repos, not just banks, which increases the ability to influence interest rates
MBS and ABS (mortgage-backed securities and asset-backed securities)
ownership claim in a a pool of mortgages
institutional investors
paid to manage other people's money, trade large volumes of securities
1. Distributing currency 2. Oversees integrity of payments system, clearing deposits and interbank lending 3. Ensure the integrity of the financial system through monetary policy implementation 4. Lender of last resort
roles of a central bank (4 things)
taxes, treasury bills
two ways to raise money for government spending
bank panic
when many banks suffer runs at the same time
USA
Which country has the largest percentage of common stocks held by households?
fiat money
assets backing the money are treasury notes of the countried
adverse selection, moral hazard
asymmetric info leads to these two types of problems
individual investors
invest for personal financial goals (retirement, house)
annual percentage rate
APR, not a discount rate, measures amount of simple interest
no (they are an independent central bank)
Does the Federal Reserve's decisions have to be ratified by the President or Congress?
effective annual rate
EAR, a discount rate, measures actual amount of interest
sell, buy
FX, money market, fixed income, equity, derivatives - are on the _______ side of financial markets, endowments, pension funds, mutual funds, individual investors, insurance companies, banks, money managers - are on the ______ side of financial markets
d
How do corporations raise capital? a) stocks b) bonds c) bank loans d) all of the above
Institutions
Since 2005, who are the larger investors in stocks, households or institutions?
12
The Federal Reserve is divided into _____ Federal Reserve Disctricts
greater
The higher the duration measure, the ____________ the interest rate.
2
U.S., U.K., Euro, and Canada have explicit targets of around ____% inflation
1. project the demand for bank notes 2. oversee the payments system 3. administer monetary policy 4. ensuring financial stability 5. government's bank
What does "the Fed" do? (5 things)
maturity (term) in years
What is the Macaulay duration of a zero coupon bond?
bank loans (credit by intermediaries)
What is the dominant source of funding for corporations?
CD (certificate of deposit)
a bank time deposit where the bank pays interest and principal to the depositor only at the end of the fixed term
variable growth model
a dividend valuation approach that allows for a change in the dividend growth rate
derivatives
a financial contract or instrument that derives its value from the value of something else
bond indenture
a legal document issued to lenders that defines the key terms of the lending agreement including the coupon rate, the trustee, and covenants
bond
a legally binding contract between a borrower and a lender (AKA fixed-income securities)
duration
a measure of effective maturity and it is telling us the length of time in years that it will take a bond's cash flows to repay the investors the price they paid for the bond (a measure of the interest rate risk of a bond)
ACH (automated clearing house)
a nationwide network operated by private institutions that electronically process credit and debit transfers of funds.
CHIPS
a private sector electronic network operated by U.S. and foreign banks to facilitate correspondent services and international transactions
asymmetric information
a problem that arises in a transaction when one party had better information than the other party
CP (commercial paper)
a short-term unsecured debt issued by large corporations
permanent
a significant change in Fed Funds rate will likely lead to ________ open market operation
affirmative covenants
actions that the bond issuer promises to carry out
swaps
an agreement to exchange a series of cash flows at periodic settlement dates over a certain period of time
forward rate
an expected rate on a short-term security that is to be originated at some point in the future
bankers acceptances
an order to a bank by a customer to pay a sum of money at a future date
gold standard
assets backing the money are commodity
financial institutions
banks, savings and loans, savings banks, credit unions, insurance companies, pension funds
purchasing power risk
bond risk: the chance that bond yields will lag behind inflation rates
interest rate risk
bond risk: the chance that changes in interest rates will affect value
business/financial risk
bond risk: the chance the issuer of the bond will default
call risk
bond risk: the risk that a bond will be called before its scheduled maturity
liquidity risk
bond risk: the risk that the bond will be difficult to sell at a reasonable price
premium bond
bond that has a market value that is above par
discount bond
bond that has a market value that is below par
demander
business, supplier or demander of funds? typically net _________
OCC (Office of the Comptroller of the Currency)
charters national banks, which are members of the Federal Reserve System
futures and forwards
contracts between two parties to buy or sell an asset at a specified price on a future date
loanable funds theory
explains interest rates and interest rate movements, it views level of interest rates in financial markets as a result of the supply and demand for loanable funds
options, futures and forwards, swaps
financial instruments of derivative markets (3 things)
common stock, preferred stock
financial instruments of equity markets (2 things)
t-bonds, federal agency debt, munis, corporate bonds, MBS and ABS
financial instruments of the bond market (5 things)
t-bills, CD, CP, bankers acceptances, eurodollars, RP, Fed Funds
financial instruments of the money market (7 things)
Fed Funds (Federal Funds)
funds in the accounts of commercial banks at the Federal Reserve
demander
government, supplier or demander of funds? typically net __________
yield curve
illustrates the relationship between the yield to maturity and term to maturity (two main types are downward sloping and upward sloping)
negative covenants
impose restrictions on the bond issuer's activities
supplier
individuals, supplier or demander of funds? typically net _________
information asymmetry costs
monitoring the borrowers
MBS, ABS, CDO
mortgage backed securities _____ is backed by residential or commercial real estate ______ underlying loans are non-mortgage loans (e.g. car loans and credit loans) _______ collateralized loan obligations are backed by corporate loans
real interest rate
nominal interest rate - inflation (actual or expected)
moral hazard
occurs after the transaction (problem from asymmetric info)
adverse selection
occurs before the transaction (problem from asymmetric info)
bad behavior problem (moral hazard)
post-contractual bad behavior that is disadvantageous to the interests of the other party
munis (municipal bonds)
tax-exempt bonds issued by state and local goverments
seigniorage
the difference between the interest earned on the government securities and the cost of issuing and making notes and coins
nominal interest rate
the interest rate actually observed in financial markets
primary market
the market in which new issues of securities are sold to the public
secondary market
the market in which securities are traded after they have been issued
capital markets
the market where long-term securities such as stocks and bonds are bought and sold
money market
the market where short-term securities (usually debt) are bought and sold
option
the right to buy/sell an asset at a specified exercise price on or before a specified expiration date
transaction, information asymmetry
the two types of costs financial institutions mitigate
market segmentation theory
theory on shape of yield curve that suggests that the bond market consists of distinct segments (based on maturity) due to the preferences of investors and borrowers
1. changing reserve requirement 2. changing reserve money supply 3. changing the interest rates
three basic types of monetary policy tools used to influence inflation
maturity, coupon rate, initial yield
three factors affecting duration
clearing, settlement
two components of any payment system can happen together- like real-time gross settlement, Fedwire or with delay- like deferred net settlement, CHIPS
opportunity cost, adjustments for individual security characteristics (default risk, maturity, liquidity risk, payment terms)
two components of nominal interest rates
money (short term), capital (long term)
two financial markets