Chapter 2 DSM

In the ______ market, corporations and governments typically issue bonds denominated in dollars and sell the to investors located outside the United States.

Eurobond Through the Eurobond market, corporations and governments typically issue bonds denominated in dollars and sell them to investors located outside the UnitedStates. Governments and firms often use this market to attract more investor interest and, therefore, offer a lower rate or place a larger issue. U.S. Treasury bonds are sold in the U.S. although many are bought by foreign investors. A domestic bond market is one where bonds are issued and sold in the same country.

Which U.S. government agency is primarily responsible for regulation and enforcement of federal securities laws?

SEC The Securities and Exchange Commission (SEC) was created by the Securities Exchange Act of 1934. The SEC is the primary government agency responsible for enforcing federal securities laws.

When information not available to the general investing public prompts the purchase or sale of stock, the practice is known as ______.

insider trading The purchase or sale of stock based on information not available to the general investing public is known as insider trading. Insider trading is illegal in the U.S. since it allows some investors to profit at the expense of others simply because they have access to private information. This activity is monitored and policed by the Securities Exchange Commission (SEC). Greenmail occurs when a firm buys its own stock back from a potential corporate raider at a premium above market price. This activity is legal, although ethically questionable since it is typically done to preserve the jobs of upper management. A red herring is a preliminary prospectus filed with the SEC by a firm going public.

The market price of a share of stock is determined by:

investors buying and selling the stock The market price of a share of stock is determined by investors buying and selling the stock. The stock market is a competitive market where the price is determined by the interaction of supply and demand. Investors supply stock (sell) and other investors demand stock (buy) and the intersection of these two groups in the marketplace determines price. The NYSE is simply the market where investors buy and sell stock. The Federal Reserve and the firm's CFO and CEO are not involved in setting stock prices or market manipulation.

__________ trade in the money market.

U.S. Treasury bills U.S. Treasury bills trade in the money market. Money market instruments include any financial security with a maturity of one year or less which includes U.S Treasury bills. U.S Treasury notes have maturities that range from one year to ten years. Corporate bonds also have maturities longer than one year so both of these financial instruments trade in the capital markets.

When a firm issues shares of stock to the public for the very first time, it is known as:

an initial public offering When a firm issues shares of stock to the public for the very first time, it is known as an initial public offering. An initial public offering, or IPO, is where the firm raises capital from the public for the very first time in the primary market. The firm sells ownership and receives cash in this transaction. All subsequent transactions involving this stock will occur on the secondary market. Prior to the issue of the IPO, the firm will put out a prospectus that provides specific detail about the firm as required by the Securities Exchange Commission. If the same firm issues additional equity at a later date, it would be dubbed a seasoned equity offering.

The __________ price is the highest price that a market maker offers to pay for a security and the __________ price is the lowest price at which a security is offered for sale.

bid, ask The bid price is the highest price that a market maker offers to pay for a security and the ask price is the lowest price at which a security is offered for sale. Market makers stand ready to provide liquidity for a stock and post both bid and ask prices. The market maker will profit on the spread, or the difference between the bid and ask price, for a given security.

Financial institutions include:

commercial banks. Financial institutions include commercial banks. A financial institution is any business that channels funds from net savers to net borrowers. In addition to commercial banks they include investment banks, savings and loans, credit unions, and many others. The SEC is the primary regulator of the U.S. stock market and the Social Security Administration is the branch of the U.S. government that provides income for U.S. retirees.

In finance, the theory of ______ tells us that changes in stock prices are nearly impossible to predict, even by professional investors.

market efficiency The theory of market efficiency tells us that stock prices are nearly impossible to predict, and they quickly adjust to any new information in the market. Market efficiency says that in general prices are accurate at a point in time. This theory is important to financial managers since their primary performance metric is stock price. Liquidity preference and segmented markets are term structure of interest rate theories you will study in later modules. Agency theory deals with the separation of ownership and management and the potential conflicts of interest that exist in this relationship. You can often see market efficiency at work when new information is released about a firm. If the information is good news, you will see the stock price move higher as this new information is reflected in the asset price. If the information is bad news, you will see the stock price fall. These reactions occur instantly in efficient markets.

The market where short-term funds are supplied and demanded is known as the __________.

money market The market where short-term funds are supplied and demanded is known as the money market. Money market securities have maturities of one year or less. The capital market refers to the markets where long-term funds are supplied and demanded. Any financial instrument that has a maturity greater than one year is considered to be a long-term security. Bonds are long-term debt instruments that trade in the capital market.

The market where small unlisted securities are traded is known as the __________.

over-the-counter market The market where small unlisted securities are traded is known as the over-the-counter market. The OTC market is a dealer market in very small low-priced stocks where various dealers serve as market makers for a security. The New York Stock Exchange is an organized stock exchange where stocks in large, highly visible firms are bought and sold via an open outcry auction process. Preferred stocks are issued by some corporations and represent a cross between debt and equity since they are a form of equity yet they pay a fixed periodic dividend payment similar to the coupon payment on a bond. Preferred stocks trade on numerous exchanges.

The market where financial securities are offered for sale to the public for the very first time is known as the:

primary market The market where financial securities are offered for sale to the public for the very first time is known as the primary market. The primary market is the market where the firm sells securities and receives money in exchange for those securities. All subsequent transactions occur on the secondary market where investors buy and sell these issued securities. The firm receives no money from the secondary market transactions. The money market is a market for short-term financial securities with maturities shorter than one year, and the New York Stock Exchange is the most recognized secondary market where financial securities for large firms are traded among investors.

The market where financial securities are offered for sale to the public for the very first time is known as the __________.

primary market The market where financial securities are offered for sale to the public for the very first time is known as the primary market. The primary market is the market where the firm sells securities and receives money in exchange for those securities. All subsequent transactions occur on the secondary market where investors buy and sell these issued securities. The firm receives no money from the secondary market transactions. The money market is a market for short-term financial securities with maturities shorter than one year and the New York Stock Exchange is the most recognized secondary market where financial securities for large firms are traded among investors.

Pennington Corporation wishes to sell stock to raise money for a planned expansion. If they elect to sell their stock directly to a group of investors, their offering will be described as a _____.

private placement A private placement involves the sale of new security directly to an investor or group of investors, such as an insurance company or a pension fund. When firms need to raise large sums of money by selling securities, they usually do so through a public offering, which is the sale of either bonds or stocks to the general public.

The Federal Deposit Insurance Corporation (FDIC) was created in 1933 to __________.

provide insurance on bank deposits The Federal Deposit Insurance Corporation (FDIC) was created in 1933 to provide insurance on bank deposits. The FDIC was created by the Glass-Steagall Act in order to restore the faith in banks that was destroyed during the early years of the Great Depression when a series of bank runs left some depositors empty-handed. Mortgage insurance is often required by lenders but is not related to the FDIC. The FDIC is funded by monies collected from bank fees but not collected from depositors.

One of the most important functions of the secondary market is to:

provide liquidity to investors One of the most important functions of the secondary market is to provide liquidity to investors. Because secondary markets provide liquidity to investors, they are willing to buy financial securities on the primary market and provide capital to firms for expansion and growth. Without this option, investors would be very reluctant to provide start-up capital. The secondary markets do not attempt to encourage day trading or force stock prices up or down. In addition, there are regulatory agencies in charge of monitoring insider trading. Countries have a difficult time seeing economic growth when they don't have a set of well-functioning financial markets. The ability to provide liquidity to investors through financial markets is one of the first institutions an emerging market country needs to adopt in order to experience economic growth. Businesses cannot grow without access to funds and investors are reluctant to invest without liquidity.

The New York Stock Exchange (NYSE) is a(n):

securities exchange. The New York Stock Exchange (NYSE) is a securities exchange. These exchanges require firms to be listed on the exchange and then traders can buy or sell the stock. IPOs may become listed on one of these organized exchanges if they are large enough. Seasoned equity offerings will already be listed on an organized exchange or traded in the OTC market. The underwriting syndicate is the group of investment bankers that helps the firm issue debt or equity. Many small firms do not become listed on the organized exchanges, but instead trade in the over-the-counter (OTC) market. The listing requirements for organized exchanges are quite strict and have much higher fees.

In the past 25 years, there has been enormous growth in the _____, a group of institutions that engage in lending activities but that do not accept deposits.

shadow banking system Unlike commercial banks, which accept deposits, institutions in the shadow banking system engage in lending but are not subject to the same level of regulation. For example, financial institutions such as mutual funds, insurance companies, or pension funds might have excess cash to invest, and a large corporation might need short-term financing to cover seasonal cash flow needs. Investment banks can act as an intermediary between these two parties and help facilitate a loan and thereby become part of the shadow banking system.

Mortgage loans made to higher-risk borrowers with poor credit histories are known as __________.

subprime mortgages Mortgage loans made to higher-risk borrowers with poor credit histories are known as subprime mortgages. Subprime refers to mortgages that are made to borrowers that are not in the "prime" category and therefore have a greater risk of loan default. Conventional mortgages are fixed-rate 30-year mortgages that were typical of most mortgages prior to the mortgage expansion of the 1990s and 2000s. ARMs are adjustable rate mortgages that allow the interest rate to change over the life of the loan. Subprime mortgage defaults were one of the primary causes of the recent financial crisis.

The Securities Act of 1933 deals primarily with:

the sale of new securities. The Securities Act of 1933 deals primarily with the sale of new securities. The purpose of this legislation was to regulate initial public offerings to ensure accurate and detailed information was provided to potential investors during this process. Security trading in the secondary market was regulated with the passage of the Securities Exchange Act of 1934 which also created the Securities Exchange Commission (SEC).

When an investment bank acts as a(n) _______ for an IPO, it bears the risk of reselling, at a profit, the securities purchased from the issuing corporation.

underwriter An underwriter bears the risk of reselling, at a profit, the securities purchased from the issuing corporation. Angel investors are individuals who purchase equity stakes in small firms. This type of financing is typically the first round of financing a firm obtains. Stockholders buy and sell ownership of public companies so have ownership stakes after the IPO.

One all-electronic market used to trade stocks via a linked computer network is the __________.

NASDAQ One all-electronic market used to trade stocks via a linked computer network is the NASDAQ. The NASDAQ trades thousands of stocks including many technology stocks such as Microsoft Corporation and Facebook Inc. The NYSE is an open-outcry auction market where about 1,800 large firm stocks such as Wal-Mart Stores Inc. and Citigroup Inc. are traded. The Eurobond market is a bond market where dollar-denominated bonds are issued and sold to investors in countries other than the U.S. There are approximately 3,200 firms that trade on the NASDAQ at this time.

The Securities Exchange Act of 1934 created the:

Securities Exchange Commission (SEC). The Securities Exchange Act of 1934 created the Securities Exchange Commission (SEC). This legislation was designed to monitor and regulate security trades in the secondary market and the SEC was created to enforce the new securities laws. The FDIC was created with the passage of the Glass-Steagall Act of 1933 which was designed to restore confidence in the banking system.

A multinational firm that receives payment in Japanese yen can convert the yen to U.S. dollars on the:

international equity market A multinational firm that receives payment in Japanese yen can convert the yen to U.S. dollars on the international equity market. This market enables corporations to raise far larger amounts of capital than they could in any single market. International equity sales have been indispensable to governments that have sold state-owned companies to private investors. Currencies are bought and sold through numerous venues including futures markets, big banks and private agreements. Billions of dollars in the major currencies such as the U.S. dollar, the euro and the Japanese yen are traded daily.