FINA chapter 2

Capital market consists of __________ and _________ markets

*primary* (where new securities are issued and sold); *secondary* (where already-issued securities are traded between investors)

The major capital market securities are _____ and ____ - both common and preferred

bonds; stock

good *financing* decision is to ______ ____ that complements a firm's assets and to use that debt in a proportion to equity that minimizes the cost of financing

obtain debt

private placement

primary offerings in which shares are sold directly to a small group of institutional or wealthy investors

Market efficiency

refers to how well current prices reflect all available, relevant information about the actual value of the underlying assets. A truly efficient market eliminates the possibility of beating the market, because any information available to any trader is already incorporated into the market price.

Gramm-Leach-Bliley Act (of 1999)

repealed the separation of commercial banking and investment banking provided for in the Glass-Steagall Act of 1933

A good *dividend* decision increases shareholder wealth by _________ ____ to owners when the firm doesn't have good investment opportunities.

returning cash

common stock

the most basic form of ownership, including voting rights on major issues, in a company

money market

the trade in short-term loans between banks and other financial institutions.

A collateralized debt obligation (CDO) bundles house payments and creates safe, okay, and risky investment vehilces.

true

what is a mortgage?

type of loan used to buy property

peer-to-peer lending (P2P)

- A method of debt financing that enables individuals to obtain loans directly from other individuals, cutting out the financial institution as the middleman - P2P lending websites connect borrowers directly to investors.

Where can firms acquire external funding from?

- Financial Institutions - Financial Markets - Private Placements

Why do firms need the financial system?

- To obtain long term funds - Accommodate near term cash inflows and outflows - To facilitate short term cash management policies

The Glass-Steagall Act of 1933

- provided for separation of commercial banking and investment banking activities in the US - Created the FDIP (federal deposit insurance program)

What is a mortgage backed security (MBS)?

Bonds created from a large pool of individual mortgage loans. The owner of MBS gets payments from the loan. Loan originators get cash to make more loans as well as fees for making the loans in the first place. The asset is backed by the collateral of houses and should be safe as long as the house value is higher than the loan.

efficient market

allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value.

The shadow banking system has escaped regulation primarily because it does not accept traditional ____ ________. As a result, many of the shadow banking institutions have been able to employ higher market, credit and liquidity risks, and do not have capital requirements.

bank deposits

Investors attempt to ______ the market by picking stocks and other securities that generate a higher return than the market average.

beat All investors have access to the same information so it is really difficult to 'beat' the market. Paradoxically, the collective act of investors trying to beat the market makes the market efficient.

Financial Institution

businesses that provide banking services to consumers and businesses intermediaries that channel the savings of individuals, businesses, and governments into loans or investments

The financial system includes:

commercial banks investment banks pension funds hedge funds mutual funds

Financial leverage is borrowing money to amplify the outcome of a ________.

deal

As the hurdle rate (the cost of financing) _________ the number of attractive investment opportunities _________.

decreases; increases

From *investors' perspectives*, the role of capital markets is to be an __________ _________ that allocates funds to their most productive uses

efficient market

Lending discrimination occurs when lenders base credit decisions on ________ other than the borrower's credit worthiness.

factors

The shadow banking system refers to ______________________ involved in facilitating the creation of credit, that is lending, much like traditional banks but are not subject to regulatory oversight.

financial intermediaries

Investment banks

help firms obtain long term financing by facilitating debt and equity offerings in the financial markets advise firms on major financial market transactions such as mergers and restructuring engage in trading and market-making activities.

Financial intermediaries

institutions that "connect" borrowers and lenders by accepting funds from lenders and loaning funds to borrowers individuals are net providers of funds

Shadow banking system includes

investment banks mortgage lenders money market funds insurance companies hedge funds private equity funds payday lenders

3 key long term financial management decisions that impact shareholder wealth

investment decisions financing decisions dividend decisions

Good *investment* decisions increase shareholder wealth by making ___________ that earn a return, greater than a hurdle rate

investments

Wall street brings together

investor and homeowners (borrowers)

From a *firm's perspective*, the role of capital markets is to be a ________ _______, a market with many available buyers and sellers and comparatively low transaction costs

liquid market

What practice made it impossible for many members of minority groups to qualify for loans to buy and improve homes?

redlining

Commercial banks

such as Wells Fargo, Citibank, and Bank of America, - accept deposits - provide security and convenience to their customers - make loans at high interest rates

cost of capital

the rate of return a company must earn in order to meet the demands of its lenders and expectations of its equity holders

What is a Collateralized debt obligation (CDO) ?

A collateralized debt obligation (CDO) is a type of asset-backed security. A CDO is issued as a bond, which is backed (collateralized) by a pool of bonds, loans, and various other assets.

collateralized mortgage obligations (CMOs)

CDOs that are created by *government agencies or investment banks* and issued as investment-grade bonds; almost all CMOs are REMICs

___________ banks make loans that individuals and businesses use to buy goods or expand business operations, which in turn leads to more deposited funds that make their way to bank

Commercial

Prior to 1999, a bank could be either a commercial bank or an investment bank, or both.

FALSE; a bank can't be both, has to be one or the other

hurdle rate (cost of financing)

Minimum acceptable rate of return (set by management) for an investment.

Characteristics of an efficient market

In an efficient market, securities can be traded *easily, quickly, and at low costs*. Markets lacking these qualities are considered inefficient.

venture capitalists

Individuals or companies that invest in new businesses in exchange for partial ownership of those businesses.

Today, what three federal laws offer protection against lending discrimination?

The Fair Housing Act The Community Reinvestment Act Equal Credit Opportunity Act

Francis Galton's discovery was

a diverse collection of independently deciding individuals is likely to make better value decisions than individuals who are experts

Capital market

a market where firms obtain external *long term* financing - trade in stocks and bonds - These are long-term assets bought by financial institutions, professional brokers, and individual investors.