Financial Institutions and Markets
Deficit spending unit (DSU)
A economic term used to describe how an economy or economic unit within an economy has spent more than it has earned over a period of time.
Structural unemployment
A form of unemployment caused by a mismatch between the skills that workers in the economy can offer, and the skills demanded of workers by employers
Common stock
Ordinary shares.
Eurodollar market
Originally, dollar-denominated deposits not subject to U.S. banking regulations were held almost exclusively in Europe. These deposits are still mostly held in Europe, but they're also held in such countries as the Bahamas, Canada, the Cayman Islands, Hong Kong, Japan, the Netherlands Antilles, Panama and Singapore. Regardless of where they are held, such deposits are referred to as ____________. Since the ___________ market is relatively free of regulation, banks in the eurodollar market can operate on narrower margins than banks in the United States. Thus, the eurodollar market has expanded largely as a means of avoiding the regulatory costs involved in dollar-denominated financial intermediation.
Federal funds
Overnight borrowings between banks and other entities to maintain their bank reserves at the Federal Reserve. Banks keep reserves at Federal Reserve Banks to meet their reserve requirements and to clear financial transactions.
Term-to-maturity
The time between when the bond is issued and when it matures (its maturity date), at which time the issuer must redeem the bond by paying the principal (or face value). Between the issue date and maturity date, the bond issuer will make coupon payments to the bond holder.
Monetary base
The total amount of a currency that is either circulated in the hands of the public or in the commercial bank deposits held in the central bank's reserves. This measure of the money supply typically only includes the most liquid currencies.
Money Markets
The trade in short-term loans between banks and other financial institutions.
Present value
The value in the present of a sum of money, in contrast to some future value it will have when it has been invested at compound interest.
Fed funds market
These loans are made at a relatively low interest rate, called the federal funds rate or overnight rate, and they typically have an extremely short duration: overnight. Federal funds help commercial banks meet their daily reserve requirements.
Conversion yield discount
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Put interest discount
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Bondholder
a person owning a bond or bonds issued by a government or a public company.
Underwriting
(Of a bank or other financial institution) engage to buy all the unsold shares in (an issue of new shares).
Municipal bonds
(chiefly in the US) a security issued by or on behalf of a local authority.
Private placement
(or non-public offering) is a funding round of securities which are sold not through a public offering, but rather through a private offering, mostly to a small number of chosen investors.
Options contract
A ______ is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An ______, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.
Dealer
A _______ is a person or firm in the business of buying and selling securities for their own account, whether through a broker or otherwise.
Bid-ask spread
A ________ is the amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it.
Negotiable certificates of deposit (NCD)
A _________ is a certificate of deposit with a minimum face value of $100,000. These are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed-in before maturity.
Implied forward rate
A ___________ is an interest rate that is determined by the difference between the spot rate and the forward/futures rate. The degree of relative costliness of a future rate can be assessed by comparing the ___________ with the spot rate.
Corporate bonds
A bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand business. The term is usually applied to longer-term debt instruments, with maturity of at least one year.
Discount bond
A bond that is issued for less than its par (or face) value, or a bond currently trading for less than its par value in the secondary market. A bond is considered a __________ when it has a lower interest rate than the current market rate, and consequently is sold at a lower price.
Premium bond
A bond that is trading above its par value. A bond will trade at a premium when it offers a coupon rate that is higher than prevailing interest rates. This is because investors want a higher yield, and will pay more for it.
Futures market
A central financial exchange where people can trade standardized futures contracts.
Conversion option
A clause associated with some adjustable-rate mortgages that allows the borrower to convert the variable interest rate to a fixed rate within a certain time period, or at certain future dates.
Futures contract
A contractual agreement, generally made on the trading floor of a futures exchange, to buy or sell a particular commodity or financial instrument at a pre-determined price in the future.
Yield curve
A curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.
Bond
A debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. They are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of them are debtholders, or creditors, of the issuer.
Zero coupon bond
A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value.
Over-the-counter market
A decentralized market, without a central physical location, where market participants trade with one another through various communication modes such as the telephone, email and proprietary electronic trading systems.
Direct claim
A financial claim issued by a deficit unit to acquire funds for investment in real assets.
Bond ratings
A grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's and Fitch provide these evaluations of a bond issuer's financial strength, or its the ability to pay a bond's principal and interest in a timely fashion.
Mortgages
A legal agreement by which a bank, building society, etc. lends money at interest in exchange for taking title of the debtor's property, with the condition that the conveyance of title becomes void upon the payment of the debt.
Bond issuer
A legal entity that develops, registers and sells securities for the purpose of financing its operations.
Call loans
A loan provided to a brokerage firm and used to finance margin accounts. Call loans use securities as collateral for the loan. It is important to note that a call loan can be canceled at any time.
Financial market
A market in which people trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand.
Eurobond market
A market where eurobonds are traded. A eurobond is a bond that is issued in a currency other than the currency of the country or market in which it is issued.
Secondary financial market
A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. The national exchanges - such as the New York Stock Exchange and the NASDAQ are __________.
Option market
A market where options are traded.
Marketability
A measure of whether a product will appeal to buyers and sell at a certain price range to generate a profit.
Direct financing
A method of financing where borrowers borrow funds directly from the financial market without using a third party service, such as a financial intermediary.
Coupon payment
A periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures.
Broker
A person who buys and sells goods or assets for others.
Liquidity premium
A premium that investors will demand when any given security can not be easily converted into cash, and converted at the fair market value. When the ________ is high, then the asset is said to be illiquid, which will cause prices to fall, and interest rates to rise.
Financial intermediation (or indirect financing)
A productive activity in which an institutional unit incurs liabilities on its own account for the purpose of acquiring financial assets by engaging in financial transactions on the market;
Regulation Q
A regulation that prohibited banks from being able to pay interest on deposits within checking accounts
Treasury bills (T-Bill)
A short-dated UK or US government security, yielding no interest but issued at a discount on its redemption price.
Price stability
A situation in which prices in an economy don't change much over time. Price stability would mean that an economy would not experience inflation or deflation. It is not common for an economy to have price stability.
Liquidity trap
A situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective.
Inflation
A sustained increase in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services.
Elastic money supply
A term that is used to identify changes in the availability of currency and coin as changes in the economy occur.
Forward rate
A term used in both bond and currency trading to represent the current expectations of future bond interest rates or currency exchange rates. In bond trading, it is calculated based on interest rates for various maturities. These rates are typically plotted on a graph as a yield curve.
Political risk
A type of risk faced by investors, corporations, and governments. It is a risk that can be understood and managed with reasoned foresight and investment.
Surplus spending unit (SSU)
An economic unit with income that is greater than or equal to expenditures on consumption or real investment over the course of a period. It will use its additional income to buy goods, invest, lend money to deficit spending units or pay off its own deficit from an earlier period.
Financial intermediary (or financial institution)
An institution, such as a bank, building society, or unit-trust company, that holds funds from lenders in order to make loans to borrowers.
Lender of last resort
An institution, usually a country's central bank, that offers loans to banks or other eligible institutions that are experiencing financial difficulty or are considered highly risky or near collapse.
Discount window
An instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank, usually on a short-term basis, to meet temporary shortages of liquidity caused by internal or external disruptions.
Call option (call provision)
An option to buy assets at an agreed price on or before a particular date.
Forward Rate Agreement (FRA) (Future Rate Agreement)
An over-the-counter forward contract between parties that determines the rate of interest, or the currency exchange rate, to be paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract. FRAs are very similar to swaps except that in a FRA a payment is only made once at maturity. Many banks and large corporations will use FRAs to hedge future interest or exchange rate exposure. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates.
Total reserves
Are the assets that a bank has immediately available to cover its liabilities.
Excess reserves
Bank reserves in excess of a reserve requirement set by a central bank. They are reserves of cash more than the required amounts.
Par bond
Bonds can be priced at a premium, discount, or at par. If it is priced at par, it is trading at its par value.
Coupon rate
Calculated by dividing the sum of the security's annual coupon payments and dividing them by the bond's par value. For example, a bond which was issued with a face value of $1000 that pays a $25 coupon semi-annually would have a ______ of 5%.
FRA Term (Forward Rate Agreement)
Date between settlement date and maturity date. E.g. 3/6 FRA has a FRA term of 3 months (6-3)
Humphrey-Hawkins Act
Employment growth legislation. No longer exists.
Financial claim
Entitles a creditor to receive a payment, or payments, from a debtor in circumstances specified in a contract between them
Speculative-grade (junk) bonds
Fixed-income instruments that carry a rating of 'BB' or lower by Standard & Poor's, or 'Ba' or below by Moody's. They are so called because of their higher default risk in relation to investment-grade bonds.
Municipal securities
Interest-paying debt securities that state and municipal governments issue to finance operating expenditures, to fund certain tax-exempt entities including colleges and nonprofit hospitals, and occasionally to provide funds to firms and individuals.
Keynesian theory
Keynesian economics focuses on psychology, uncertainty and expectations in driving macroeconomic decisions and behaviour.
Disintermediation
Reduction in the use of intermediaries between producers and consumers, for example by investing directly in the securities market rather than through a bank.
Open-market operations
Refers to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Purchases inject money into the banking system and stimulate growth while sales of securities do the opposite.
Commercial paper
Short-term unsecured promissory notes issued by companies.
Underwriting spread
The _____ is the difference between the amount paid by the underwriting group in a new issue of securities and the price at which securities are offered for sale to the public. It is the underwriter's gross profit margin, usually expressed in points per unit of sale (bond or stock).
Default risk premium
The additional amount a borrower must pay to compensate the lender for assuming default risk. A default premium is generally paid by all companies or borrowers indirectly, through the rate at which they must repay their obligation.
Call interest premium
The dollar amount over the par value of a callable fixed-income debt security that is given to holders when the security is called by the issuer.
Default risk
The event in which companies or individuals will be unable to make the required payments on their debt obligations. Lenders and investors are exposed to default risk in virtually all forms of credit extensions.
Federal Open Market Committee (FOMC)
The formulation and conduct of monetary policy.
Discount rate
The interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve Bank's discount window. The ___________ also refers to the interest rate used in discounted cash flow (DCF) analysis to determine the present value of future cash flows. The discount rate in DCF analysis takes into account not just the time value of money, but also the risk or uncertainty of future cash flows; the greater the uncertainty of future cash flows, the higher the discount rate.
Ask price
The lowest price a prospective seller is willing to accept
Par value (principal, face value)
The nominal value or dollar value of a security stated by the issuer. For stocks, it is the original cost of the stock shown on the certificate. For bonds, it is the amount paid to the holder at maturity (generally $1,000). Also known as "par value" or simply "par."
Capital markets
The part of a financial system concerned with raising capital by dealing in shares, bonds, and other long-term investments.
Primary financial market
The part of the capital market that deals with issuing of new securities. Companies, governments or public sector institutions can obtain funds through the sale of a new stock or bond issues through primary market. Can buy directly from the company.
Margin requirements
The percentage of marginable securities that an investor must pay for with his/her own cash
Bid price
The price at which a market-maker or dealer is prepared to buy securities or other assets. The highest price that a prospective buyer is willing to pay for the security.
Discounting
The process of determining the present value of a payment or a stream of payments that is to be received in the future. Given the time value of money, a dollar is worth more today than it would be worth tomorrow given its capacity to earn interest. ________ is the method used to figure out how much these future payments are worth today.
Term structure of interest rates
The relationship between interest rates or bond yields and different terms or maturities. The _____________ is also known as a yield curve and it plays a central role in an economy.
Term-to-maturity
The remaining life of a debt instrument.
Required reserves
The reserve requirement (or cash reserve ratio) is a central bank regulation employed by most, but not all, of the world's central banks, that sets the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves (rather than lend out).
Foreign exchange risk
The risk of an investment's value changing due to changes in currency exchange rates
Liquidity risk
The risk that a company or bank may be unable to meet short term financial demands. This usually occurs due to the inability to convert a security or hard asset to cash without a loss of capital and/or income in the process.
Interest rate risk
The risk that arises for bond owners from fluctuating interest rates. How much interest rate risk a bond has depends on how sensitive its price is to interest rate changes in the market. The sensitivity depends on two things, the bond's time to maturity, and the coupon rate of the bond.
Put option
an option to sell assets at an agreed price on or before a particular date.
Investment-grade bonds
if a bond's credit rating is BBB- or higher by Standard & Poor's or Baa3 or higher by Moody's. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them.
Compounding
the ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings.
Time value of money
the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.
Credit risk
the potential that a bank borrower or counterparty will fail to meet its obligations in accordance with agreed terms.
Call price
the price at which a bond or a preferred stock can be redeemed by the issuer. This price is set at the time the security is issued.
Frictional unemployment
the time period between jobs when a worker is searching for, or transitioning from one job to another.