Money and Banking Test

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Nominal

the value of money in money terms

Real

It is the value of money

What do Surplus Units Value?

Liquidity, Low Risk, Reasonable Return Rate

The Loanable Funds Theory

The interest rate is the price of loanable funds; It is determined by the Demand and Supply for loanable funds

Fed Funds Rate

The interest rate for inter-banking loans

Open-Market Operations

Buys bonds to supply loanable funds at lower interest rates by buying bonds

Fisher Effect

It states that interest rates will be higher than inflation

Term Structure of interest is also known as

the yield curve

Capital Markets

involve equity and debt instruments with maturities of more than one year

Bonds

are long-term debt obligations issued by corporations and government units

Bond markets

are markets in which bonds are issued and traded

Treasury notes are

T-notes and T-bonds

Municipal bonds are known as

Munis

Treasuries notes and bonds

are issued by the federal government to finance the national debt and other government expenditures

The annual federal deficit is equal to

Government Expenditures minus Taxes

The national debt (ND)

is the sum of the historical annual federal deficits:

Default Risk Free

Backed by the full faith and credit of the US government

Low Returns

low interest rate yields (yields to maturity) reflect low default risk

Interest Rate Risk

because of their long maturity, T-notes and T-bonds experience wider price fluctuations than money market securities when interest rates change

Liquidity risk

older issued T-bonds and T-notes trade less frequently than newly issued T-bonds and T-notes

Mortgages

are loans to individuals or businesses to purchase homes, land or other real state property

Securitized

Packaged and sold as assets backing publicly traded or privately held debt instruments

If interests go up that means the value of the asset that collects interest goes

down

If the interest goes down the price of the assets goes

up

GNMAES

Hybrid between a mortgage and a bond

T-notes have original maturities from

over 1 to 10 years

T-bonds have original maturities from

over 10 years

inflation-indexed bonds are called

Treasury Inflation Protection Securities (TIPS)

the principal value of TIPS is adjusted by

the percentage change in the Consumer Price Index(CPI) every six months

Bond Prices are quoted as

percentages of face value, and 32nds

STRIPS

are used to immunize against interest rate risk

Munis

are securities issued by state and local governments

Munis are used to

fund imbalances between expenditures and receipts and finance long-term capital outlays

Muni bonds are attractive to household investors because

interest is exempt from federal and most local income taxes

General Obligation (GO) bonds

are backed by the full faith and credit of the issuing municipality

Revenue Bonds

are sold to finance specific revenue generating projects

common stock

the fundamental ownership claim in a public or private corporation

preferred stock

A hybrid security that has characteristics of both bonds and common stocks

The primary market

part of the capital markets that deals with the issuance of new securities; Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue

The secondary market

the financial market where previously issued securities and financial instruments such as stock, bonds, options, and futures are bought and sold

Classify the following transactions as taking place in the primary or secondary markets; IBM issues $200 million of new common stock

Primary

Classify the following transactions as taking place in the primary or secondary markets; The New Company issues $50 million of common stock in an IPO

Primary

Classify the following transactions as taking place in the primary or secondary markets; IBM sells $5 million of GM preferred stock out of its marketable securities portfolio

Secondary

Classify the following transactions as taking place in the primary or secondary markets; The Magellan Fund buys $100 million of previously issued IBM bonds

Secondary

Classify the following transactions as taking place in the primary or secondary markets; Prudential Insurance Co. Sells $10 million of GM common stock

Secondary

How does the location of the money market differ from that of the capital market?

Money market deals with maturities one year or shorter, the capital market deals with securities longer than one year

The money market

deals with maturities one year or shorter while capital markets deal with securities longer than one year

The capital market

is a market for securities, where business enterprises and governments can raise long-term funds; It is defined as a market in which money is provided for periods longer than a year

What are the major instruments traded in the capital markets?

Equities and Bonds

Financial institutions

commercial and savings banks, credit unions, insurance companies, mutual funds.

Commercial banks

A commercial bank (or business bank) is a type of financial institution and intermediary; It is a bank that provides transactional, savings, and money market accounts and that accepts time deposits.

Thrifts

Depository institutions in the form of savings associations, savings banks, and credit unions.

Insurance Companies

Financial institutions that protect individuals and corporations (policyholders) from adverse events; Life insurance companies provide protection from untimely death, illness, and retirement; Property casualty insurance protects against personal injury and liability due to accidents, theft, fire, etc.

Securities firms and investment banks

The principal businesses of most large investment banks include, investment banking business managed by the Investment Banking Division, which focuses on capital raising and M&A transactions for corporate clients and capital raising for government clients

Finance companies

financial intermediaries that makes loans to both individuals and businesses; Unlike depository institutions, finance companies do not accept deposits but instead rely on short- and long-term debt for funding.

Mutual Funds

financial institutions that pool financial resources of individuals and companies and invest those resources in diversified portfolios of asset.

Pension Funds

offer savings plans through which fund participants accumulate savings during their working years before withdrawing them during their retirement years; Funds originally invested in and accumulated in a pension fund are exempt from current taxation.

Why would a world limited to the direct transfer of funds from suppliers of funds to user of funds likely result in quite low levels of funds flows?

Because, it reduces liquidity risk for investors; A financial institution that knows what they are doing will provide a reasonable rate of return; The ability to purchase a share of the financial institution will reduce the liquidity risk since they are (or should be) diversified.

How do FIs alleviate the problem of liquidity risk faced by investors wishing to invest in securities of corporations?

Because financial institutions are diversified, a loss in any market sector does not signify a collapse in the value of the financial institution; Allowing for investors to trade the security or asset quickly and prevent loss (or make the required profit).

What is meant by maturity intermediation?

Making long-term loans on funds borrowed at short-term interest rates; It is a vulnerable position for a bank.

What countries have the largest commercial banks?

United States of America.

simple interest

Simple interest is calculated only on the principal amount.

compound interest

When interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest; This addition of interest to the principal is called compounding; A bank account, for example, may have its interest compounded every year.

Calculate the future value in five years of $5,000 received today if your investments pay 6% compounded annually

6691.13.

Calculate the future value in five years of $5,000 received today if your investments pay 8% compounded annually

7346.64.

Calculate the future value in five years of $5,000 received today if your investments pay 10% compounded annually

8052.55.

Calculate the future value in five years of $5,000 received today if your investments pay 10% compounded semi-annually

6381.41.

Calculate the future value in five years of $5,000 received today if your investments pay 10% compounded quarterly

5657.04.

Who are the suppliers of loanable funds?

Households, Foreign investors, the Federal Reserve

Who are the demanders of loanable funds

Businesses and Governments.

What factors cause the supply for funds curve to shift?

The increase or decrease of loanable funds.

What factors cause the demand for funds to shift?

The increase or decrease in cost of loanable funds. (Interest)

If we observe a one-year Treasury security rate higher than the two-year Treasury security rate, what can we infer about the one-year rate expected one year from now?

You can, one year hence, expect that the interest rate will be lower.

Capital markets

involve equity and debt instruments with maturities of more than one year. Bonds markets-are markets where debt instruments (bonds) with maturities of more than one year are traded.

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