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Financial Markets

A place or mechanism by which borrowers, savers,and financial intermediaries trade securities

Financial Security

A contract in which a borrower seeks to obtain money from a lender to whom he promises to compensate in the future

Debt Security

A contract that promises to pay a given amount of money to the owner of the security at specific dates in the future


The original amount of credit extended on a security


the time until borrowered funds(the principal) must be repaid.


payments made by a borrower to the owner of a debt security in addition to the repayment of principal; usually expressed as a percentage

Equity security

a contract that gives a share of ownership in the firm to the owner of a security


periodic payments from an equity security based on the earnings of the issuing-firm

Money Market

market for short-term (less than one year) financial securities; includes debt instruments such as Treasury bills,commercial paper, and certificates of deposits.

Capital Market

market for intermediate and long term(over one year) financial securities; includes debts securities such as bonds and notes issued by firms and government, as well as equity securities(stock) issued by firms

Primary market

market for newly issued securities; funds go directly to issuer

Secondary market

market for prev. issued sec. being sold by a first or subsequent owner. funds go to the seller of the security.


how easy an asset can be transformed into cash on short notice and at a low risk

direct finance

the firm/govt borrows funds directly from savers; both saver and borrower directly know eachother

indirect finance

flow of funds is done through financial intermediaries; saver and borrower do not know eachothers identity.


institutions that collect and pull funds to borrowers

Pooling of funds

allows large loans to be made, connects short term to long term, reduces transaction costs

information gathering

intermediaries are able to centralize information; savers benefit from intermediaries directing funds to productive activities


located in New York City, auction market, maximum listing fee is $250,000.


exists on a telecommunications network, dealer market,only at $150,000


any items that individuals are willing to accept in exchange for goods and services

Transaction costs

costs of trading sich as shopping, negotiating, or transforming assets into something that can be used in exchange


the percentage increase in the overall level of prices over a given period of time,typically monthly or anually

Commodity money

money whose value is determined by its value as a material/commodity

Fiat money

money whose value derives from government decree and from indiviuals' willingness to accept it in the exchange prociess

outside money

money created by government or nature

inside money

monet created in the private sector(i.e. banks)

monetary aggregate

a measure of the total money supply in the economy based on a standard of liquidity


coins+currency+checking accounts+travelers checks


M1+saving+small denomination(less than $100,000)+non institutional money market mutual funds

commercial bank

a depository institution that specializes in issuing checking deposits and making commercial, consumer, and real estate loans

savings institutions

a depository institution that specializes in issuing savings deposits and making mortgage loans

credit union

a depository institution that issues transactions deposits and makes loans to members of the credit union where members owns shares in the credit union

assymetric information

occurs when one party to a transactopns has superior information relative to another party

adverse selection

occurs when the most high risk borrowers are also those most likely to seek financing (before any finance takes place)

moral hazard

occurs when boorowers pursue riskier- than-expected activities once financing is acquired(after the funds have already been granted)

medium of exchange

1 of 4 functions of money- money reduces transactions costs by eliminating double coincidence of wants, but requires the publics nearly- universal acceptance

units of account

2 of 4 functions of money- allows prices to be denoted in terms of money, but can break down in economies where prices are highly volatile

store of value

3 of 4 functions of money- occurs when individuals hold money to reduce transaction costs instead of spending or invsting, but can break down in cases of hyperinflation

standard of deffered payment

4 of 4 functions of money- allows future payment of current spending(i.e. loans), but again requires universal-acceptance (backed by government decree)


eliminated in mar'06, (M2+large time deposits+overnight and term repurchase agreements+ overnight and term eurodollor deposits

Central bank

an institution whose primary function is to control a nations moneysupply

Federal Reserve System

a system of agencies that acts as the central bank of the United States

NEgative externality

occurs when a transaction imposes uncompensated costs onto parties not involved in the transaction

systematic risk

the risk posed to one financial institutions credit agreements by the potential failure of transactions by other institutions that are otherwise unrelated

Lender of Last resort

an institution (theFed) that is willing and able to lend any temporarily illiquid but otherwisw solvent institution to prevent a general loss of confidence in the financial system

Federal funds market/rate

market where banks loan/borrow reserves with each other at the market-determined federal funds rate

discount window/rate

the process of depository institutions requesting loans from the Fed at the Feds determined discount rate

term auction facility

a processes by which depository institutions bid for short term collateralized loans from the fed while maintaing anonymity

monetary policy

policy that influences the flow of money and credit in an economy

BOard of governors

a group of seven individuals appointed by the president and confirmed by the senate that has key policy making responsibilities within the Federal Reserve System

federal reserve district banks

the 12 central banking institutions that oversee regional activities on the federal reserve system

federal open market committee

a group comprised of the seven governors and five district bank presidents that determine how to conduct monetary policy

credit risks

risk that someones not going to pay back on loan rick of asset losses due to non performing loans

leverage risks

the risk that asset losses cannot be sufficiently offset with reductions in liabilites; represents a solvency prob for the bank;(i.e. filing for bankruptcies)

liquiidty risks

that risk that short term assets cannot be sufficiently liquidated to meet short term liabilities.

interest rate risks

when banks hold securities,issue loans, go up or down effect the bank revenue when up or down.

required reserves

total value of cash reserves that depository insitutions hold in proportion to transactions deposits as required by law, can be held as vault cash or at fed reserve district banks

required reserve ratio:

the legal ratio (q) of cash reserves that depository institutions must hold relative to transactions deposits, set by the Fed Reserve

Excess reserves

total value of cash reserves that depository institutions hold in excess of their legal requirements

total reserves

the sum of excess reserves and required reserves

loaned up

refers to a depository institution that meets its reserve requirements but does not hold excess reserves

Monetary base

the sum of currency outstanding outstanding and bank reserves

open market operations

the activity by which the federal reserve buys and sells securities with its primary dealers

deposit multiplier

the factor by which transactions deposits change in the banking system due to a given change in bank reserves; 1/q

money multiplier

the factor by which M1 changes in the economy due to a given change in the monetary base[(c+1)/(c+qO]


the proportion of currency held by the public in relation to their transaction deposits; c=C/D

primary dealer

large investment banks and brokers that meet certain capital(size) requirements and agree to activley transact with the fed when it engages in OMOs

three primary roles of central banks

1. banking functions for the federal govt
2. lender of last resort to depository institutions
3.formulates and executes monetary policy

negative externalities

actions of one party impose negative on other parties and receive no compensation

discount window

1 of 3 ways of lending- banks can borrow money directly from the fed at a given interest rate

term auction facility

2 of 3 ways of lending- process by which banks can bid on short term collaterized loans from the fed

extension to non depository institutions

3 of 3 ways of lending- process by which certatin non dep. ins. can bid for short term collaterized loans

monetary policy

the control of the flow of money and credit in the economy

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