Money Market Securitiesfacilitate the sale of short-term debt securities by deficit units to surplus units; Debt securities that have a maturity of one year or lessCapital Market Securitiesfacilitate the sale of long-term securities by deficit units to surplus unitsBonds, Mortgages, Mortgage Backed Securities, StocksCapital Market Securities include: (4)Bondslong-term debt securities issued by the Treasury, government agencies, and corporations to finance their operationsMortgageslong-term debt obligations created to finance the purchase of real estateMortgage-Backed Securitesdebt obligations representing claims on a package of mortgagesStocksrepresent partial ownership in the corporations that issued themDerivative Securitiesfinancial contracts whose values are derived from the values of underlying assetsSpeculationallow an investor to speculate on movements in the value of the underlying assets without having to purchase those assetsRisk Managementfinancial institutions and other firms can use derivative securities to adjust the risk of their existing investments in securities1. Estimation of Future Cash Flows
2. Economic or Industry Information
3. Published Opinions on Firm's ManagementInformation that impacts valuation (3)1. More Timely Pricing
2. More Accurate Pricing
3. More Informative PricingImpact of internet on valuation (3)Behavioral Financethe application of psychology to make financial decisionsThe Securities Act of 1933intended to ensure complete disclosure of relevant financial information on publicly offered securities and to prevent fraudulent practices in selling these securitiesThe Securities Act of 1934extended the disclosure requirements to secondary market issuesSarbanes-Oxley Actrequired that firms provide more complete and accurate financial informationForeign Exchange MarketInternational financial transactions normally require the exchange of currencies, _________ facilitates this exchangeMarket ImperfectionsFinancial institutions are needed to resolve the limitations caused by ______________ such as limited information regarding the creditworthiness of borrowers.Depository Institutionsaccept deposits from surplus units and provide credit to deficit units through loans and purchases of securitiesCommercial Banks, Savings Institutions, Credit UnionsTypes of Depository Institutions (3)Finance Companies, Mutual Funds, Securities Firms, Insurance Companies, Pension FundsTypes of Non-Depository Institutions (5)Finance Companiesobtain funds by issuing securities and lend the funds to individuals and small businessesMutual Fundssell shares to surplus units and use the funds received to purchase a portfolio of securitiesSecurities Firmsprovide a wide variety of functions in financial markets. (Broker, Underwriter, Dealer, Advisory)Insurance Companiesprovide insurance policies that reduce the financial burden associated with death, illness, and damage to property. Charge premiums and invest in financial marketsPension Fundsmanage funds until they are withdrawn for retirementActivist ShareholdersFinancial Institutions serve as ____________, they can help ensure that managers of publicly held corporations are making decisions that are in the best interests of the shareholdersSystemic Riskthe spread of financial problems, among financial institutions and across financial markets, that could cause a collapse in the financial systemEmergency Economic Stabilization Act of 2008Intended to resolve the liquidity problems of financial institutions and to restore the confidence of the investors who invest in themFinancial Reform Act of 2010Also referred to as Wall Street Reform Act or Consumer Protection Act; Mortgage lenders must verify the income, job status, and credit history of mortgage applicants before approving mortgage applicationsfinancial conglomeratesMany financial institutions have been consolidated (due to mergers) into __________; provides many types of financial servicesThe Loanable Funds Theorysuggests that the market interest rate is determined by the factors that control supply of and demand for loanable fundsInterest Rate; Quantity of Loanable Funds DemandedInverse relationship between the ___________ and the ____________________Interest InelasticGovernment demand is said to be ____________ insensitive to interest rates because expenditures and tax policies are independent of the level of interest ratesGreater, GreaterA country's demand for foreign funds depends on the interest rate differential between the two; The ______ the differential, the _______the demand for foreign fundsInverselyThe quantity of U.S. loanable funds demanded by foreign governments will be _________ related to U.S. interest ratesAggregate Demand for Loanable FundsThe sum of the quantities demanded by the separate sectors at any given interest rateHouseholdsAre the largest suppliers of loanable funds, but some are supplied by governmental unitsEquilibrium Interest Ratethe intersection of the aggregate supply curve and aggregate demand curveSurplusAbove the equilibrium rate, there is a _______ of loanable fundsShortageBelow the equilibrium rate, there is a _______ of loanable fundsupward pressure in interest rates by shifting demand outwardImpact of economic growth on interest ratesupward pressure on interest rates by shifting supply of funds inward and demand for funds outwardImpact of inflation on interest ratesUpward (downward)When the Fed reduces (increases) the money supply, it reduces (increases) the supply of loanable funds, putting ________ (__________) pressure on interest ratesCrowding-Out EffectGiven a certain amount of loanable funds supplied to the market, excessive government demand for funds tends to "crowd out" the private demand for fundsEconomic Conditionsare the primary forces behind a change in the supply of savings provided by households or a change in the demand for funds by households, businesses, or the governmentAggregate Demand minus Aggregate SupplyNet Demand (ND) equals:1. Credit Risk
2. Liquidity
3. Tax Status
4. Term to MaturityThe yields on debt securities are affected by (4)HigherAll else being equal, securities with a higher degree of default risk must offer ______ yieldsRating Agencycharge the issuers of debt securities a fee for assessing default riskHigherThe lower a security's liquidity, the _______ the yield preferred by an investoryield differentialthe difference between the yield offered on a security and the yield on the risk-free rateTreasury Bondshave the lowest yield because of their low default risk and high liquidityMunicipal Bondshave the lowest before-tax yield but their after-tax yields are typically higher than Treasury bondsPure Expectations TheoryTerm structure reflected in the shape of the yield curve is determined solely by the expectations of interest ratesUpward sloping yield curveImpact of an Expected Increase in Rates leads to anDownward Sloping Yield CurveImpact of an expected Decline in Rates leads to aLiquidity Premium TheoryInvestors prefer short-term liquid securities but will be willing to invest in long-term securities if compensated with a premium for lower liquiditySegmented Markets TheoryInvestors choose securities with maturities that satisfy their forecasted cash needsPreferred Habitat TheoryAlthough investors and borrowers may normally concentrate on a particular maturity market, certain events may cause them to wander from their "natural" or preferred marketRecessionSome analysts believe that flat or inverted yield curves indicate a __________ in the near future
