economics of money, banking, and financial markets – Flashcards
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security
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aka financial instrument; a claim on the issuer's future income or assets
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asset
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any financial claim or piece of property that is subject to ownership
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bond
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a debt security that promises to make payments periodically for a specified period of time
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interest rate
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the cost of borrowing or the price paid for the rental of funds
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common stock
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represents a share of ownership in a corporation; a security that is a claim on the earnings and assets of the corporation
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financial intermediary
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an institution that borrows funds from people who have saved and makes loans to others
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financial crises
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major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms
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bank
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a financial institution that accepts deposits and makes loans; commercial banks, savings and loan associations, mutual savings banks, and credit unions
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financial innovation
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the development of new financial products and services
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e-finance
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the delivery of financial services electronically
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money
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aka the money supply; anything that is generally accepted in payment for goods or services or in the repayment of debts
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aggregate price level
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the average price of goods and services in an economy
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inflation
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a continual increase in price level
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monetary policy
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the management of money and interest rates
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central bank
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the organization responsible for the conduct of a nation's monetary policy
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fiscal policy
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decisions about government spending and taxation
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budget deficit
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the excess of government expenditures over tax revenues for a particular time period
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budget surplus
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when tax revenues exceed government expenditures
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GDP
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measure of aggregate output
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foreign exchange market
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where the conversion of currency takes place
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foreign exchange rate
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the price of one country's currency in terms of another's
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liability
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IOUs or debts
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capital
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wealth, either financial or physical, that is employed to produce more wealth
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maturity
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the number of years (term) until an instrument's expiration date
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short-term
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less than a year
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long-term
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ten years or longer
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intermediate-term
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between one and ten years
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equity
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claims to share in the net income and the assets of a business e.g. common stock
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dividends
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periodic payments by corporations to shareholders
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primary market
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a financial market in which new issues of a security are sold to initial buyers by the corporation or government agency borrowing the funds
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secondary market
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financial market in which securities that have been previously issued can be resold
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investment bank
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financial institution that assists in the initial sale of securities in the primary market; does not take in deposits and lend them out
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underwriting
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the act of guaranteeing a price for a corporation's securities and then selling them to the public
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brokers
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agents of investors who match buyers with sellers of securities
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dealers
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agents who link buyers and sellers by buying and selling securities at stated prices
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exchange
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where buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades
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over-the-counter market
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dealers at different locations who have an inventory of securities stand ready to buy and sell securities "over the counter" to anyone who comes to them and is willing to accept their prices
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money market
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financial market in which only short-term debt instruments are traded
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capital market
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financial market in which longer-term debt and equity instruments are traded
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default
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a situation in which the party issuing the debt instrument is unable to make interest payments or pay off the amount owed when the instrument matures
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currency
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paper money or coins
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federal funds rate
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the interest rate on federal funds (bank to bank) loans
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mortgage
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a loan to a household or firm to purchase land, housing, or other real structures in which the structure or land itself serves as collateral for the loans
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mortgage-backed security
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a bond-like debt instrument backed by a bundle of individual mortgages, whose interest and principal payments are collectively paid to the holders of the security
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foreign bonds
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bonds sold in a foreign country that are denominated in that country's currency
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Eurobond
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a bond denominated in a currency other than that of the country in which it is sold
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Eurocurrencies
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foreign currencies deposited in banks outside the home country
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Eurodollars
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US dollars deposited in foreign banks outside the US or in foreign branches of US banks
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financial intermediation
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the process of indirect finance using financial intermediaries; primary route for moving funds forom lenders to borrowers
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liquidity services
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services provided by financial intermediaries that make it easier for customers to conduct transactions
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risk sharing
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the process by which financial intermediaries create and sell assets with risk characteristics that people are comfortable with and using the funds acquired to purchase other assets that may have far more risk
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asset transformation
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alternate name for risk sharing; risky assets are turned into safer assets for investors
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asymmetric information
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the inequality of information where one party doesn't know enough about the other to make an accurate decision
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adverse selection
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the problem created by asymmetric information before the transaction occurs
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moral hazard
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the problem created by asymmetric information after the transaction occurs
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economies of scope
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the low cost of information production for each service by applying one information resource to many different services; employed by financial intermediaries
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conflict of interest
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a type of moral hazard where a person or institution has multiple
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depository institutions
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institutions that accept deposits from individuals and institutions and make loans; commercial banks, savings and loan associations, mutual savings banks, credit unions
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thrift institutions
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aka thrifts; savings and loan associations, mutual savings banks, and credit unions
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contractual savings institutions
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financial intermediaries that acquire funds at periodic intervals on a contractual basis; life insurance companies, fire and casualty insurance companies, pension funds and government retirement funds
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investment intermediaries
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finance companies, mutual funds, money market mutual funds, and investment banks
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financial panic
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widespread collapse of financial intermediaries
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cash flow
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debt instruments' streams of cash payments to the holder
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present value
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concept based on the notion that a dollar paid to you one year form now is less valuable than a dollar paid to you today; a dollar today in a savings account can earn interest
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simple loan
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a loan in which the lender provides the borrower with an amount of funds (called the principal) that must be repaid to the lender at the maturity date along with an additional payment for interest
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fixed payment loan
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aka fully amortized loan; a loan in which the lender provides the borrow with an amount of funds, which must be repaid by making the same payment every period, consisting of part of the principal and interest for a set number of years
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coupon bond
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a bond that pays the owner of the bond a fixed interest payment (coupon payment) every year until the maturity date, when a specified final amount (face or par value) is repaid
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coupon rate
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the dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond
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discount bond
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aka zero-coupon bond; a bond bought at a price below its face value (at a discount), and the face value is repaid at the maturity date; does not make any interest payments
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yield to maturity
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the interest rate that equates the present value of cash flow payments received from a debt instrument with its value today
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consol
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also perpetuity; a perpetual bond with no maturity date and no repayment of principal that makes fixed coupon payments for $C forever
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rate of capital gain
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the change in a bond's price relative to the initial purchase price
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current yield
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the yearly coupon payment divided by the price of the security
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rate of return
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also return; how well a person does by holding a bond or any other security over a particular time period
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interest-rate risk
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the riskiness of an asset's return that results from interest rate changes
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real interest rate
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the interest rate that is adjusted by subtracting expected changes in the price level so that it more accurately reflects the true cost of borrowing; aka ex ante interest rate
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ex post interest rate
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the interest rate that is adjusted for actual changes in price level; describes how well a lender has done after the fact
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indexed bonds
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bonds whose interest and principal payments are adjusted for changes in the price level
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wealth
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the total resources owned by the individual, including all assets
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expected return
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The return expected over the next period on one asset relative to alternative assets
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risk
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the degree of uncertainty associated with the return on one asset relative to alternative assets
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liquidity
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The ease and speed with which an asset can be turned into cash relative to alternative assets
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theory of portfolio choice
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tells us how much of an asset people want to hold in their portfolios based on factors such as wealth, expected return, risk, and liquidity
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demand curve
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the relationship between quantity demanded and the price when all other economic variables are held constant
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market equilibrium
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when the quantity of bonds demanded equals the quantity of bonds supplied
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Fisher effect
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the observation that when expected inflation rises, interest rates will rise
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liquidity preference framework
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a way to determine the equilibrium interest rate in terms of the supply and demand of money
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risk structure of interest rates
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the relationship among bonds with the same term to maturity but different interest rates
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term structure of interest rates
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the relationship among bonds with different terms to maturity
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default-free bonds
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bonds with no default risk
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risk premium
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the spread between bonds with default risk and default free bonds
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credit-rating agencies
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investment advisory firms that rate the quality of corporate and municipal bonds in terms of the probability of default
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junk bonds
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bonds with ratings below Baa or BBB; aka high-yield bonds
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yield curve
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a plot of the yields on bonds with differing terms to maturity but the same risk, liquidity, and tax considerations
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expectations theory
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the interest rate on a long-term bond will equal an average of the short0term interest rates that people expect to occur over the life of the long-term bond
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segmented markets theory
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sees markets for different-maturity bonds as completely separate and segmented
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liquidity premium theory
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states that the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a liquidity premium that responds to supply and demand conditions for that bond
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preferred habitat theory
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assumes that investors have a preference for bonds of one maturity over another, a particular bond maturity (preferred habitat) in which they prefer to invest
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residual claimant
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the stockholder receives whatever remains after all other claims against the firm's assets have been satisfied
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cash flows
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funds flowing into a firm
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adaptive expectations
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view of expectation formation that suggests that changes in expectations will slowly occur slowly over time as past data change
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rational expectations
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expectations will be identical to optimal forecasts (the best guess of the future) using all available information
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efficient market hypothesis
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the theory of rational expectations applied to financial markets
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unexploited profit opportunities
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returns on a security that are larger than what is justified by the characteristics of that security
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market fundamentals
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items that have a direct impact on future income streams of the securities
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bubbles
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when the prices of assets rise well above their fundamental values
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behavioral finance
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the application of concepts from social sciences such as anthropology, sociology, and psychology to understand the behavior of securities prices
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short sale
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borrowing stock from brokers and then selling it in the market, with the aim that they can earn a profit by buying the stock back again ("covering the short") after it has fallen in price
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Federal Reserve Banks
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each of the twelve Federal Reserve districts has one main Federal Reserve bank, which may have branches in other cities in the district; each of the banks is a quasi-public institution owned by the private commercial banks in its district that are members of the Federal Reserve System
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open market operations
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the purchase and sale of government securities that affect both interest rates and the amount of reserves in the banking system
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national banks
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commercial banks chartered by the Office of the Comptroller of the Currency
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tightening of monetary policy
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a rise in the federal funds rate
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easing of monetary policy
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a lowering of the federal funds rate
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political business cycle
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scenario in which just before an election, expansionary policies are pursued to lower unemployment and interest rates
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instrument independence
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the ability of the central bank to set monetary policy instruments
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instrument goal independence
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the ability of the central bank to set the goals of monetary policy
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income
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flow of earnings per unit of time
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medium of exchange
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the fact that money is used to pay for goods and services
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unit of account
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the fact that money is used to measure value in the economy
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store of value
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the fact that money is a repository of purchasing power over time
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hyperinflation
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extreme inflation; when inflation exceeds 50% per month
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payments system
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the method of conducting transactions in the economy
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commodity money
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money made up of precious metals or another valuable commodity
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fiat money
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paper currency decreed by governments as legal tender but not convertible into coins or precious metal
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check
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an instruction from you to your bank to transfer money from your account to someone else's account when he/she deposits the check
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e-money
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electronic money; money that exists only in electronic form; debit card was the first form
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smart card
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the more sophisticated stored-value card that has a preset dollar amount
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e-cash
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electronic money which is used on the Internet to purchase goods or services
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monetary aggregates
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the Fed's measures of money
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M1
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narrowest measure of money that the Fed reports; includes the most liquid assets: currency, checking account deposits, and traveler's checks
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M2
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monetary aggregate that includes M1 and other assets that are not quite as liquid as those included in M1: assets that have check-writing features (money market deposit accounts and money market mutual fund shares) and other assets (savings deposits and small-denomination time deposits) that can be turned into cash quickly at very little cost
