lecture 3 practice questions chapter 1 chapter 2
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CHAPTER 2The Financial Environment: Markets, Institutions, and Interest Rates and Taxes
Financial markets Types of financial
institutions Determinants of interest
rates Yield curves
1-3
What is a market? A market is a venue where goods
and services are exchanged. A financial market is a place where
individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds.
1-4
Types of financial markets Physical assets vs. Financial assets Money vs. Capital Primary vs. Secondary Spot vs. Futures Mortgage vs. Consumer credit
1-5
Physical assets vs. Financial assets Physical assets: wheat, autos, real
estate, machinery Financial assets: Stocks, bonds
1-6
Money vs. Capital Money mkt: for debt securities with
maturity of less than 1 year Capital mkt: for long-term debt
AND common stock
1-7
Primary vs. Secondary Primary mkts: in which
corporations & governments raise new capital
Secondary mkts: in which existing, previously issued (already OUTSTANDING) securities are traded
1-8
Spot vs. Futures Spot markets: where assets are
bought or sold for “on the spot” delivery (immediately or within a few days)
Futures markets: where assets are bought or sold for delivery at a later date (e.g. six months or a year into the future)
1-9
Mortgage vs. Consumer credit Mortgage mkts: loans on
commercial, residential, industrial real estate & farmland
Consumer credit markets: loans for autos, appliances, education etc.
1-10
How is capital transferred between savers and borrowers?
1. Direct transfers2. Investment
banking house3. Financial
intermediaries
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Capital transfer…
Business sells stocks or bonds to savers w/o going through any financial institution
1-12
Capital transfer…
Intermediary obtains funds from investors, issuing its own securities
The intermediary might lend to business
Intermediaries create new forms of capital (e.g. certificates of deposit)
Efficiency of financial mkts increases
1-13
Capital transfer…
Investment bank deals with the issuance of securities not loans and deposits
Investment bank buys & holds securities for a period of time—so it is taking a chance
1-14
Types of financial intermediaries
Commercial banks Pension funds Life insurance companies Mutual funds
1-15
Physical location stock exchanges vs. Electronic dealer-based markets
New York Stock Exchange (NYSE)
National Association of Securities Dealers Automated Quotations (NASDAQ)
1-16
NYSE (New York Stock Exchange) All trades occur in a physical place, on the
trading floor of the NYSE An auction market, wherein individuals are
typically buying and selling between one another and there is an auction occurring
Highest buying (bidding) price will be matched with the lowest selling (asking) price
Stocks of well established (Blue chip) companies
1-17
NASDAQ (National Association of Securities Dealers’ Automated Quotations) Located on a telecommunications
network. Dealer's market, wherein market
participants are not buying from and selling to one another but to and from a dealer
The dealer is the market maker Stocks of firms dealing with the Internet
or electronics. Stocks are more volatile
1-18
Differences have narrowed NASDAQ exchange was listed as a
publicly-traded corporation, while the NYSE was private corporation.
In March 2006 the NYSE went public after being a not-for-profit exchange for nearly 214 years.
The shares of these exchanges, like those of any public company, can be bought and sold by investors on an exchange.
1-19
Organized exchange vs. OTC market Organized exchange: Physical
place Over-the-Counter market: Brokers
and Dealers connected over an electronic network
Although, it started out as an OTC market, today NASDAQ is considered a sophisticated market separate from the OTC market
1-20
Video Clip: Key Takeaways Most people think of the stock
market when we talk of financial markets but there are many different markets
Primary and Secondary markets Public financial markets
Where govts borrow money Corporate financial markets
Where corporations borrow money Organized security exchanges vs.
virtual networks
1-21
Cost of money The price, or cost, of debt capital
is the interest rate. The price, or cost, of equity
capital is the required return. The required return investors expect
is composed of compensation in the form of dividends and capital gains.
1-23
What four factors affect the cost of money?
1. Production opportunities The returns available within an
economy from investment in productive (cash-generating) assets
The higher the production opportunities, the more the borrower (producer) can offer
1-24
Factors affecting cost of money…
2. Time preferences for consumption Preferences of consumers for current
consumption as opposed to saving for future consumption
The higher the time preference the more the lender will demand
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