Review for Exam 1
Review for Exam 1 FINA 30653
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This 9 page Study Guide was uploaded by Vanessa on Monday September 26, 2016. The Study Guide belongs to FINA 30653 at Texas Christian University taught by Dr. Dahlquist in Fall 2016. Since its upload, it has received 9 views. For similar materials see Financial Planning in Finance at Texas Christian University.
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Date Created: 09/26/16
Finance Review: Exam 1 Arbitrage: buying and selling securities at the same time to hedge against price changes; way to diversify and hedge against losses and risk Ask price: the price the seller of a share of stock is asking for the stock; price the stock is being offered at Barter: the act of trading goods or services between two or more parties without the use of money; what was used before a monetary system was in place Bid price: the price someone who is interested in buying a share of stock is offering to pay Bid-ask spread: the amount by which the ask price exceeds the bid price; the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it Broker: middleman of the transaction that connects two parties; works on commission; work to make deals happen but NEVER use their own money in the transaction Brokerage firm: where brokers work; the firm that brings buyers and sellers together to complete transactions (i.e. stock or real estate) Capital market: place for trading debt securities (bonds and stocks) that will not mature for more than a year (long-term); stock has an indefinite life, so included in this market Central bank: the bank responsible for defining and regulating the country’s money supply; also allows for money transfers between banks; oversees the entire system but cannot be used by the general public, thus known as the banker’s bank Commercial banks: allow for basic banking functions (depositing, writing checks and obtaining loans); for business clients; use the deposits to make loans to other customers Contractual savings institution: organization that receives premiums to provide coverage against potential losses or to assist with retirement; insurance companies and pension funds are examples Credit life insurance: insurance policy that pays off your debts IF you die Credit union: non-profit organizations that use the deposits of members to make loans to other members; small, local community banks usually or for employees of a certain company; do not pay taxes, so can offer better rates Crowding out: the reduction in investment spending due to interest rate increases, often caused by increased government spending or a reduction in taxes Currency exchange rate: the amount received in a trade for one type of currency for another; $1 = 18 pesos Dealer: actually takes ownership of the asset and tries to turn around and sell it; instead of making commission, makes a profit on the bid/ask spread; takes on risk since takes on ownership, but can get higher return Deficit economic unit: when governments, businesses or consumers have more expenditures than income; where the money goes in financial intermediation Defined benefit plan: provides a specific benefit upon retirement; old school way of saving for retirement; knew the amount of the monthly check that stays constant Defined contribution plan: newer way of saving for retirement; employees pay in and a portion is matched by employers; get to contribute tax-free, but no guaranteed amount upon retirement Depository institutions: take in deposits from people, businesses and governments and loan out these deposits to earn money; commercial banks, thrift institutions and credit unions are all examples Disability insurance: insurance that provides payments when an individual becomes unable to work or must work less (due to injury or ailment); younger people obtain disability insurance more than life insurance Discount rate: the only interest rate set by the Federal Reserve; what the Federal Reserve charges member banks to borrow from it; higher rates mean lower money supply, so less loans and more unemployment; lower rates mean larger money supply, so more loans and less unemployment Dual banking system: how the banking system operates in the United States; federal and state banks operated under different charters and regulations Euro: the currency accepted amongst most members of the European Union Excess reserves: reserves that are in excess of the reserve requirement; the monies that can be loaned out Federal funds rate: the rate that banks charge one another to borrow reserves from one another, usually overnight Fiat money: money provided and authorized by the central bank but not backed by a commodity; valued because the government deemed it so (US dollars) Finance companies: companies that provide loans directly to consumers and businesses to purchase items (cars, equipment, household goods) Financial asset: money, debt instruments, equity securities and other financial contracts that are backed by real assets (collateral) but have no physical substance; help get resources from savers to borrowers Financial intermediation: when financial institutions (like banks) enter the transaction and assist in matching the coincidence of wants; add another party to the process Fiscal policy: how the government controls the economy through changes in government spending and taxation; created by Congressional changes Flexible exchange rate: when the exchange rate between two currencies fluctuates based on supply and demand Foreign exchange market: global marketplace for buying, selling and trading currencies; largest market in the world based on volume Forward exchange rate: the exchange rate that banks agree on to exchange one currency for another at a future date Fractional reserve system: system which allows banks to only keep a fraction (percentage) of the deposits actually on hand; the rest can be loaned out Glass-Stegall Act of 1933: legislation that stopped the practice of having universal banks (commercial and investment banks in one); repealed in 1999 Gross domestic product (GDP): measure of the output of goods and services in an economy; measures size of economy and trends in growth from year to year Inflation: a sustained increase in the general price level of goods and services in an economy over a period of time; when the price level rises, each unit of currency buys fewer goods and services Insurance companies: firms that provide financial protection to businesses and individuals regarding uncertainties (life, health, property, liability); help hedge against risk Investment bank: firms that work with businesses and investors; do not come in contact with general public; provide financing for companies first starting out Liquidity: the availability of liquid assets to a market or company; liquid assets like cash and cash equivalents Medium of exchange: what allows for payment; eliminates the need to barter and finalizes the payment (rids the debt); standardized quality and durable, valuable relative to its weight and divisible Monetary base: the total amount of currency that is either circulating amongst the public or in deposits held by the central bank in reserves Monetary policy: the intentional change of the money supply to meet macro (large) economic goals; Fed uses monetary policy, like open market operations Monetizing the debt: a two-part process where the government issues debt (government securities) to cover its spending and the central bank buys the debt to increase the money supply Money: what is needed for exchange; how people can reciprocate for the provision of goods and services (eliminates the need for barter and trade); something that is generally accepted for payment for goods and services Money market: place where debt securities that will mature in one year or less are sold or traded; short-term transactions of borrowing and lending Money supply: defined in terms of M1 (currency, traveler’s checks, demand deposits, checking accounts) or M2 (M1 + savings accounts, money market accounts, mutual funds) Mutual fund: the pooling of individual investments to create a larger, diversified portfolio that is commonly owned; allows for larger investment through pooled funds Open market operations: the primary instrument of monetary policy; involves buying and selling government securities to control the money supply; buy bonds to increase the money supply, sell bonds to shrink the money supply Pension fund: a fund that receives contribution from employees and/or employers to invest on behalf of the employees that eventually pays out a set amount upon retirement; increased need for these because people living longer Primary market: place where the initial public offering (IPO) or origination of debt and equity occurs; the money goes to the companies selling the debt or equity; where borrowing and lending first takes place; i.e. buying stock from Facebook when the company goes public Real asset: something of value that is directly owned; land, buildings, homes, equipment, inventory, durable goods and precious metals (has physical substance) Required reserves: the amount (or percentage) of deposits that must stay on hand at the bank; cannot be loaned out Savings and loan: institutions designed to meet the needs of households, not businesses; promotes home ownership and increased savings; crisis with these from mid-1980s to mid-1990s due to mismanagement and greed Secondary market: where bonds, mortgages and equity securities are traded and sold between investors; none of the money goes to the companies of the securities; no new money is generated; known as a resale market Securities firms: accept and invest individual savings and provide the means for the sale and transfer of securities between investors; how people buy and sell shares of stock and bonds Spot exchange rate: the exchange rate between two currencies immediately; the rate you see at currency exchange locations Standard of value: uniform value that is recognizable and retained; a yardstick or a foot Store of value: retains its worth over time; does not expire or erode Surplus economic unit: when a government, business or household earns more income than it spends; this is where the funds come from in financial intermediation Term life insurance: the main type of life insurance; buy it for a certain length of time; after that time, the insurance expires; cheaper option Thrift institution: compile savings to provide consumers with loans and mortgage loans; for savings accounts that will go untouched for a long time; do not provide credit/debit services Treasury bill: government security that is short-term and does not pay interest, but is purchased at a discount; risk-free Universal bank: bank that engages in both commercial banking and investment banking Velocity of money: how quickly money in the money supply circulates Whole life insurance: insurance that is paid every month or every year and remain intact as long as payments are made; builds up cash value over time; more expensive option Direct finance: can be informal arrangement or a legal one (lease); most common type of financing; the borrower and lender must know each other; must have a coincidence of wants at the same time; these are small transactions Semi-direct finance: involves a middleman or intermediary (usually a broker or dealer); parties do not know of each other without middleman Indirect finance: most important type of financing because largest sums; no direct relationship between the borrower and the lender; no direct contractual relationship either; how homes are typically financed The secondary market is important, because even though it does not generate any new money for companies, it allows the investor to retain liquidity. Thus, if they want to cash out of their securities, they can sell or trade them and get rid of those investments. If the secondary market did not exist, people would be stuck with their initial investments. People buy securities in the primary market, because they know they can sell them in the secondary market; thus, the secondary market supports and encourages the primary market Functions of money: 1. Medium of exchange: means of payment; creates a system that no longer relies on barter and trade and finalizes the payment (cancels debt) 2. Unit of account: standard of value; creates relative prices to understand value; understand what a $1 means relative to other goods 3. Store of value: retains its worth over time; does not expire or erode 4. Standard of deferred payment: common to receive money after the fact; deferred payments, like paychecks Structure of the Federal Reserve System: 1. Member banks (the banks everyday people use) 2. Federal Reserve district banks (12 of them) 3. Board of Governors a. Appointed by President b. Janet Yellen is the Chairwoman c. 7 positions, but only 5 currently filled 4. Federal Open Market Committee (FOMC) a. Direct the open market operations (buying and selling government bonds) b. Voters are the President of the New York Reserve Bank, the Board of Governors (7 votes), and 4 of the remaining 11 presidents of the other district banks 5. Advisory committees How the Fed uses tools to change monetary policy: Open market operations o Buy bonds back – puts money into money supply (expansionary), grows the economy o Sell bonds – shrinks the money supply (contractionary) Discount rate (the rate charged by the Fed to borrow) o The only rate the Fed actually sets o Higher the discount rate, the less investment spending, the higher the unemployment o Lower the discount rate, the more investment spending, the lower unemployment Reserve requirements o If you lower reserve requirements, grow the money supply o If you increase reserve requirements, shrink the money supply o Fed rarely ever messes with the reserve requirements Factors that impact currency exchange rates: Interest rates Confidence in the market (largely influenced by politics) Current account balance on payments (surplus or deficit) Economic growth Comparison of inflation rates
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