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Chapter 10, Financial Markets and Securities--ECON 2006

by: Shannon Cummins

Chapter 10, Financial Markets and Securities--ECON 2006 ECON 2006

Marketplace > Virginia Polytechnic Institute and State University > Macroeconomics > ECON 2006 > Chapter 10 Financial Markets and Securities ECON 2006
Shannon Cummins
Virginia Tech
GPA 3.34

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About this Document

These notes cover the difference between direct and indirect securities and go over a variety of the tools used for each. Stocks, bonds, securitization, home mortgage loans, and treasury securitie...
Principles of Economics
Class Notes
Econ, 2006, Economics, Macroeconomics, Stocks, bonds, securitization, home, Mortgage, Loans, treasury, securities, Tools, financial, markets, Interest, Rates, Default, Primary, Secondary
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This 3 page Class Notes was uploaded by Shannon Cummins on Sunday October 2, 2016. The Class Notes belongs to ECON 2006 at Virginia Polytechnic Institute and State University taught by Staff in Fall 2016. Since its upload, it has received 6 views. For similar materials see Principles of Economics in Macroeconomics at Virginia Polytechnic Institute and State University.


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Date Created: 10/02/16
Financial Markets and Securities—9.23.2016 $$ Indirect Finance Banks/other $$ financial Savers deposit Banks lend to intermediaries funds in bank borrowers Savers/ Borrowers/ lenders investors Savers buy financial securities from $$ borrowers. $$ Direct Finance Direct finance – occurs when borrowers go directly to savers for funds.  Firms sell a security (stock or bond) directly to the public in exchange for funds. Indirect finance – occurs when savers deposit funds into financial intermediaries, which then loan these funds to borrowers.  Financial intermediaries – firms that help channel funds from savers to borrowers (ex. banks). Tool LENDER BORROWE S $$$ RS Tools:  Bonds – contract between a lender and a borrower by which the borrower promises to repay a loan with interest. o Used by large established firms when they need an infusion of money. o Securities are issued and sold to the public (direct finance). o Funds generated are used for investment. o Formal IOU—a contract specifying who owes how much, and a date for payment. Interest rate: o Bond buyers (lenders)  Look for the highest interest rate o Bond sellers (borrowers)  Try to sell bonds at the lowest interest rate possible Interest Rate(%) ce ValuePrice at Inception Price at Inception Default risk – the risk that the borrower will not pay the face value of a bond on the maturity date. Either… 1. The borrower pays maturity value of the bond to the lender OR 2. The borrower defaults on the loan (lender gets $0 back).  Stocks – ownership share in the firm.  Treasury securities – the bonds sold by the U.S. government to pay for the national debt.  Home mortgage loans – a contract that states the willingness to repay the loan over several years.  Securitization – the creation of a new security as a combination of other securities and loan agreements. More on Bonds Definitions: 1. $ is the dollar price (D) 2. Date 1 is the maturity date D x (1 + i) 3. $(1 + i) is the face value (F) Remarks: 1. F is fixed. 2. Given #1, when D increases, i decreases and vice versa. 3. The lender aims to decrease D and increase i (i is the reward). The borrower aims to increase D and decrease i (i is the cost) The case of default: There are two possible states of nature. 1. Consider the {F} / 1 – p state of nature. F The borrower pays the amount agreed (F) and thus, no 1 - p default. 2. Consider the infinite number of states {0, F} / [p, 1 – F p). p The borrower pays an amount lower than agreed (F) O and thus, default. More on Stock Date 0: Stoc LENDER k BORROWE S $$$ RS Date 1: Dividend LENDER BORROWE S RS Or: $$$ LENDER ANOTHER S LENDER Stock Remarks: 1. The transaction on Date 0 is the first sale of the stock. In this case, the stock is traded in the primary market. 2. Lender is part owner, thus voting rights gains dividend 3. The transaction on Date 1 is the second sale of stock In this case, the stock is traded in a secondary market. The value of the stock is not necessarily the same as before (Date 0: issued price, Date 1: market price).


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