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What is the primary purpose of capital market securities?
What does liquidity refer to in the context of secondary markets?
Which of the following is a type of capital market security?
What characterizes an active secondary market for a security?
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What does selling securities in a secondary market allow investors to do?
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Which of the following is NOT a capital market security?
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Why are secondary markets important for investors?
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Primary capital markets are distinguished from secondary markets by their focus on what?
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What is the primary function of financial markets regarding surplus units?
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What do deficit units access from financial markets?
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What marks the time when surplus units can redeem debt securities?
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What do surplus units receive periodically from debt securities they purchase?
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Who typically incurs debt by issuing debt securities?
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What is a key characteristic of capital markets?
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How do financial institutions function within financial markets?
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What is represented by debt securities issued by a deficit unit?
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What is the primary benefit of increased financial disclosure in a country?
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What type of institution is primarily responsible for providing credit to deficit units?
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What is one function of depository institutions?
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How does international integration of financial markets benefit governments and corporations?
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Why are financial institutions necessary in addressing market imperfections?
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What is a characteristic of depository institutions in relation to investors?
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What factor contributes to the willingness of investors to participate in financial markets?
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How does the enforcement of securities laws differ among countries?
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What role do commercial banks play in relation to surplus and deficit units?
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How does international financial market integration impact countries?
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What is a key advantage of commercial banks in evaluating creditworthiness?
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What is necessary for a bank to meet regulatory requirements?
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Which is a primary function of the federal funds market?
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How do commercial banks typically gather funds relative to their loan requirements?
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What happens when depository institutions do not exist for surplus and deficit unit transactions?
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What is a characteristic of how banks manage loan diversification?
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What is the role of savings institutions in the financial system?
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Which of the following distinguishes a loan from a debt security?
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What might cause surplus units to refrain from lending their funds to deficit units?
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What is the significance of the federal funds market for savings institutions?
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What type of institution is classified as a credit union?
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Which statement accurately describes commercial banks?
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What is a key feature of the loan agreement provided by savings institutions?
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What might lead to a surplus unit's decision to hold their funds tightly?
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Study Notes
Capital Markets
- Capital markets facilitate the issuance of long-term securities by deficit units such as corporations and governments.
- Capital markets provide a means for investors to invest surplus funds.
- Capital markets allow corporations to obtain new funds.
- Securities traded in capital markets are referred to as capital market securities.
- Examples of capital market securities include bonds, mortgages, and stocks.
Secondary Markets
- Secondary Markets facilitate the trading of existing securities, allowing investors to change their investments by selling their securities and buying different ones.
- Liquidity is a key characteristic of securities traded in secondary markets, meaning that securities can be readily sold without a significant loss of value.
- In active secondary markets, many buyers and sellers of the security are present at any given moment.
Role of Financial Markets
- Financial markets accommodate surplus units who want to invest their funds in debt or equity securities.
- Financial markets act as intermediaries between surplus units and deficit units, channeling funds from surplus to deficit.
- Financial institutions serve as intermediaries in financial markets.
- As shown in Exhibit 1.1, financial institutions also act as investors and channel their own funds to corporations.
Market Imperfections
- Countries with lower financial disclosure tend to have less liquid financial markets because investors are less willing to invest in securities without adequate information about the issuing corporations.
- Financial institutions bridge the gap between investors and deficit units, offering expertise in assessing the creditworthiness of borrowers.
- This ensures that deficit units are able to access funding that may be otherwise difficult due to a lack of information or risk aversion.
Depository Institutions
- Depository institutions accept deposits from surplus units and provide credit to deficit units through loans and the purchase of securities.
- Depository institutions offer deposit accounts that meet the needs of most surplus units in terms of amount and liquidity.
- They repackage deposit funds to offer loans in amounts and maturities desired by deficit units.
- They assume the risk of default on the loans they provide to deficit units.
- Depository institutions have more expertise than individual surplus units in evaluating the creditworthiness of borrowers.
- These institutions use their expertise to diversify their loans among multiple deficit units.
- This diversification helps them absorb defaults better than individual surplus units.
Federal Funds Market
- The federal funds market facilitates the flow of funds between depository institutions, including banks.
- Commercial banks with excess funds can lend to institutions in need of funds for short-term periods (typically 1 to 5 days).
- Commercial banks are subject to regulations aimed at limiting their exposure to the risk of failure.
- These regulations include requirements for minimum levels of capital relative to their size to protect against loan defaults.
Savings Institutions
- Savings institutions, also known as thrift institutions, are a type of depository institution.
- Savings and loan associations (S&Ls) and savings banks are examples of savings institutions.
- Similar to commercial banks, they accept deposits from surplus units and lend these funds to deficit units.
- Savings institutions rely on the federal funds market to lend excess funds or borrow funds short-term.
Credit Unions
- Credit unions are financial cooperatives that are owned and controlled by their members.
- Credit unions offer financial services to members who share a common bond (e.g., employment, geographic location, or membership in a particular organization).
- They often offer more favorable interest rates on loans and savings accounts compared to commercial banks.
- Credit unions are not-for-profit institutions, so any profits are distributed to members.
- Credit unions play a crucial role in delivering financial services to underserved communities and promoting financial inclusion.
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Description
This quiz covers the fundamental concepts of capital markets, including their role in issuing long-term securities and the features of secondary markets that facilitate trading existing securities. Test your understanding of how these markets function and their importance to investors and corporations alike.