Podcast
Questions and Answers
What was the trend in derivative activity from 1992 to 2013?
What was the trend in derivative activity from 1992 to 2013?
What was the primary cause of the drop in derivative activity from 2013 to 2019?
What was the primary cause of the drop in derivative activity from 2013 to 2019?
Which agency is responsible for regulating financial instruments like derivatives?
Which agency is responsible for regulating financial instruments like derivatives?
What is the main claim of the Capital Market Authority (CMA) regarding securities issues?
What is the main claim of the Capital Market Authority (CMA) regarding securities issues?
Signup and view all the answers
What characteristic of derivative markets is highlighted in the content?
What characteristic of derivative markets is highlighted in the content?
Signup and view all the answers
What happens to the demand for loanable funds when the utility derived from an asset purchased with borrowed funds increases?
What happens to the demand for loanable funds when the utility derived from an asset purchased with borrowed funds increases?
Signup and view all the answers
Which of the following would likely shift the demand curve for loanable funds?
Which of the following would likely shift the demand curve for loanable funds?
Signup and view all the answers
How does an increase in nonprice conditions affect the demand for loanable funds?
How does an increase in nonprice conditions affect the demand for loanable funds?
Signup and view all the answers
What is the relationship between economic conditions and the demand for loanable funds?
What is the relationship between economic conditions and the demand for loanable funds?
Signup and view all the answers
What is the impact of the interest rate on the demand for loanable funds as per its relationship described?
What is the impact of the interest rate on the demand for loanable funds as per its relationship described?
Signup and view all the answers
What was a significant event that occurred on September 15, 2008?
What was a significant event that occurred on September 15, 2008?
Signup and view all the answers
How much in losses related to subprime mortgage-backed securities was reported in the last half of 2007?
How much in losses related to subprime mortgage-backed securities was reported in the last half of 2007?
Signup and view all the answers
What contributed to the crisis starting around late 2006 and early 2007?
What contributed to the crisis starting around late 2006 and early 2007?
Signup and view all the answers
What was the total amount of losses that reached over $400 billion worldwide through 2007?
What was the total amount of losses that reached over $400 billion worldwide through 2007?
Signup and view all the answers
What effect did subprime mortgage defaults have on financial institutions (FIs)?
What effect did subprime mortgage defaults have on financial institutions (FIs)?
Signup and view all the answers
What economic sector was primarily affected by the defaults of subprime mortgage borrowers?
What economic sector was primarily affected by the defaults of subprime mortgage borrowers?
Signup and view all the answers
What was the general trend for home prices in late 2006 and early 2007?
What was the general trend for home prices in late 2006 and early 2007?
Signup and view all the answers
Which event indicated the ongoing financial crisis related to subprime mortgages in September 2008?
Which event indicated the ongoing financial crisis related to subprime mortgages in September 2008?
Signup and view all the answers
What role do financial institutions play in managing the risk of mismatching maturities?
What role do financial institutions play in managing the risk of mismatching maturities?
Signup and view all the answers
What was the purpose of increasing the deposit cap to $250,000 per person per bank in 2008?
What was the purpose of increasing the deposit cap to $250,000 per person per bank in 2008?
Signup and view all the answers
Which of the following best describes fintech?
Which of the following best describes fintech?
Signup and view all the answers
How do financial institutions contribute to credit allocation in the economy?
How do financial institutions contribute to credit allocation in the economy?
Signup and view all the answers
What is a significant benefit of the liquidity offered by financial institutions to household savers?
What is a significant benefit of the liquidity offered by financial institutions to household savers?
Signup and view all the answers
What is a potential consequence of failures of financial institutions?
What is a potential consequence of failures of financial institutions?
Signup and view all the answers
Which of the following services provided by financial institutions directly benefits the economy?
Which of the following services provided by financial institutions directly benefits the economy?
Signup and view all the answers
How do economies of scale manifest in financial institutions?
How do economies of scale manifest in financial institutions?
Signup and view all the answers
What is the relationship between domestic economic conditions and the demand for funds?
What is the relationship between domestic economic conditions and the demand for funds?
Signup and view all the answers
How does an increase in risk of financial security affect the supply of loanable funds?
How does an increase in risk of financial security affect the supply of loanable funds?
Signup and view all the answers
Which of the following is a common index used to measure inflation?
Which of the following is a common index used to measure inflation?
Signup and view all the answers
What happens to interest rates when inflation levels rise?
What happens to interest rates when inflation levels rise?
Signup and view all the answers
What impact does near-term spending need have on the supply of loanable funds?
What impact does near-term spending need have on the supply of loanable funds?
Signup and view all the answers
What is the effect of monetary expansion on the supply of loanable funds?
What is the effect of monetary expansion on the supply of loanable funds?
Signup and view all the answers
What does default risk refer to in the context of interest rates?
What does default risk refer to in the context of interest rates?
Signup and view all the answers
What happens to the supply of loanable funds when economic conditions in a domestic country improve?
What happens to the supply of loanable funds when economic conditions in a domestic country improve?
Signup and view all the answers
If the default risk associated with a security increases, what is expected to happen to interest rates?
If the default risk associated with a security increases, what is expected to happen to interest rates?
Signup and view all the answers
How does a restriction in monetary policy affect the supply of loanable funds?
How does a restriction in monetary policy affect the supply of loanable funds?
Signup and view all the answers
What role do the Consumer Price Index (CPI) and Producer Price Index (PPI) serve in economic analysis?
What role do the Consumer Price Index (CPI) and Producer Price Index (PPI) serve in economic analysis?
Signup and view all the answers
Which statement is true regarding liquidity risk in the context of securities?
Which statement is true regarding liquidity risk in the context of securities?
Signup and view all the answers
How is equilibrium interest rate affected by an increase in the supply of loanable funds?
How is equilibrium interest rate affected by an increase in the supply of loanable funds?
Signup and view all the answers
What is the relationship between supply of loanable funds and economic conditions in a foreign country?
What is the relationship between supply of loanable funds and economic conditions in a foreign country?
Signup and view all the answers
Which of the following factors does NOT directly influence interest rates for securities?
Which of the following factors does NOT directly influence interest rates for securities?
Signup and view all the answers
What happens to the equilibrium interest rate when the supply of loanable funds decreases?
What happens to the equilibrium interest rate when the supply of loanable funds decreases?
Signup and view all the answers
Caa is the highest rating given by Moody's for bonds in poor standing.
Caa is the highest rating given by Moody's for bonds in poor standing.
Signup and view all the answers
The rating 'D' indicates a payment default for bonds according to Moody's and S&P.
The rating 'D' indicates a payment default for bonds according to Moody's and S&P.
Signup and view all the answers
Bond market indexes reflect only the monthly capital gain or loss on bonds, excluding interest income.
Bond market indexes reflect only the monthly capital gain or loss on bonds, excluding interest income.
Signup and view all the answers
A rating of 'CC' from S&P signifies the highest quality with good prospects for investment.
A rating of 'CC' from S&P signifies the highest quality with good prospects for investment.
Signup and view all the answers
Indexes managed by major investment banks can help bond traders evaluate the attractiveness of bonds.
Indexes managed by major investment banks can help bond traders evaluate the attractiveness of bonds.
Signup and view all the answers
The lowest bond quality is represented by the rating 'C'.
The lowest bond quality is represented by the rating 'C'.
Signup and view all the answers
The term 'Ca' indicates the lowest quality of bonds, also indicating payment default.
The term 'Ca' indicates the lowest quality of bonds, also indicating payment default.
Signup and view all the answers
Fitch Ratings also uses letter grades such as 'CCC' to indicate the quality of bonds.
Fitch Ratings also uses letter grades such as 'CCC' to indicate the quality of bonds.
Signup and view all the answers
Bonds rated below Baa by Moody’s are often considered investment grade.
Bonds rated below Baa by Moody’s are often considered investment grade.
Signup and view all the answers
The highest credit quality assigned by rating agencies is a triple-B rating.
The highest credit quality assigned by rating agencies is a triple-B rating.
Signup and view all the answers
Bonds rated B1 by Moody's are classified as speculative, but may provide some assurance of principal payments.
Bonds rated B1 by Moody's are classified as speculative, but may provide some assurance of principal payments.
Signup and view all the answers
The classification 'medium grade' includes bonds rated Baa2 and BBB.
The classification 'medium grade' includes bonds rated Baa2 and BBB.
Signup and view all the answers
High-yield bonds are also known as investment grade bonds.
High-yield bonds are also known as investment grade bonds.
Signup and view all the answers
Primary markets are where corporations raise funds through existing financial instruments.
Primary markets are where corporations raise funds through existing financial instruments.
Signup and view all the answers
A bond rated Ba3 by Moody’s corresponds to a BB− rating by S&P.
A bond rated Ba3 by Moody’s corresponds to a BB− rating by S&P.
Signup and view all the answers
Secondary markets provide liquidity and low transaction costs for traded financial instruments.
Secondary markets provide liquidity and low transaction costs for traded financial instruments.
Signup and view all the answers
An initial public offering (IPO) is an example of a transaction occurring in the secondary market.
An initial public offering (IPO) is an example of a transaction occurring in the secondary market.
Signup and view all the answers
Bonds rated A1 are considered to have a very low risk of issuer default.
Bonds rated A1 are considered to have a very low risk of issuer default.
Signup and view all the answers
Bonds rated below Baa2 are not considered speculative investments.
Bonds rated below Baa2 are not considered speculative investments.
Signup and view all the answers
Money markets involve the trading of long-term debt securities with maturities exceeding one year.
Money markets involve the trading of long-term debt securities with maturities exceeding one year.
Signup and view all the answers
The financial crisis had a significant negative impact on firms' primary market sales.
The financial crisis had a significant negative impact on firms' primary market sales.
Signup and view all the answers
Capital markets primarily deal with trading short-term debt instruments.
Capital markets primarily deal with trading short-term debt instruments.
Signup and view all the answers
Secondary markets facilitate the transfer of funds for newly issued financial instruments.
Secondary markets facilitate the transfer of funds for newly issued financial instruments.
Signup and view all the answers
Short-term debt securities are typically traded in capital markets.
Short-term debt securities are typically traded in capital markets.
Signup and view all the answers
Finance companies primarily focus on accepting deposits from individuals.
Finance companies primarily focus on accepting deposits from individuals.
Signup and view all the answers
Pension fund investments are subject to taxation upon accumulation.
Pension fund investments are subject to taxation upon accumulation.
Signup and view all the answers
Insurance companies only provide life insurance to protect against adverse events.
Insurance companies only provide life insurance to protect against adverse events.
Signup and view all the answers
Thrifts are a type of depository institution that primarily focuses on real estate and consumer loans.
Thrifts are a type of depository institution that primarily focuses on real estate and consumer loans.
Signup and view all the answers
FinTechs utilize traditional banking methods to offer financial services.
FinTechs utilize traditional banking methods to offer financial services.
Signup and view all the answers
Investment funds pool financial resources to create diversified portfolios of assets.
Investment funds pool financial resources to create diversified portfolios of assets.
Signup and view all the answers
Consumer loans are not included in the types of loans offered by financial institutions.
Consumer loans are not included in the types of loans offered by financial institutions.
Signup and view all the answers
Depository institutions include thrifts and commercial banks but not finance companies.
Depository institutions include thrifts and commercial banks but not finance companies.
Signup and view all the answers
The loanable funds theory suggests that interest rates decrease as the quantity of loanable funds supplied increases.
The loanable funds theory suggests that interest rates decrease as the quantity of loanable funds supplied increases.
Signup and view all the answers
Governments and foreign investors do not contribute to the supply of loanable funds in financial markets.
Governments and foreign investors do not contribute to the supply of loanable funds in financial markets.
Signup and view all the answers
Changes in interest rates can affect the performance of individuals and businesses.
Changes in interest rates can affect the performance of individuals and businesses.
Signup and view all the answers
According to the loanable funds theory, the supply of loanable funds only comes from the household sector.
According to the loanable funds theory, the supply of loanable funds only comes from the household sector.
Signup and view all the answers
The equilibrium interest rate in financial markets is achieved through the balance of loanable funds supply and demand.
The equilibrium interest rate in financial markets is achieved through the balance of loanable funds supply and demand.
Signup and view all the answers
Interest rates do not fluctuate over time and remain constant.
Interest rates do not fluctuate over time and remain constant.
Signup and view all the answers
The quantity of loanable funds supplied is influenced by the reward offered by interest rates.
The quantity of loanable funds supplied is influenced by the reward offered by interest rates.
Signup and view all the answers
The loanable funds theory does not take into account the demand for money in the economy.
The loanable funds theory does not take into account the demand for money in the economy.
Signup and view all the answers
Common stock is a type of liability security that guarantees dividends.
Common stock is a type of liability security that guarantees dividends.
Signup and view all the answers
Preferred stockholders have a higher claim on assets than common stockholders.
Preferred stockholders have a higher claim on assets than common stockholders.
Signup and view all the answers
Secondary stock markets are the least reported financial security markets.
Secondary stock markets are the least reported financial security markets.
Signup and view all the answers
All public corporations issue both common and preferred stock.
All public corporations issue both common and preferred stock.
Signup and view all the answers
One characteristic of common stock is limited liability for shareholders.
One characteristic of common stock is limited liability for shareholders.
Signup and view all the answers
Voting rights are a feature exclusive to preferred stockholders.
Voting rights are a feature exclusive to preferred stockholders.
Signup and view all the answers
Corporate stocks may be among the least held financial securities.
Corporate stocks may be among the least held financial securities.
Signup and view all the answers
The movements in stock markets are often viewed as indicators of economic conditions.
The movements in stock markets are often viewed as indicators of economic conditions.
Signup and view all the answers
Study Notes
Learning Goals
- Differentiate primary and secondary markets
- Differentiate money and capital markets
- Understand foreign exchange markets
- Understand derivative security markets
- Identify different types of financial institutions
- Know the services financial institutions provide
- Understand the risks financial institutions face
- Understand why financial institutions are regulated
Why Study Financial Markets?
- Markets and institutions play a key role in allocating capital
- Understanding how money flows through the economy is important for both managers and individual investors
- Managers and individuals need to understand domestic and international financial markets
Financial Markets
- Structures through which funds flow
- Can be primary and secondary markets, or money and capital markets
Primary versus Secondary Markets
- Primary markets: Corporations raise funds through new issues of financial instruments like stocks and bonds (e.g., IPOs)
- Secondary markets: Existing financial instruments are traded after initial issuance; offer liquidity, pricing information, and lower transaction costs
Primary and Secondary Market Transfer of Funds Timeline
- Funds flow from users of funds (corporations issuing debt/equity) through underwriting by investment banks to initial suppliers of funds (investors) in primary markets
- In secondary markets, economic agents (investors) wanting to buy or sell securities exchange funds
How were primary markets affected by the financial crisis?
- Primary market sales significantly declined in 2008 (to $1,068 billion from $2,389 billion in 2007), but sales still have not fully recovered to pre-crisis levels by 2018.
Money versus Capital Markets
- Money markets: Short-term debt securities and instruments with maturities of one year or less are traded (lower risk, less price fluctuations)
- Capital markets: Trade debt (bonds) and equity (stocks) instruments with maturities greater than one year (higher price fluctuations)
Foreign Exchange Markets
- Global market for exchanging currencies of different countries
- Foreign exchange risk refers to the sensitivity of foreign investment cash flows to changes in the foreign currency's value.
Derivative Security Markets
- A derivative security is a financial security whose payoff is related to another existing security in money, capital, or foreign exchange markets.
- Examples include futures, options, swaps, or mortgage-backed securities
- Often involve an agreement between parties to exchange an asset or cash flow at a later date, and at a pre-stated price
Derivative Security Markets (additional info from table)
- Derivative activity saw significant growth between 1992 and 2013.
- 2014 Volcker Rule led to a drop in activity
- There are a variety of derivative contracts including futures and forwards, swaps, options, and credit derivatives. Amounts held by commercial banks fluctuated greatly over time in the 1992-2019 timeframe as shown in Table 1-4
Financial Market Regulation
- Agencies like the Capital Market Authority (CMA) regulate financial instruments
- The CMA's main function is to ensure that information on security issues is fully and fairly disclosed to investors
- The CMA monitors trading on exchanges to prevent insider trading
Overview of Financial Institutions
- Financial institutions transfer funds from surplus to deficit entities.
- Types include: commercial banks, thrifts, insurance companies, securities firms, finance companies, and investment funds
- Commercial banks provide a range of loans and accept various deposits
- Thrifts offer loans (similar to banks) but often specialize in real estate or consumer areas
- Insurance companies protect individuals and corporations from adverse events (e.g., life and property/casualty)
- Securities firms and investment banks help corporations issue securities and provide brokerage/trading services
- Finance companies provide loans (with no deposits needed)
- Investment funds pool funds and invest in diversified portfolios
Types of Financial Institutions (continued)
- Pension funds: Offer savings plans for retirement
- Fintechs: Institutions using tech for financial services
Risks Incurred by Financial Institutions
- Default risk: Risk assets are not repaid (loans, stocks, bonds)
- Foreign exchange risk: Risk arising from exchange rate changes
- Interest rate risk: Risk from mismatched asset/liability maturities
- Market/asset price risk: For institutions active in asset trading
- Off-balance-sheet risk: Risk from contingent assets/liabilities
- Liquidity risk: Risk of liability withdrawal or inability to meet demand for liquidity
- Technology/operational risk: Risk from tech failures in services
- Insolvency risk: Risk of insufficient capital to cover losses
Benefits and Functions of FIs
- Lower monitoring costs with economies of scale
- Increased liquidity and reduced price risk for claims
- Reduced transaction costs
- Maturity intermediation (matching assets and liabilities)
Regulation of Financial Institutions
- FIs prevent market failures by preventing runs and protecting depositors
- Regulations are designed to prevent widespread panic
Fintech
- Financial technology using tech to deliver financial solutions
- Includes services like crypto/blockchain, peer-to-peer, and mobile payments
- Risks from disrupting traditional financial services
Appendix 1A - The Financial Crisis: The Failure of FIs
- Home prices dropped, causing subprime mortgage defaults
- This impacted the mortgage industry and wider economy
- FIs holding mortgages/mortgage-backed securities suffered significant losses
- Loss of over $400 billion worldwide through 2007
Chapter Two: Determinants of Interest Rates
-
Learning Goals:
- Identify suppliers/demanders of loanable funds
- Understand equilibrium interest rate determination
- Analyze factors shifting supply/demand curves
- Understand interest rate determinants for individual securities
- Understand how interest rates impact present/future values
- Interest Rate Fundamentals: Nominal interest rates (directly impacting security values); affect individual, business, and government decisions. Fls want to understand how interest rates are determined and fluctuate.
Loanable Funds Theory
- The supply and demand for funds explain interest rates.
- Participants (consumers, businesses, gov't, foreigners) are either suppliers or demanders of funds.
Supply of Loanable Funds
- Supplied by net suppliers of funds (households/businesses/governments/foreign investors)
- Quantity of supplied funds increases with increasing interest rates, as the reward for supplying funds is higher.
Demand for Loanable Funds
- Total net demand for funds by fund users.
- Quantity of demanded funds rises as interest rates fall; households (homes, goods), businesses (investment, working capital), governments, and foreign investors are all fund users.
Factors Affecting Supply/Demand
- Various factors (risks, spending needs, economic conditions) cause changes in supply and demand of funds, leading to changes in interest rates.
Determinants of Interest Rates for Individual Securities
- Inflation: Higher inflation leads to higher interest rates, reflecting a higher price level for goods and services (measured by indexes like CPI and PPI)
- Liquidity risk: Risk of not being able to sell a security at a predictable price easily. Highly liquid assets (e.g., stocks, short-term T-Bills) have lower interest rates; less liquid assets (e.g., long-term bonds) have higher interest rate premiums
- Default risk: Risk that security issuer may not make promised interest and principal payments. Higher default risk = higher interest rates (as a premium)
- Special provisions: Convertible bonds (exchangeable for other securities), callable bonds (redeemable by the issuer), and sinking fund provisions (require a certain amount of repayment each year) all affect interest rates.
- Term to maturity: Longer-term securities generally have higher interest rates than short-term ones, which is called the maturity premium.
Time Value of Money
- Current money is more valuable than future money due to the opportunity cost of delaying spending; this time preference is reflected in interest rates.
- Present Value (PV) represents the value of future cash flows in present terms
- Future Value (FV) represents the value of money now into a future time period
Common Shapes for Yield Curves
- Yield curves reflect the relationship between interest rates and term to maturity with several variations possible.
Bond Markets
- Markets for buying and selling bonds
- **Treasury notes/bonds:**Issued by the U.S. Treasury to finance debt; traded in active secondary matkets. T-notes mature in 1-10 years; T-bonds mature in over 10 years
- **Municipal bonds:**Issued by state/local governments; exempt from federal income tax, lowering the required rate of return
- **Corporate bonds:**Issued by corporations. Traded either in exchange markets or over-the-counter(OTC), higher risk compared to U.S. government bonds.
Treasury Inflation Protected Securities (TIPS)
- Adjust their principal value and interest payments based on inflation (CPI) metrics; investors receive a return that keeps pace with inflation.
STRIPS
- Treasury securities with separated coupon payments from principal payment; investors can choose between interest-only or principal-only investments.
- Investors buy principal portion for near-future payment or interest portions for near-term cash-flows
Problem Set
- Future/present value problems involving interest rate calculations and related factors (example provided).
- Problems about investment returns using different interest rate compounding methods (e.g., annually, semiannually, quarterly).
- Example problems about present and future value calculations provided in the document.
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Related Documents
Description
This quiz explores key concepts in financial derivatives and the demand for loanable funds. It covers trends in derivative activity from 1992 to 2019, regulatory agencies, and factors affecting the demand for loans. Test your understanding of the interactions between derivatives and the financial market.
