Financial Markets Overview Quiz
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Questions and Answers

What is one of the principal economic functions of financial assets?

  • To transfer funds from surplus units to deficit units. (correct)
  • To provide fixed returns on investments indefinitely.
  • To eliminate risk completely in financial transactions.
  • To manufacture tangible assets for investors.

How do financial intermediaries contribute to the financial system?

  • By restricting access to financial markets for deficit units.
  • By issuing more liabilities than assets.
  • By preventing the trading of financial instruments.
  • By transforming final liabilities into different financial assets. (correct)

What are surplus units in financial markets?

  • Entities that can only borrow from the market.
  • Investors who receive more money than they spend. (correct)
  • Participants who spend more than they receive.
  • Financial institutions offering loans without restrictions.

What type of securities do deficit units typically issue?

<p>Debt securities representing borrowed funds. (B)</p> Signup and view all the answers

Which statement best describes financial markets?

<p>They facilitate the redistribution of risk and funds. (B)</p> Signup and view all the answers

What defines deficit units in the financial system?

<p>Participants who spend more than they receive. (B)</p> Signup and view all the answers

Which of the following is NOT a characteristic of financial assets?

<p>They provide definitive ownership of tangible assets. (C)</p> Signup and view all the answers

What primarily dictates tax rates on financial assets?

<p>The issuer, duration asset is held, and owner's nature. (D)</p> Signup and view all the answers

Who are the surplus units that purchase debt securities?

<p>Creditors (A)</p> Signup and view all the answers

What do equity securities represent?

<p>Ownership in the firm (B)</p> Signup and view all the answers

Which function of financial markets refers to determining the price of traded assets?

<p>Price discovery (A)</p> Signup and view all the answers

What do financial markets provide that allows investors to sell financial assets?

<p>Liquidity (C)</p> Signup and view all the answers

What type of costs are classified as search costs in financial transactions?

<p>Time spent finding a buyer or seller (D)</p> Signup and view all the answers

Which of the following is a reason businesses might issue equity securities instead of debt securities?

<p>Equity does not require financial capability for repayments (B)</p> Signup and view all the answers

What is the benefit of liquidity in financial markets?

<p>It allows for quick access to cash when needed (A)</p> Signup and view all the answers

How do financial markets reduce the cost of transacting?

<p>By reducing search and information costs (C)</p> Signup and view all the answers

What is meant by 'self-insuring' in the context of financial markets?

<p>Building up wealth as protection against future losses. (C)</p> Signup and view all the answers

How does the financial system assist in risk sharing?

<p>By enabling transfers of risk exposure to willing parties. (D)</p> Signup and view all the answers

What role does the financial system play in government economic policy?

<p>It manipulates interest rates and credit availability. (B)</p> Signup and view all the answers

What function does the financial system serve regarding price-related information?

<p>It coordinates decentralized economic decisions. (D)</p> Signup and view all the answers

In what way does the transfer function of a financial system operate?

<p>It enables resource transfers across geographic boundaries. (D)</p> Signup and view all the answers

What are financial assets primarily characterized by?

<p>Their intangibility and claims to future cash flows. (A)</p> Signup and view all the answers

What is one function of financial markets in information dissemination?

<p>To help participants form opinions about investments and holdings. (A)</p> Signup and view all the answers

What does the reformatory function of a financial system involve?

<p>Innovating and restructuring financial assets and services. (B)</p> Signup and view all the answers

What does the debt market primarily deal with?

<p>Fixed claims (C)</p> Signup and view all the answers

Which financial market is characterized by the trading of instruments with maturities longer than ten years?

<p>Capital market (A)</p> Signup and view all the answers

What is a key characteristic of equity instruments?

<p>They provide dividends periodically. (C)</p> Signup and view all the answers

How are money market instruments typically described?

<p>Short-term with smaller price fluctuations (B)</p> Signup and view all the answers

What ensures that prices in an efficient market reflect collective information?

<p>Active participation of all market participants (C)</p> Signup and view all the answers

Which of the following describes short-term financial instruments in the money market?

<p>Instruments with maturities less than one year (C)</p> Signup and view all the answers

Which market primarily deals with fixed payment contracts?

<p>Debt market (C)</p> Signup and view all the answers

What is the main purpose of the capital market?

<p>To facilitate long-term financial claims (A)</p> Signup and view all the answers

Which market is described as where new issues of a security are sold to initial buyers?

<p>Primary Market (A)</p> Signup and view all the answers

What role do brokers play in the secondary market?

<p>They match buyers with sellers. (D)</p> Signup and view all the answers

Which of the following would represent a characteristic of an exchange-traded market?

<p>Standardized procedures within a centralized organization (C)</p> Signup and view all the answers

What is a defining feature of the cash or spot market?

<p>Immediate purchase and sale of financial instruments (B)</p> Signup and view all the answers

What do secondary markets primarily increase for the instruments traded?

<p>Liquidity (B)</p> Signup and view all the answers

Which type of market involves delivery at a pre-determined time in the future?

<p>Forward or Futures Market (C)</p> Signup and view all the answers

Who typically underwrites new securities in the primary market?

<p>Investment banks (C)</p> Signup and view all the answers

Which of the following is an example of a secondary market?

<p>National Association of Securities Dealers’ Automated Quotation System (NASDAQ) (C)</p> Signup and view all the answers

What does a deficit budget unit (DBU) indicate about the relationship between current revenue and expenditures?

<p>Current expenditures exceed current revenue. (D)</p> Signup and view all the answers

What action can a surplus budget unit (SBU) take when its current receipts exceed current expenditures?

<p>Build up holdings of financial assets. (A)</p> Signup and view all the answers

If current revenue (R) equals current expenditures (E), which of the following best describes the economic unit?

<p>Balance budget unit. (D)</p> Signup and view all the answers

What does the equation $R - E = \Delta FA - \Delta D$ represent in the financial system?

<p>The relationship between financial assets and debt. (B)</p> Signup and view all the answers

Which group is generally classified as a net lender of funds?

<p>Household sector. (B)</p> Signup and view all the answers

What happens if an economic unit chooses to issue debt or stock?

<p>It reduces its holdings of financial assets. (D)</p> Signup and view all the answers

In what circumstance would a household likely draw money out of its savings account?

<p>To cover current expenditures exceeding revenue. (A)</p> Signup and view all the answers

Which of the following scenarios best describes a net borrower of funds?

<p>Issuing new stock or debt. (D)</p> Signup and view all the answers

Flashcards

Self-Insurance

Individuals and businesses can use financial markets to protect themselves from future losses by building up assets as a safety net.

Risk Reduction

The process of spreading your wealth across various assets to minimize potential losses.

Risk Sharing

Shifting risk from one party to another, like when you buy insurance.

Information Function

Financial markets provide information that helps people make better economic and financial decisions.

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Transfer Function

Financial markets facilitate the movement of resources across different locations.

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Policy Function

Governments use financial markets to influence the economy by adjusting interest rates and credit availability.

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Financial Assets

Financial assets represent claims to future cash flows, creating a valuable exchange medium.

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Reformatory Functions

Continuous development and adaptation of financial instruments and services to meet evolving needs.

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What is the primary function of financial assets?

Financial assets represent claims to future cash flows, facilitating the transfer of funds from those with excess funds to those who need them.

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How do financial assets manage risk?

Financial assets redistribute risk associated with investments by allowing investors to spread their investments across different assets.

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What is the role of financial markets?

Financial markets are platforms where financial assets are bought and sold, facilitating the transfer of funds between surplus and deficit units.

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What is a surplus unit?

Surplus units are participants in financial markets who have more money than they spend, typically investors.

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What is a deficit unit?

Deficit units are participants in financial markets who spend more money than they receive, typically borrowers.

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What are debt securities?

Debt securities represent borrowed funds incurred by an issuer and are typically issued by deficit units to access funds from financial markets.

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What role do financial intermediaries play in financial markets?

Financial intermediaries act as middlemen in financial markets, transforming liabilities issued by borrowers into financial assets preferred by investors.

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How are financial markets classified?

Financial markets are categorized based on the maturity of the financial assets traded, including money markets for short-term assets and capital markets for long-term assets.

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Debt Securities

Debt securities that surplus units purchase, expecting periodic interest payments and principal repayment at maturity.

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Equity Securities

Equity securities represent ownership in a firm, allowing holders to share in profits and losses.

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Price Discovery

The process of buyers and sellers interacting in a financial market to determine the price of an asset.

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Required Return

The required return that investors demand in order to purchase a financial instrument, reflecting the risk and opportunity cost involved.

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Liquidity

The ability of an investor to sell a financial asset quickly and easily at a fair price.

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Search Costs

The costs associated with finding a counterparty to purchase or sell a financial asset, including explicit fees and implicit time spent searching.

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Information Costs

The costs associated with gathering information needed to make informed decisions about financial assets, including research and due diligence.

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Cost Reduction

Financial markets reduce transaction costs by facilitating efficient exchange of goods and services.

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Equity Market

The financial market where claims to share in the net income and assets of a business are traded.

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Money Market

The financial market for short-term debt instruments (generally with maturity less than a year).

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Debt Instruments

Financial claims that represent borrowed funds incurred by an issuer, obligating them to repay the principal and interest.

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Capital Market

The financial market for long-term financial claims, typically with maturities of over one year.

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Efficient Market

Financial markets where prices reflect all available information, making it difficult to consistently earn abnormal returns.

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Market's Role in Reducing Search Costs

The process by which financial markets reduce the cost of finding and assessing investment opportunities.

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Money Market: Short-Term Securities

The financial market where short-term debt instruments are traded, characterized by relatively smaller price fluctuations than long-term securities.

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Primary Market

The market where new securities are initially sold to investors. Think of it as the first public offering of shares or bonds.

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Secondary Market

A financial market for trading already issued securities, like stocks and bonds, between investors. Think: buying and selling used cars, but with financial assets.

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Cash or Spot Market

A market for immediate transactions, where financial instruments are bought and sold at the current price. Think: buying groceries at the store, you pay and take them home right away!

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Forward or Futures Market

A market that involves contracts for future delivery of financial instruments at a pre-agreed price. Think: ordering a product online, it arrives later.

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Exchange Traded Market

A financial market with centralized organization, standardized rules, and a specific physical location or platform. Think: a busy marketplace with booths and traders.

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Over the Counter Market

A decentralized market where financial instruments are traded directly between parties, often with customized procedures. Think: a private negotiation between two individuals.

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Financial Intermediaries in Capital Markets

Financial institutions like pension funds and insurance companies that hold long-term securities due to their stable funding positions. Think: institutions that manage money for the long term.

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Deficit Budget Unit (DBU)

A unit in the financial system where current expenditures exceed current revenue, leading to an increase in debt or a decrease in financial assets.

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Surplus Budget Unit (SBU)

A unit in the financial system where current revenue exceeds current expenditures, resulting in an increase in financial assets or a decrease in debt.

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Balance Budget Unit (BBU)

A unit in the financial system where current revenue equals current expenditures, maintaining a balance between financial assets and debt.

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Net Borrower of Funds

The process by which a deficit budget unit (DBU) obtains funds from the financial system by issuing debt or stock to acquire funds.

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Net Lender of Funds

The process by which a surplus budget unit (SBU) provides funds to the financial system by purchasing financial assets or paying off debt.

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Household Sector

The sector of the economy consisting of all households and individuals that generally act as net lenders of funds to the financial system.

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Business Sector

The sector of the economy comprising businesses that typically act as net borrowers of funds for operations and expansion.

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Government Sector

The sector of the economy representing the government which often acts as a net borrower of funds to finance public services and projects.

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Study Notes

Introduction

  • Financial systems are crucial for economic development, providing essential financial resources for production and improving the standard of living.
  • Efficient allocation of resources is a key function, directing funds to their most profitable use.
  • Financial systems enable the collection and distribution of funds from savers to investors.

Financial System Components

  • The financial system encompasses markets and intermediaries used by households, firms, and governments for financial decisions.
  • Markets for stocks, bonds, and other securities are included, along with intermediaries like banks and insurance companies.
  • It facilitates a smooth, efficient, and effective link between depositors and investors.
  • The financial system is a complex network of interconnected institutions, markets, and transactions.

Roles of Financial System

  • Mobilizing Savings: The system channels savings into productive activities and ventures.
  • Promoting Liquidity: Facilitates the ability of investors to convert financial assets into cash quickly.
  • Payment Function: Provides means for conducting transactions and payments for goods and services.
  • Protection Function (Risk Management): Offers mechanisms for managing various uncertainties and risks, including insurance.
  • Information Function: Provides price and other information to help make financial decisions.
  • Transfer Function: Facilitates the transfer of funds across geographical boundaries.
  • Reformatory function: develops and introduces new assets and practices to cater for growing needs of the market.

Financial Assets

  • Real assets generate goods and services over time. Tangible assets like land, buildings, and machinery are examples of real assets.
  • Financial assets are legal contracts that represent a claim to payments derived from real assets. Examples include stocks, bonds, bank loans.

Financial Markets

  • Types by Financial Claim:
    • Debt market: involves debt instruments (e.g., bonds) with fixed payments.
    • Equity market: involves ownership claims (e.g., stocks) with variable returns.
  • Types by Maturity:
    • Money market: for short-term debt.
    • Capital market: for long-term debt and equity.
  • Types by Organization:
    • Exchange-traded market: centralized trading.
    • Over-the-counter market: decentralized trading.

Financial Institutions & Participants

  • Various entities participate in the financial markets, including households, businesses, governments, and supranational organizations.
  • Participants include individuals, businesses, and governments needing funds and those needing to invest.
  • Intermediaries play a crucial role in transforming liabilities into assets to make available to the public.

Lending and Borrowing

  • Businesses, households, and governments can be borrowers and lenders in the financial system.
  • Financial institutions facilitate these transactions.

Important Concepts in Lending and Borrowing

  • Surplus units: Those with more funds than needed.
  • Deficit units: Those who need more funds than they have available.
  • Identity Equation: demonstrates the relationship between financial inflows and outflows for individuals and businesses. Income minus expenses (current or future) determines funding needs.

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Financial System Overview PDF

Description

Test your knowledge about the functions and characteristics of financial markets and assets. This quiz covers essential topics such as financial intermediaries, surplus and deficit units, equity securities, and market liquidity. Dive into the intricacies of how financial markets operate and their significance in the economy.

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