Introduction to Financial Systems and Markets

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Questions and Answers

What is a primary characteristic of money markets?

High illiquidity

Long-term tenure

Complex securities

Low default risk (correct)

Which of the following is NOT an instrument typically found in money markets?

Negotiable Certificates of Deposit

Commercial Paper

Banker's Acceptances

Common Stocks (correct)

Who are the major investors in commercial paper?

Pension funds (correct)

Mutual funds

Corporate investors

Retail investors

What usually indicates a higher yield on negotiable certificates of deposit compared to T-bills?

Higher credit risk Signup and view all the answers

What is a potential risk for investors concerning reinvestment rate?

Interest rates may drop, affecting reinvestment returns Signup and view all the answers

Which of the following best describes banker's acceptances?

They are orders to pay that create liabilities for banks. Signup and view all the answers

Which group of entities primarily issues bonds in capital markets?

Primarily corporations and governments Signup and view all the answers

What main factor influences the interest rates of negotiable certificates of deposit?

Issuer's creditworthiness Signup and view all the answers

What was a significant effect of deregulation in the financial sector related to subprime mortgages?

More money available for subprime borrowers Signup and view all the answers

How did the rating agencies classify securitized subprime mortgages?

AAA due to expected stability Signup and view all the answers

What economic condition contributed to the creation of an asset bubble in housing?

Abnormally low interest rates Signup and view all the answers

What is a consequence of lenders suffering from adverse selection and moral hazard?

Increased uncertainty in the economy Signup and view all the answers

What can cause a bank run during a financial crisis?

Significant losses in a bank's portfolio Signup and view all the answers

What impact did the collapse of Lehman Brothers in 2008 have on financial markets?

Exacerbated recession and increased uncertainty Signup and view all the answers

What was one purpose of the Emergency Economic Stabilization Act in 2008?

To stabilize the financial system Signup and view all the answers

What were homeowners more likely to do due to low interest rates and rising housing prices?

Refinance their homes Signup and view all the answers

What is the primary goal of credit assessment in a bank?

To determine if a company can repay its loan Signup and view all the answers

Which of the following is NOT a characteristic of an optimal loan candidate?

High levels of debt Signup and view all the answers

What does the 'moat' refer to in the context of a company's market position?

The competitive advantage protecting profitability Signup and view all the answers

Which of the following factors is NOT considered when determining credit ratings?

Customer satisfaction Signup and view all the answers

What is the role of leverage ratios in debt covenants?

Assess the company's financial risk Signup and view all the answers

What distinguishes default covenants from incurrence tests?

Incurrence tests restrict further borrowing during a breach Signup and view all the answers

What is the implication of a high leverage ratio for a company?

Denotes worse credit quality Signup and view all the answers

What does a credit risk premium signify?

Increased returns demanded by investors for higher risk Signup and view all the answers

Which of the following describes a negative covenant in debt agreements?

Prohibits certain actions that could jeopardize repayment Signup and view all the answers

Which of the following best describes the state of Germany's banks as compared to the global industry?

Less profitable with less pressure on profit maximization Signup and view all the answers

What was a major contributing factor to Deutsche Bank's downfall?

Aggressive competition in the US market Signup and view all the answers

What impact does a company's credit rating have on its debt pricing?

Credit ratings influence the terms and interest rates of debt Signup and view all the answers

Why is it challenging for a company to maintain a credit rating higher than the country it operates in?

Because the country's credit rating significantly influences company ratings Signup and view all the answers

What does EBITDA/Interest measure in a company's finances?

Debt repayment capability Signup and view all the answers

What is a characteristic of secondary market transactions?

Existing owners sell securities to another party. Signup and view all the answers

Which type of offering requires registration with the SEC?

Public Offering Signup and view all the answers

What is the main feature of an underwritten offering?

The underwriter guarantees a specific amount of capital. Signup and view all the answers

What does a 'Red Herring' represent in the context of securities offerings?

Preliminary prospectus without final terms. Signup and view all the answers

Which type of contract is standardized in terms of amounts and delivery dates?

Future contract Signup and view all the answers

What is the role of the Board of Governors in the Federal Reserve System?

Sets the nation's monetary policy. Signup and view all the answers

What was a major outcome of the Emergency Economic Stabilization Act of 2008?

It provided a bailout for the US financial system. Signup and view all the answers

Which is NOT a tool of monetary policy used by the Federal Reserve?

Capital Gains Tax Signup and view all the answers

What term describes an agreement to buy or sell an asset at a future date and price?

Forward contract Signup and view all the answers

What is the 'Too big to fail' problem addressed by the Dodd Frank Act?

Systemic risk posed by larger financial firms. Signup and view all the answers

How does the Federal Reserve directly increase the money supply?

By buying government securities. Signup and view all the answers

Which of the following best defines American Depository Receipts (ADRs)?

Securities that enhance investment in foreign stocks. Signup and view all the answers

What is a characteristic of options in financial derivatives?

They give the right, but not the obligation, to trade an asset. Signup and view all the answers

How does Basel III aim to improve the banking system?

By establishing minimum capital and liquidity requirements. Signup and view all the answers

Which factor significantly lowers the default risk for a loan?

Additional collateral Signup and view all the answers

What does matched-funding loan pricing help banks control?

Interest rate risks Signup and view all the answers

Which of the following is NOT one of the Five Cs of Credit?

Contribution Signup and view all the answers

Which statement about credit scoring is true?

A high score signifies lower borrower risk. Signup and view all the answers

Which service provided by correspondent banking is primarily aimed at small banks?

Check clearing and collection Signup and view all the answers

What is the primary benefit of securitization for banks?

It provides a less expensive funding source. Signup and view all the answers

How is net interest margin calculated?

Gross interest income minus gross interest expense Signup and view all the answers

Which of the following does NOT represent a risk in international lending?

Market interest risk Signup and view all the answers

What is a syndicated loan?

A loan funded by a group of banks to spread risk Signup and view all the answers

What is a characteristic of international loans?

Often funded in the Eurocurrency market Signup and view all the answers

Which regulatory act allowed US banks to establish international banking facilities?

DIMCA of 1980 Signup and view all the answers

What does the term 'off balance sheet banking' refer to?

Loan commitments and contingent liabilities Signup and view all the answers

In terms of customer profitability, which group contributes the most to bank earnings?

A customers Signup and view all the answers

What significant change occurred due to the Federal Reserve Act of 1913?

National banks could branch outside the US Signup and view all the answers

What happens to the value of a bond when interest rates rise?

The value of the bond decreases. Signup and view all the answers

Under what condition would an investor be indifferent between a short-term bond and a long-term bond?

When spot rate is equal to forward rate. Signup and view all the answers

Which theory suggests that long-term bonds are more risky and therefore must offer a premium?

Liquidity preference theory Signup and view all the answers

What is the primary assumption of expectations theory regarding investor behavior?

Investors are risk neutral. Signup and view all the answers

How does the duration of a bond relate to its interest rate risk?

Longer duration bonds have greater price volatility. Signup and view all the answers

What defines a zero coupon bond in relation to its duration?

Duration equals its maturity. Signup and view all the answers

Which statement best describes the relationship between bond prices and yields?

Bond prices move inversely to changes in yields. Signup and view all the answers

What does the term 'current yield' measure?

The annual income from a bond as a percentage of its price. Signup and view all the answers

What is one consequence of a rising yield curve?

It generally signals expectations of higher future interest rates. Signup and view all the answers

What does Macaulay's duration formula help to determine?

The weighted average time until all cash flows are paid. Signup and view all the answers

What does the liquidity preference theory suggest about the forward rate?

It includes a liquidity premium over expected short-term rates. Signup and view all the answers

Which of the following best describes the market segmentation theory?

There are distinct markets for different maturities of securities. Signup and view all the answers

How do bond portfolios maintain their target duration under interest rate changes?

They are rebalanced periodically to maintain target durations. Signup and view all the answers

What is the impact of holding period return on bond investments?

It reflects total returns including price changes and reinvestment of coupons. Signup and view all the answers

Study Notes

Course Introduction

Financial System: Transfers funds efficiently
Two types of financing:
- Indirect: Savers → intermediaries → borrowers
- Direct: Savers → borrowers
Financial intermediaries:
- Banks
- Insurance companies
- Pension funds
- Mutual funds
Buy side vs. sell side institutions:
- Buy side: Asset management (e.g., asset managers, pension funds, hedge funds, private equity)
- Sell side: Service providers (e.g., banks, insurance companies)
Largest financial institutions by size:
- Asset managers (BlackRock, Vanguard, Fidelity)
- Banks (in China primarily)
- Insurance companies (in Japan and China primarily)
- Pension funds (in Japan, Norway and South Korea primarily)
- Small: Hedge funds

Major Financial Markets

Money markets: Short-term, standardized securities, low default risk
Instruments: Commercial paper, negotiable certificates of deposit, banker's acceptances
Bond markets: Debt-based capital market
Major issuers/investors: corporations and governments / households and financial intermediaries
Investor considerations: long term, safety, tax considerations, reinvestment risk, interest rate movements
Bond indenture: collateral (mortgages, equipment, collateral bonds, debentures), provisions (sinking fund, call provision)
Types of bonds based on classification (collateral, debentures)

Security Sales

Underwritten: Firm commitment, Underwriter buys securities from company and resells at a higher price
Negotiated: Issuer negotiates better terms with investment banks
Public offering: Prospectus, Red Herring
Private placement: Sale to limited sophisticated buyers

Equity Markets

US has the largest equity market but the most listed companies are in Asia
Types of investors: Corporate, public, strategic and institutional

Studying That Suits You

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Description

Explore the essentials of financial systems, including funding transfers and the roles of various financial intermediaries. This quiz covers key concepts in money and bond markets, as well as insights into buy side and sell side institutions. Test your knowledge on the largest financial institutions and the major financial markets.