Basic Financial Concepts
Terms
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- Financial Markets
- Directly match borrowers and savers
- The key services are provided in the secondary markets
- risk sharing, liquidity, information
- opportunity a mismatch has between income and spending provide
- Trading Opportunity
- Highly Liquid Assets
- Money, Stocks, Treasury Securities
- Long-term maturity
- >10 years
- Equity Funding
- the lender of funds receives an ownership interest and claim to the future profits of the funds' receiver
- Lower Risk Investments
- Money Market Accounts, Certificates of Deposit, Savings Accounts
- Short-term maturity
- < 1 year
- Return
- The level of profit generated by an investment
- Ways to reduce risk
- diversify your holdings, careful selection of borrowers, restrict borower's money use activities, require collateral, advantageously loan structures
- Interest is often called
- the cost of money
- Secondary markets
- Where previously issued claims are sold between investors
- Financial Intermediaries include
- banks, mutual funds, life insurance companies, pension funds
- All Other Things Being Equal
- When looking at a specific variable, all other variables are held constant
- measure of a financial system's efficiency
- ability to transform illiquid assets into liquid assets and financial integration
- Financial Intermediaries (Institutions)
- Indirectly match borrowers and savers (go-betweens)
- Arbitrage
- the trading of equivalent securities to in different markets to obtain a risk-free profit
- Finanicial markets and intermediaries use this to gather information
- economies of scale
- Risk
- The chance that the value of a financial investment will be different than expected.
- Illiquid Assets
- Real Estate, Cars, Artwork
- Derivatives
- assets that derive their value from an underlying security
- Borrowers can raise funds through
- debt or equity sales
- the Key Purpose of the Financial System
- To match savers and borrowers
- Key Services the Financial System Provide
- Risk Sharing, Liquidity, Communication of Information
- RISK-RETURN TRADEOFF
- Investments with higher risk must offer higher than average returns
- Intermediate-term maturity
- 1 yr < maturity ≤ 10 yrs
- Higher Risk Investments
- Stock Market, Junk Bonds, Margin Trading
- Seconday markets
- auctions, over the counter markets ,cash, derivative
- Borrowers and savers are matched in
- primary markets
- Risk sharing with banks
- can diversify loans, invest in securities requiring large minimums, governed by regulation, covered by depository insurance
- Why do we have regulation
- Timely/equal access to accurate information, Maintain financial stability, Advance economic policy objectives