Financial Markets Theory

• What is an investment?

  Current commitment of resources for future benefits
• What do real assets determine?

  Productive capacity and net income of the economy
• What are financial assets?

  Claims on real assets like equity and bonds
• What is a portfolio?

  A collection of assets
• What is money?

  Generally accepted in payment for goods
• What are the functions of money?

  Medium of exchange, unit of account, store of value
• What is the medium of exchange?

  Standardized, widely accepted, divisible
• What is the unit of account?

  Used to measure value
• What is the store of value?

  Used to save purchasing power
• What are the forms of money evolution?

  Commodity money, fiat money, cheques, electronic payment
• What do financial markets do?

  Bring together surplus and shortage of funds
• Who are the lenders in financial markets?

  Households and some institutions
• Who are the borrowers in financial markets?

  Government, firms, individuals
• What are the direct responsibilities of governments?

  Fiscal policy and national debt management
• What are devolved responsibilities of governments?

  Monetary policy and cash management
• What is one role of financial markets?

  Reduction in transaction costs
• How do financial markets allocate risk?

  Investors select securities based on risk preferences
• What is corporate governance?

  System of rules and practices for firms
• What is the Sarbanes-Oxley Act?

  Tightens rules of corporate governance
• What do financial intermediaries do?

  Bring lenders and borrowers together
• What is asset transformation?

  Changing maturity, risk, and size of assets
• What is the money market?

  Short-term, low-risk, highly liquid debt securities
• What are capital markets?

  Long-term debt and equity markets
• What are primary markets used for?

  Issuing new stocks and bonds to the public
• What are secondary markets?

  Where previously issued securities are traded
• What are characteristics of secondary markets?

  Broad, deep, liquid, efficient
• What do brokers do?

  Take orders from investors and charge commissions
• What do dealers do?

  Post bid-ask quotes and trade assets
• What are market-makers?

  Obliged to trade in registered securities
• What is asset allocation?

  Choice among broad asset classes
• What is security selection?

  Choice of which securities to hold within asset class
• What are the three types of financial assets?

  Fixed income, common stock, derivative securities
• What is fixed income?

  Payments fixed or determined by a formula
• What is common stock?

  Equity or ownership in a corporation
• What are derivatives?

  Value derives from prices of other securities
• What are the types of markets for trading securities?

  Direct search, brokered, dealer, auction markets
• What is the bid price?

  Price bid to buy the security
• What is the ask price?

  Price asked for by the participant to sell
• What is the touch price?

  Difference between bid and ask spread
• What are determinants of the bid-ask spread?

  Information asymmetry, volatility, liquidity, competition