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• Financial markets allow for the exchange of funds between financial market participants such as lenders, investors and borrowers.
• Financial systems operate at the national and global levels.
• Financial systems is a combination of people, institutions, businesses, and processes that facilitate financial transactions.
• Secondary markets are markets that sell existing securities such as stocks and bonds to be traded among investors, often local stock markets.
• Investment banks help corporations design securities to attract investors, buy these securities and resell them to savers.
• Treasury bills are money market instruments with a maturity of 91 days to 1 year.
• Financial services corporations are large conglomerates that combine many financial institutions within a single corporation.
• Commercial banks cater to certain financial services such as savings, checking and time deposits.
• Mutual funds accept money from savers then use it to buy securities to reduce risks through diversification.
• Common stock is a capital market instrument issued by private corporations that is risky.
• Preferred stock is a capital market instrument issued by private corporations that is more risky than corporate bonds but less risky than common stock.
• Savings and Loans Associations accept deposits from savers and issue mortgage loans to borrowers.
• Life Insurance Companies pay the beneficiary of an insured person after death in exchange for premiums paid during the lifetime of the insurer.
• Capital markets are markets that sell intermediate and long-term securities such as corporate bonds and stocks.
• A robust formal financial sector facilitates the proper movement of funds from lenders to borrowers.
• Commercial papers are money market instruments issued by private corporations with a maturity of 270 days.
• Corporate bonds are capital market instruments issued by private corporations with a maturity of up to 40 years.
• Money markets are markets that sell short-term, highly liquid debt securities, including treasury bills and commercial papers.
• Primary markets are markets in which corporations raise new capital by issuing new stocks and bonds, often in an initial public offering.
• Interest rates are the cost of money and are affected by production opportunities, time preferences for consumption, risk, and inflation.
• Production opportunities are investment opportunities in cash generating assets such as stocks of publicly-listed blue chip corporations.
• Time preferences for consumption refer to the preferences of consumers for current consumption rather than savings for future consumption.
• Risk is the probability that an investment will provide a low or negative return.
• Inflation is the amount by which prices increase over time.
• Savers and borrowers factor in the level of interest rates in the market before making their decision.
• Quoted Interest Rate = r* + IP + DRP + LP + MRP, where r* is the real-risk free rate of interest, IP is the inflation premium, DRP is the default risk premium, LP is the liquidity premium, and MRP is the maturity risk premium.
• Real risk free rate is the rate of interest that would exist on default-free treasury securities if no inflation were expected.
• Inflation premium is a premium equal to expected inflation that investors add to the risk-free rate of return.
• Default risk premium is the difference between the interest rate of government treasury bonds and corporate bonds of equal maturity and marketability, and reflects the risk that a borrower will not be able to meet scheduled payments of interest and principal.
• Liquidity Premium is a premium added to the equilibrium interest rate on a security if that security cannot be converted to cash on short notice and at close to its “fair market value”.
• Maturity risk premium is the premium that reflects interest rate risk, which is the risk of capital losses to which investors are exposed because of changing interest rates.
• Normal yield curve is when long-term rates are generally above short-term rates.
• Inverted yield curve is when short-term rates are higher than long-term rates.
• Central banks can increase or decrease key interest rates.
• Budget surplus or deficit can affect interest rates as they increase if the government requires more funds.
• International factors such as amount of foreign trade surplus or deficit can affect interest rates.
• Business activity can affect interest rates as they increase if there is additional demand for funds to finance its operations.