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Fin 308 Test 1 - Notes for Finance 308 Test 1 Chapter 1...

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Notes for Finance 308 Test 1 Chapter 1: introduction Why Study Financial markets? They help effectively allocate capital to the best possible risk versus return (allocational efficiency) They facilitate the transfer of funds from SSUs to DSUs keeping transactional costs at a minimum (operating efficiency) They help provide for efficient informational flow through the economy (informational efficiency) Overview of Financial Markets: Primary vs. Secondary Primary markets (new issues) o Markets in which users of funds (corporations, governments) raise funds by issuing financial instruments (stocks, bonds) o Raises cash to fund positive NPV projects Public offerings IPOs-spinning and laddering Seasonal offerings-firm has issued securities in past Secondary Market (previously issued) o Markets where financial instruments are traded among investors (NYSE, NASDAQ) o Provide liquidity and pricing info o Preferred to investors Efficiency of the operation of secondary mkt effects growth rate on overall economy through their effect on the primary markets Overview of Financial Markets: Money vs. Capital Money markets - short term, high denomination, safe, little risk of principle loss o Markets that grade debt securities with maturity of one year or less (CDs, US treasury bills) Capital Markets -long term, riskier, pay higher rate of return o Markets with trade debt (bonds) and equity (stock) instruments with maturities of more than one year Commercial paper –decline in 2000 and 2004 due to credit concerns about credit quality of corporate issuers Overview of Financial Markets: Foreign Exchange Markets FX markets deal in trading one currency for another (dollar for yen) Spot FX transaction involves the immediate exchange of currencies at the current exchange rate
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Forward FX transaction involves the exchange of currencies at a specified date in the future and at a specified exchange rate Historically: o When nations current acct deficit surpasses 5% of GDP a correction occurs in currency value o What has kept dollar strong despite deficit? Foreign and central banks (germany, japan) have purchased dollars to keep their currency’s down in value to foster their export sector Overview of Financial Market: derivative Security markets Markets in which derivative securities trade. Derivative securities derive their value form some underlying asset or market condition Transfer of risk among mkt participats o Futures and forwards o Options o Swaps o Hedgers versus speculators Speculator-bet on price movements Hedgers-reduce exposure in underlying cash/spot market o Exchange traded vs. Over the Counter Derivatives ET-liquid OTC-custom, between two counterparties (counter party risk) Overview of Financial Institutions Institutions that perform the essential functions of channeling funds from those with surplus funds to those with shortages of funds (banks, thrifts, insurance companies, securities firms and investment banks, finance
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