econ330ch3notes - Chapter 3 Financial instruments stocks,...

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Chapter 3 Financial instruments – stocks, bonds, loans, options, insurances Financial markets – where savers and borrowers come – NYSE Financial institution – firms that provide access to markets to both savers and borrowers are brought together. They act as intermediates and are known as financial intermediaries Types of finance indirect – institution that stands btw lenders and borrowers involving asset transactions – example – banks direct – borrowers and lenders deal directly with each other an example of financial intermediation – a commercial bank issues a savings account to an individual, and uses the proceeds to loan a local farmer funds to purchase a new tractor in this case the bank serves as the “middleman” btw the saver and farmer An example of direct finance – Bowie Bonds Sources of external finance for non financial institution stock issues bonds loans from financial institutions others Financial instruments – is the written legal obligation of one party to transfer something of value, usually money, to another Securities – pieces of papers that give the simple contracts negotiable – can be resold used in both direct and indirect finance Loans – contracts that are more complicated that securities give borrower funds today in return for future payments collateral, covenants, usually no negotiable, used almost exclusively indirect finance Financial instruments used to transfer risk future contracts options insurance Liquidity – the ease with an asset may be converted into money Risk – the possibility that the owner of an asset will be unable to recover the full value of funds originally invested default risk market risk interest rate risk
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yield – the rate of return on an asset, expressed as a percentage per year relationships liquidity and yield relate reversely risk and yield relate positively liquidity and risk relate inversely Classify Financial Instruments -type of claim equity – common stock debt – loans and bonds, and commercial papers Maturity – length of the claim – money market or capital market – equity does not mature Risk – the degree of uncertainty as payment. Equity generally has the highest risk, next is various grades of debt, then unsecured debt such as consumer loans Liquidity – how quickly assets can be converted into medium of exchange (money) demand deposits, followed by saving deposits, treasury securities, CDs have penalties for early withdrawl Expected returns – typically higher for riskier, less liquid and longer maturing assets higher risk equity, followed by junk binds lower risk treasury bills, demand deposits
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This note was uploaded on 10/14/2009 for the course ECON 330 taught by Professor Neri during the Spring '08 term at Maryland.

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econ330ch3notes - Chapter 3 Financial instruments stocks,...

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