Money & Banking study guide

Widely traded more liquid have smaller fluctuations

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widely traded; more liquid; have smaller fluctuations in prices (aka, safer investments) - US Treasury Bills : ST debt instruments; most liquid; most actively traded; safest o No possibility of default : situation in which the party issuing the debt instrument can’t make interest payments or pay off the amount owned when the instrument matures o Done b/c fed gov’t can raise taxes or issue Currency : paper money or coins - Certificate of Deposit (CD) : debt instrument sold by a bank to depositors that pays annual interest of a given amount and at maturity pays back the original purchase price; sold in secondary markets - Commercial Paper : ST debt instrument issued by large banks and well-known corps - Repurchase Agreements (repos) : ST loans (maturity = 2 weeks-) for which Treasury bills serve as collateral (an asset the lender receives if the borrower doesn’t pay back the loan) - Fed Funds : overnight loans b/t banks of their deposits at the Fed Reserve; banks to other banks; sensitive to credit needs of banks o Federal funds rate : closely watched barometer of tightness of credit market conditions in the banking system and the stance of monetary policy Capital market : market in which LT debt and equity instruments are traded; maturities = 1+ year; wider price fluctuations and are fairly risky investments - Stocks : equity claims on the net income and assets of a corporation - Mortgages and Mortgage-Backed Securities o Mortgages : loans to HH or firms to purchase land, housing or other real structures; mortgage market is the largest debt market in the US o Mortgage-backed securities : bond-like debt instrument backed by a bundle of individual mortgages, whose interest and principal payments are collectively paid to the holders of the security Fannie Mae, Ginnie Mae, Freddie Mac – provide funds to the mortgage market by selling bonds and using these proceeds to buy mortgages - Corporate Bonds (convertible bonds): LT bonds issued by corps w/ strong credit ratings allowing the holder to convert them into a specified number of shares of stock at any time until maturity date; not very liquid; market size is smaller - US Gov’t Securities : most widely-traded bonds; most liquid security; held by Fed reserve, banks, HH, foreigners
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- US Gov’t Agency Securities : LT bonds issued by various gov’t agencies; function like US gov’t bonds - State & Local Gov’t Bonds (municipal bonds): LT debt instruments issued by state and local gov’ts to finance expenditures on schools, roads, and other programs; their interest payments are exempt from fed income tax & generally from state taxes in the issuing state (commercial banks are biggest buyers of this security, then wealthy individuals, insurance companies) - Consumer & Bank Commercial Loans : loans to consumers and businesses are made principally by banks but also by finance companies Foreign bonds : traditional instruments in the international bond market; sold in foreign country & are denominated in the country’s currency Eurobond
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