answer the questions

JULIO : Hey Guys, SO the questions highlighted in yellow are the ones that I found answers to. The ones highlighted in red are the ones that I have NO clue about LOL hope this and whatever you share helps

*****Page 33 has the questions and what we believe are correct answers to the midterm that is posted below

Finance 141: The Money and Capital Markets

Midterm Review

The following topics will be covered on this examination:

1. Definitions of all rates/markets we are following in the market monitoring project.

Short term rates

Prime: rate that commercial banks charge their most creditworthy customers (admin rate)

Discount rate: The discount rate is the interest rate charged to commercial banks and other depository institutions for loans received from the Federal Reserve's

Federal Funds: the rate at which banks borrow from other banks on an overnight basis.

`Why is the fed funds rate closely monitor?

Describe the federal funds futures contract: agreement btw two entities to borrow or lend in the fed funds market at a certain point in the future.

What about non-banks?

Question 4: How do institutions utilize federal funds contracts? to hedge against short term interest rate markets

Federal Funds Target discount window. (admin rate)

: (admin rate)à rate target by the FED

3 month-U. S Treasury Bill (risk free rate): (market rate) short-term debt obligation backed by the Treasury (less than 1 year)

3-month Libor à rate that banks borrow and lend US dollar deposits off shore (benchmark for interest swap rates) (market rate) is a benchmark rate that some of the world’s leading banks charge each other for short-term loans.

3-Month Prime (A1/P1) Commercial Paperà short term debt instrument of a corporation (market rate) (unsecured debt) As a result, only firms with high-quality debt ratings will easily find buyers without having to offer a substantial discount (higher cost) for the debt issue

Long Term rates

· 10 Year-U. S Treasury Note: treasury borrow for 10 years debt obligation issued by the United States government with a maturity of 10 years upon initial issuance.

· 10-Year Japanese Government

· 10-Year German Government

· 10-Year Spanish Government

· EMBI Global Index: The emerging markets bond index is a benchmark index for measuring the total return performance of international government bonds issued by emerging market countries that are considered sovereign (issued in something other than local currency) and that meet specific liquidity and structural requirements.

· 30-Year U.S Treasury Bond (long bond) (60 coupon payments)

· U.S Corporates Double-A-Rated: (high quality) corporate bonds

· High Yield 100: Speculative bonds. a high paying bond with a lower credit rating than investment-grade corporate bonds, treasury bonds, and municipal bonds. Since there is a higher risk of default, these bonds pay better. (IDK what else to add - alec)

· Fixed-Rate Mortgage-Backed ???? - can be bought and sold through a broker; rate that is issued by either a federal gov’t agency company, government sponsored enterprise, or private financial company. It is secured by a mortgage or collection of mortgages. (feel free to correct add more or be more specific)

· Muni Master : municipalities

Foreign Exchange Rates

· Y/US $

· US$/British Pound

· US $/ Euro

· Chinese Yuan/ US $

· Brazilian Real/ US $

Commodities

1. Gold (per oz.)

2. Oil (per barrel)

Equity Indexes

1. Dow Jones Industrial Average: The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the Nasdaq.

2. S & P 500: The S&P 500 Index (formerly Standard & Poor's 500 Index) is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value, The index is widely regarded as the best single gauge of large-cap U.S. equities

3. Russell 2000: The Russell 2000 index is an index measuring the performance of approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.

4. NASDAQ Composite: The Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange.

5. Nikkei- Japanese stock exchange / the leading and most-respected index of Japanese stocks. It is a price-weighted index composed of Japan's top 225 blue-chip companies traded on the Tokyo Stock Exchange.=

6. Stoxx Euro 600 - has a fixed number of 600 components representing large, mid, and small cap companies among 17 European countries.

7. San Paulo Bovespa

8. Shanghai Composite -made up of all A-shares and B-shares that trade on the shanghai stock exchange.

Other Benchmarks

VIX Index (CBOE Volatility): Measure of market expectations of future volatility AKA fear index

2. Why are the money and capital markets important? **function of the money and capital markets is the efficient transfer of money

Capital markets Importance: provide an opportunity for the public community/ enables a nation to achieve economic growth/ , only through capital markets long-term funds are raised by the business community./ capital markets are more frequently used for long-term assets, which are those with maturities of greater than one year.

Money Markets: Money markets are used by government and corporate entities as a means for borrowing and lending in the short term, usually for assets being held for up to a year

These markets. allow funds to move from people who lack productive investment opportunities to people who have such opportunities.

These markets are critical for producing an efficient allocation of capital (wealth, either financial or physical, that is employed to produce more wealth), which contributes to higher production and efficiency for the overall economy.

3) Factor that’s characterize the instruments are:

Negotiability: All of the instruments can be buy and sold

Liquidity: how quickly you can turn assets into cash without losing value (time, value, and volume component)

Market-Determined Prices: forces of supply and demand

4. What are the two ways money can be exchanged in the economy?

Money can be exchange indirectly or directly

Indirectly-Financial Intermediation: it involves a financial intermediary that stands between the lender-savers and the borrower-spenders and helps transfer funds from one to the other. Banks take in deposits from lenders and borrows these deposits to borrowers

Direct finance: method of financing where borrowers borrow funds directly from the financial market without using a third-party service,

5. What is the composition of the global money and capital markets? Be prepared to identify and define major market segments (ie. fixed income; equity and derivatives). What are the major differences between fixed income and equity?

Differences between Fixed Income and Equity à main difference is they make profit for investors/ manner in which they traded/ level of risk

Fixed income - Equity

· Fixed income is a market segment that consists of money markets and bonds. This area of investment is one of less risk. So investors will see little return since they are in a low-risk environment. Investors also buy and trade these bonds on the market but they see little return to what was invested. Buying T-Bills are generally regarded as taking on no risk since the gov’t would have to default which is highly unlikely.

· The equity market consists of common stock. Common stock is the purchasing of a share(s) of a publicly traded company to take part ownership. The capital invested is more risky to the investor since there is no guarantee of them making their money back. Stocks are mostly long term investments since the price of a stock fluctuates daily, but for the most part continuously increases over time.

· Derivatives are a broad term for the 5 subcategories that make it up. Forwards, futures, options, interest rate swaps, and credit default swaps all make up the derivative market. Options are a form of a derivative that use puts and calls to trade among the market.

6. Describe the instruments of the money markets, including treasury bills; commercial paper; federal funds; repurchase agreements; certificates of deposit; Eurodollar.

US Treasury Bills: Most widely held and most liquid security/ Treasury bills are sold with 4-, 13-, 26-, and 52-week maturities/ A Treasury Bill (T-Bill) is a short-term debt obligation backed by the Treasury Department of the U.S. government with a maturity of less than one year,

Commercial Paper: (unsecured/debt instrument) Commercial paper securities are unsecured promissory notes, issued by corporations, that mature in no more than 270 days. Because these securities are unsecured, only the largest and most creditworthy corporations issue commercial paper. The interest rates the corporation is charged reflects the firm’s level of risk.

Bankers’ Acceptance: A banker’s acceptance is an order to pay a specified amount of money to the bearer on a given date/ traded at a discount from face value on the secondary market, which can be an advantage because the banker's acceptance does not need to be held until it matures.

Federal funds: Federal funds are short-term funds transferred (loaned or borrowed) between financial institutions, usually for a period of one day/ excess reserves that commercial banks and other financial institutions deposit at regional Federal Reserve banks;

Repurchases agreements: A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. The dealer sells the government securities to investors, usually on an overnight basis, and buys them back the following day. (collateralized)

Certificates of deposit: A certificate of deposit (CD) is a savings certificate with a fixed maturity date, specified fixed interest rate and can be issued in any denomination aside from minimum investment requirements. A CD restricts access to the funds until the maturity date of the investment/ Customers buy CDs to earn interest while keeping their money safe.

Euro Dollar: The term eurodollar refers to U.S. dollar-denominated deposits at foreign banks or at the overseas branches of American banks. By being located outside the United States, eurodollars escape regulation by the Federal Reserve Board, including reserve requirements.

7. What is a bond? What are the important features of a bond? Who are the major issuers of bonds?

Bonds are securities that represent a debt owed by the issuer to the investor. Bonds obligate the issuer to pay a specified amount at a given date, generally with periodic interest payments. / A bond is a fixed income investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate.

Important features of a bond:

Face/par value: Principal portion of the loan/ Amount you get back from the issuer on the day bond matures

Maturity: The maturity is the date at which the bond’s principal comes due and must be repaid to lenders in full. Maturities for corporate bonds are typically in the range of one to five years, with some bonds maturing in 10 or even 30 years

Coupon/Yield: is the rate of interest that the issuer must pay, and this periodic interest payment is often called the coupon payment. This rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates.

** Federal Government (treasury bonds), State governments (munis), and companies are major issuers of bonds (corporate bonds)

8. Why are credit ratings important to the money and capital markets?

Investors use credit ratings (e.g., Aaa or Baa) that reflect the probability of default to determine the creditworthiness of particular debt securities. As a consequence, debt ratings play a major role in the pricing of debt securities and in the regulatory process

Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations. Large bond issuers receive ratings from one or two of the big three rating agencies. In the United States, the agencies are held responsible for losses resulting from inaccurate and false ratings

9. Be prepared to discuss the following from the report, The New Dynamics of Financial Market Globalization: What is financial globalization? What trends are significant in financial globalization in the 2001-2016 period?

Financial globalization is the consolidation or integration of financial markets across the world. The main goal to financial globalization is to connect different nations/institutions to global capital markets promoting growth and stability in the global economy.

Significant Trends

1. Significant trends observed from the years 2007-2016 are: a decline of global cross-border capital flows including a limitation of lending across nations; a decrease of foreign claims by European banks; slight changes on the value of foreign investment relative to the global GDP; and the percentage of equities and bonds owned by foreign investors.

10. What are the functions of the Federal Reserve? How is the Federal Reserve organized; how does it operate and especially how do they control monetary policy? What is meant by the “dual mandate?” and “QE”? How do we follow the Fed in the money and capital markets?

Three traditional functions

1. Conducting Monetary Policy which is to control the supply of money in the banking system to achieve the dual mandate .

3. Providing Payment services to financial institutions : The FED holds cash reserves and processes check and electronic payments for depository institutions.

Functions of the FED:

· Control monetary policy

· Coordination of Monetary Policy with Foreign Central Banks

· Foreign exchange market intervention and coordination with foreign central banks

· Bank regulation and supervision

· Lender of Last resort

· System for check clearance

**** Monetary policy is the fed’s behavior in pursuit of price stability, moderate long interest rates, and maximum employment.

The FOMC sets monetary policy by choosing an interest rate. That cost is important since it is the cost- to a bank- of holding reserves.

How is the Fed Organized?

Board of Governors: consist of 7 members, appointed by the president and confirmed by the senate

Federal Open Market Committee (FOMC) à Fed’s monetary policy making body /made up of the board of governors and the presidents of the reserve banks.

FOMC sets monetary policy by establishing a target for the federal funds rate

Quantitative Easing: Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply

Dual Mandate– the balancing act where the fed tries to promote full employment and economic prosperity while trying to keep low inflation rates.

How do we follow the fed in the money and capital markets? We follow the fed by following the federal funds rate target and the actual rate

11. Why is the New York Federal Reserve considered the most powerful of the district banks?

The New York Fed has its ear to the ground in the finance capital of America. Its seats are the closest to Wall Street, meaning the New York Fed is responsible for sniffing out information that could move markets ahead of other banks./ he New York Fed is the largest in terms of assets of the twelve regional banks. Operating in the financial capital of the U.S., the New York Fed is responsible for conducting open market operations, the buying and selling of outstanding U.S. Treasury securities. / The Federal Reserve Bank of New York is responsible for executing the central bank's monetary policy by reviewing price inflation and economic growth, and by regulating the banks within its territory.

12. The important role of banks as financial intermediaries. What is financial intermediation? What are the benefits of this process? What is spread banking? Why is spread banking inherently risky for a depository institution? What are the two main types of liabilities of a bank? Why are banks so heavily regulated? (I emailed her about these two subquestions so i will write them out when i hear back from Gioia)UPDATED!!!!!!!!!!!!!!!!!!!!!!

It involves a financial intermediary that stands between the lender-savers and the borrower-spenders and helps transfer funds from one to the other. A financial intermediary does this by borrowing funds from the lender-savers and then using these funds to make loans to borrower-spenders. The process of indirect finance whereby financial intermediaries link lender-savers and borrower-spenders/ This process allows fund to be transferred from those who have capital to those who lack capital

Benefits: hedge risk-spread out decrease risk, reduces the costs of lending and borrowing, greater liquidity, ease of borrowing

Spread Banking? In simple terms, the net interest spread is like a profit margin. The greater the spread, the more profitable the financial institution is likely to be; the lower the spread, the less profitable the institution is likely to be.

Balance Sheet of a Bank: Asset = credit ex. Credit cards, line of credit, etc.

Liabilities = Savings Accounts - dont know about the other one

The two main types of liabilities for banks are deposits and borrowed funds(When banks go to the money and capital markets to borrow).

Banks are heavily regulated b/c the regulators want to make sure that banks are healthy and can perform their very important function of financial intermediation; facilitating the transfer of money in the economy.

13. What is securitization? Why is securitization an important theme in the money and capital markets?

is the process of bundling small and otherwise illiquid financial assets (such as residential mortgages, auto loans, and credit card receivables), which have typically been the bread and butter of banking institutions, into marketable capital market securities. Securitization is the fundamental building block of the shadow banking system.

14. How does the Fed administer discount window borrowings? How has this process changed? Why did the Fed make these changes?

How Does the fed administer window borrowings?

How has this process changed?

The fed administers rates to depository institutions by setting the discount rate above the federal funds rate

Old system Discount window: 3 conditions Have to be me

1. they would have to need money or else liquidity crisis

2. no traditional forms of financing is available to them

3. They can’t relend the funds

New system /Discount window

Discount rate was below the federal funds rate

NEW SYSTEM:

1. All banks have access to the discount window Primary credit--> healthy institutions

Secondary credit--> higher rate for unhealthy institutions

Discount rate is above the federal funds rate

Why did the fed make these changes?

The intention was to rely on an above the market discount rate instead of 12 federal reserve banks to ration borrowing at the discount window.

· Federal funds future contract is an interest rate futures contract that is based on the average federal funds rate over a particular calendar month.

· Think of a future contract as specifying that a certain good or asset is to be delivered at some future date at a pre-set price the futures price.

The fed funds future market is not very good at predicting, The rate does not tell us where the market thinks rates will be in the future. Fed fud future rates, on average, overpredict future fed fund rates.

Market partcipants can utilize this market by directly hedging against the fed funds rate to match the borrowing rate with the fed funds futures contract - Mark Accardo

16. What are derivatives? Define the five different types of derivatives. What is a credit default swap? What benefits do derivatives, like the credit default swap, provide the market?

Derivatives are financial instruments that derive their value from some underlined asset

Forwards: A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging. (over the counter product)

Futures: A futures contract is a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future. (standardized also trade in exchange)

Reserve requirmenets

PCEI: P

Options: option to buy or sell an underlying asset at a set price/time. It ahs two values (Intrinsic value and time value) (market price vs strike price)

Call right to buy

Put right to sell at strike price

Interest Rate Swaps: Counterparties exchange interest rates / An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another, over a set period of time. Swaps are derivative contracts and trade over-the-counter.

Credit Default swaps: A credit default swap (CDS) is insurance against default on a financial instrument, usually some kind of securitized bond. Typically, the holder of debt will buy a CDS from an investment or insurance company, such as AIG, to shift the risk of default to a third party. When the probability of default is low, the cost of the CDS is similarly low. By lowering the risk of these insured bonds with default insurance, the market price of the bonds would increase./ a financial contract whereby a buyer of corporate or sovereign debt in the form of bonds attempts to eliminate possible loss arising from default by the issuer of the bonds. This is achieved by the issuer of the bonds insuring the buyer’s potential losses as part of the agreement.

Benefits of Derivatives: Price discovery, risk management (hedge risk), improve market efficiency/ help reduce market transaction costs

17. Discuss the “too big to fail” philosophy. How did “moral hazard” contribute to the financial crisis?

The moral hazard created by a government safety net and the desire to prevent financial institution failures have presented financial regulators with a particular quandary, the too-big-to-fail problem

Which regulators are reluctant to close down large financial institutions and impose losses on the institutions’ depositors and creditors because doing so might precipitate a financial crisis.

Similarly, the too-big-to-fail policy increases the moral hazard incentives for nonbank financial institutions that are extended a government safety net. Knowing that the financial institution will be bailed out, creditors have little incentive to monitor the institution and pull their money out when the institution is taking on excessive risk. As a result, large or interconnected financial institutions are more likely to engage in highly risky activities, making a financial crisis more likely.

18. What is “stretch for yield”? Be prepared to cite examples of this phenomenon in today’s money and capital markets and refer to its effects on the rates and relationships we are following.

Stretch for yield happens in low interest rate environment--bonds, other safer assets

Investors wants to invest in riskier assets in hope of higher/enhancing returns

Demand increases in riskier assets caused prices to increase and rates to decrease

In the market monitoring project, bonds like US and other countries have seen decreases in their prices and the stock markets are continuing to rally.\

Specific rates that have gone up include DJ Corporate, HY100, Fixed-Rate MBS, etc. - all rates have generally gone up with exceptions of 2-3 negative weeks, causing bond prices to drop.

19. What is a “flight to quality”? Be prepared to cite examples of this phenomenon in today’s money and capital markets and refer to its effect on the rates and relationships we are following.

Flight to quality is the action of investors moving their capital away from riskier investments to safer ones

For example, during a bear market, investors will often move their money out of equities and into government securities and investment grade corporate securities. Another example is investors moving investments from high-risk countries with political unrest like Thailand or many thriving yet still not fully established markets like Uganda and Zambia to more stable markets of other countries, like Germany, Australia, and the United States. One indication of a flight to quality is a dramatic fall of the yield on government securities, which is a result of the increased demand for them

Many investors will monitor for a decrease bond yields as a metric for more challenging economic conditions, including increasing rates of unemployment, stagnating economic growth or even a recession. As interest rates increase, bond prices also tend to fall

Slower-than-expected economic growth, corporate scandals, wars, high oil prices, and other factors can convince investors that markets are about to slow or fall.

20. What is the yield curve? Why is it so important to the study of the money and capital markets? What type of yield curve maximizes a bank’s net interest margin?

Yield Curve: A graph that depicts the relationship between bond yields and maturities (is an important tool in fixed-income investing) Investors use the yield curve as a reference point for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. Type of yield curve to maximize net interest margin? Positive yield curve or upward Steeper (The steeper the curve, the bigger the profit because banks lend long term but borrow short term)

21. What are the key trends in the money and capital markets over our base period (9/17-9/18)? Has the market followed these trends this semester? What trends are evident this semester?

Key trends in the mcm’s over our base period:

· Short term and longterm rates increased

· Bond prices went down

· Yield curve flattened

· Stock markets increased

· Volatility increased

Key Trends this semester:

· FED increased administered rates.

· Stock markets have been volatile

· Bond prices and rates have been volatile

· Credit differentials have widened

22. What are credit differentials? Why are they important to the study of the money and capital markets? What has happened to credit differentials over the last year? This semester?

A credit spread is the difference in yield between a U.S. Treasury bond and another debt security with the same maturity but of lesser quality. Credit spreads between U.S.

IF ANYONE CAN ADD ANYTHING HERE (WOULD BE APPRECIATED)

23. What is the term structure of interest rates? How do we study this? What has happened over the last year? This semester?

The term structure of interest rates is the relationship between interest rates and time to maturity . We study this by looking at the yield curve. Over the past year and semester, the yield curve has flattened.

24. What are international interest rate differentials? How do we study this? What has happened over the last year? This semester?

International interest rate diferentials reflect the contrast in interest rates between simmilar rates in different countries . (US treasury compared to other countries in the project). Over the past year they have narrowed, and over the past semester they have widened.

25. What are the key fundamental factors affecting the money and capital markets today? Make sure you can discuss these with reference to the many Wall Street Journal articles distributed this semester.

· Economic announcements

· Fiscal Policy

· Federal Reserve Policy

· Political Announcements

· Supply and Demand.

·

26. What is fiscal policy? How has fiscal policy influenced the markets this semester?

Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy./ Fiscal policy refers to the use of government spending and tax policies to influence macroeconomic conditions, including aggregate demand, employment, inflation and economic growth.

27. What are the important economic indicators that influence market behavior? Be prepared to cite specific economic indicators that have influenced the money and capital markets this semester. And why?

5 Economic Indicators that influence market behavior

· Employment (non-farm payrolls, unemployment rates, hourly earnings, average workweek) Jobless claim Weekly

· Inflation: PCEIàFed’s preferred inflation measure, CPI, PPI, GDP Deflator

· Consumer Confidence: (consumer confidence index / consumer sentiment index/ retail sales/ purchasing managers Index/ industrial production)

· GDP

· Housing: building permits, housing starts, new home sales, existing home sales. Case-schiller price index (measures of home prices)

28. Describe the role of the Federal Reserve in the money and capital markets this semester. How did we follow the Fed this semester?

29. What are the two major investor types in the money and capital markets? Who are the major institutional investors? Who are the major issuers in the money and capital markets? Be prepared to discuss what instruments these issuers use to fund themselves in the money and capital markets.

Two types of investors

Retail (small investors)

Institutional: pension funds, hedge-funds, mutual funds.

Major issuers in the money and capital markets: U.S government, financial institutions, and corporations, municipalities

Instruments they use include corporate/government securities, stocks, and bonds

30. Why is the US Treasury so important to the study of the money and capital markets? When following the markets, what should we follow in terms of the US Treasury’s activities? What is meant by the term “crowding out?”

31. How does a universal bank like Bank of America Merrill Lynch make money?

What are their major business segments? (Bjorneby presentation)

Banks like Bank of America make money through the net interest net margin which is the difference between interest income-interest expense (Aka spread banking) The larger the spread, the higher the interest margin would be

Major Business Sectors: commercial banking, investment bank sales and trading business, manage money and individuals and business out of wealth management sector

Financial Services and Banking at a High Level

There are Two major types of banks

1. Global investment banks

2. Retail and Commercial banks

If a firm does both of those things, you’d refer to them as a Universal Bank

Bank of America – Breakdown

· Global Banking & Markets

· Consumer banking

· Global wealth & investment mgmt. and other

Revenue and income for the company is split relatively evenly amongst those groups

(around 33.3% per division.)

Within the company you can be an Industry banker, brining all of the products to your client

Or you can focus on a particular product.

Some examples include, M&A advice, investment grade and non-investment grade.

32. What is risk as it relates to the money and capital markets? How is risk measured in the money and capital markets? THIS NEEDS MORE RESEARCH - It would help if anyone adds more.

Risk is the uncertainty of return Risk is measured by Beta and Standard Deviation

33. What are the two perspectives on return in the money and capital markets? How are each of these calculated in the bond and equity markets?

34. What is the risk/return tradeoff?

The risk-return tradeoff states that the potential return rises with an increase in risk. Using this principle, individuals associate low levels of uncertainty with low potential returns, and high levels of uncertainty or risk with high potential returns. According to the risk-return tradeoff, invested money can render higher profits only if the investor will accept a higher possibility of losses.

· When risk increases/ return increases

35. What is liquidity as it relates to the money and capital markets?

Another factor that affects the demand for an asset is how quickly it can be converted into cash at low cost—its liquidity. An asset is liquid if the market in which it is traded has depth and breadth, that is, if the market has many buyers and sellers.

The more liquid an asset is relative to alternative assets, holding everything else unchanged, the more desirable it is, and the greater will be the quantity demanded .

Market Liquidity incorporates key elements of volume, time and transaction costs (bid/offer spread). These dimensions equate to the amount of assets that can be sold at any time within mar

ket hours, with minimum losses and at a competitive price. Market liquidity can be difficult to measure depending on the asset type, whether the asset is fungible, and the time horizon to liquidate the asset.

36. Review all of the graphs in the Wall Street Journal articles distributed this semester.

_______________________________________________________________________________________________________

The Graphs are not in date ordered; based on my notes and what was handed out in class. Did not miss any class but please add to it just in case if I miss one

This graph shows that other countries’ stock markets are lagging behind and US stock markets continue to rally. Other countries have not recovered from crisis fast enough unlike the US.

Emerging markets are weak and very speculative.

Concerns about the decline of equity and how the decline causes investors to invest in with its effects

Emerging markets are falling behind with their currency depreciates.

Fed funds rate moves like steps; the increase of the rate started in 2016 and continues to this day.

I don’t remember this graph in class

Notes are in the picture

Yield curve is flattening

I don’t know

Yield curve is flattening

Japan stock index has been strong. It was affected by stagnation for a while

Yield curve is flattening

Consumer Confidence is high

I don’t know why - will research

Backup info has arrived

MIDTERM QUESTIONS

Direct Finance: financing where borrowers borrow funds from the financial market without using a third-party as an intermediary ex) stock/bond market

Discount Window Borrowing: The discount window is an instrument of monetary policy that allows eligible institutions to borrow money from the central bank, to meet temporary shortages of liquidity.

Old System: Banks could only borrow from the federal reserve if they met 3 conditions

Need $ to prevent a liquidity crisis, Can’t borrow from anyone else, No relending of funds

Triggered a mandatory evaluation audit of the institution. NOT EVERYONE CAME TO FED

New System: All banks have access to discount window primary–for healthy institutions. Secondary–higher rate for unhealthy institutions. Discount rate is now HIGHER than the Fed Funds Rate. PRICE RATIONING banks don’t borrow from Fed. If discount rate was lower, banks would borrow from the fed and re lend to other banks for a profit because they would be charging (fed funds rate) at a higher rate

They made these changes b/c there was a lot of volatility in the market. TO MAKE FED FUNDS MARKET LESS VOLATILE, DISCOUNT RATE SERVE AS A CAP

Investment Grade: refers to the company’s quality of credit. Anything above BBB is considered investment grade and anything below BBB is considered non-investment grade. Anything rated BB or lower is considered a junk grade and the probability that a company with a junk grade repays its debt is considered “speculative”

Financial Intermediation: A financial intermediary channels money from lenders to borrowers. Benefits include allowing individuals to spread risk. Greater Liquidity.

Securitization: Assemble a pool of illiquid assets, primarily loans, and sell an interest in the pool as a liquid, tradable, security asset.

Reserve Requirements: changing the amount of bank reserves that banks need to keep at the FED

Moral Hazard: Moral hazard is risk in regulated environment that managers will take riskier positions because of the protection of the regulations (a safety net.) Individuals act irresponsibly b/c of the safety net that the govt implies. The market implies that they have a government guarantee. Helped lead to many people acting irresponsibly and purchasing terribly rated mortgage loans that they could not afford.

This refers to Financial Institutions who are so big and ingrained in the economy that if they were to fail it would have a huge ripple effect throughout the economy.

Quantitative Easing: introduction of new money into the supply by the central bank. During the financial crisis, the Fed started buying longer-term bonds to inject money into the market in an attempt to stimulate the economy.

Commercial Paper: short term debt securities issued by corporations. Sold at discount. Companies do it to pay short term liabilities. Unsecured, no collateral. Highly credit sensitive market. Only the highest quality issuers can issue commercial paper. Little bit of the flight to quality in the commercial paper market.

Credit Default Swap: A credit default swap is a swap to transfer the credit of fixed income products between two or more parties. Buyer makes payments to the swap’s seller up until the maturity date of contract. Seller agrees in the event of default, the seller will pay buyers premium & interest payments that would have been paid. Protect lenders against credit risk. Companies that sell swaps protect themselves with diversification.

1) Buyer of the bond 2) Issue of the bond 3) The seller of the CDS.

Repurchase Agreement: A form of short-term borrowing in which - The dealer sells the government securities to investors (usually overnight basis) and buys them back the following day.

Open Market Operations: OMO – buying and selling of securities primary t bills to either ease or add reserves, they buy, or tighten by selling. Tightening right now, draining reserves to raise the fed funds rate. Manipulating the amount of reserves in the banking system by buying and selling treasuries

PCEI: The personal consumption expenditure price index (PCEPI) is one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy.

Prime Rate:Rate that commercial banks lend to their largest highest quality borrowers. Prime Rate is important because it is a benchmark for bank lending.

Foreign Bonds:

1. US vs Japan (10-year bonds issued by developed countries governments)

2. US vs German (10-year)à Bunds

3. US vs Spanish (10-year) à Bonos

FOMC: FOMC: 7 Board of Governors + President of NY Fed +Presidents of 4 other Fed Banks who vote on rotating policy. **FOMC sets monetary policy**

- hawks are inflation concerned

- doves are on recession.

- Minutes released a month after a meeting, meet 8 times a year. There are 12 members who can vote on the FOMC. Board of Governors which includes the chair and 5 district bank presidents. There are 12 district banks.

Callable Bonds: A callable bond is a type of bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches its date of maturity.

Dual Mandate: The dual mandate is the line that the FED walks trying to balance between inflation and recession. Keep inflation at ideal rate (2%) while minimizing unemployment

Essay Questions

1) Discuss key trends in the money and capital markets. Cite a minimum of 6 trends:

· Gold has been increasing - Flight to Quality

· Oil has been decreasing

· Yield Curve has continued to flatten/stay positive: when the yield curve flattens,One reason the yield curve may flatten is market participants may be expecting inflation to decrease or the Federal Reserve to raise the federal funds rate in the near term. ... Consequently, the slope of the yield curve would flatten as short-term rates increase more than long-term rates.

· Shanghai Composite is typically the worst foreign equity index

· US administered rates have changed minimally since we’ve been tracking them, however compared to 2017 they have increased

· US interest rates have slowly continued to rise (Federal Funds rate)

a. Have these trends continued this semester? What trends continued, what trends have emerged?

All of them have continued this semester during our study of money and capital markets

EMERGED Trends:

· Year on year hourly rate has increased over the year

· Expectations of housing have stabled/steadied to prevent overshooting

2) Functions of the Federal Reserve?

Functions of the Federal reserve:

1. Control monetary policy: (Monetary policy – controlling the supply of money in the banking system to achieve the dual mandate)

2. Coordinate monetary policy with foreign banks

3. Foreign exchange intervention

4. Bank regulation and supervision - DODD Frank

5. Lender of last resort

6. System for check clearance

7. Fiscal Agent- for US treasury holds all the auctions, social security payments, government payroll.

a. How do we follow the Federal Reserve in the money and capital markets?

Follow the FED in the money and capital markets by looking at:

1. Release of the FOMC minutes. Must be released 30 days after last meeting.

2. Humphrey Hawkins testimony. Chairperson of FED is required to go into front of congress and release their balance sheet.

3. FOMC statement released every 8 weeks

b. Discuss the tools the Fed uses to control monetary policy.

How do they control monetary policy?

1. OMO: Buying and selling of securities primary t bills to either ease or add reserves. Manipulating the amount of reserves in the banking system by buying and selling treasuries

- Easing=Adding reserves buying/T Bills/Lower Fed Funds Rate

- Tightening=Draining Reserves/selling T Bills/Raise Fed Funds Rate

- FED Funds Rate - target and market

2. Discount Rate Policy

3. Reserve requirements- changing the amount of bank reserves that banks need to keep at the FED

3) What are the 5 most important economic categories of announcements today? For each, cite 2 important indicators.

· GDP: Flash (first GDP report of the year) and the Final (last of the year - most important)

· Employment: employment situation, Jobless claims weekly

· Housing: case-shiller price index, new home sales, existing home sales

· Inflation: PCEI (personal consumption expenditure index) and CPI (consumer price index)

· Consumer/Business confidence: Purchasing managers index (PMI), Consumer Sentiment Index (CSI)

4) What are the themes of money and capital markets? Refer to events, announcements that reflect these themes.

1. When & how aggressively will Fed raise int. rates.

· Fed will not increase rates at the next FOMC meeting (wednesday) but are expected to raise rates in December FOMC meeting in an attempt to cool the economy

2. How will monetary policy shifts in other countries affect the money and capital markets?

a. Monetary policy – controlling the supply of money in the banking system to achieve the dual mandate

3. Will global equity markets continue to lag the US?

· Recently US equity has been volatile and seemingly closing the gap between itself and the rest of the world. However, whatever the US does, since its an economic leader, it has a trickle down effect and other countries are also affected.

4. How will trade disputes affect financial markets?

· Foreign Investors lose confidence in the United States protectionist trade policies and pull money out of our equities market. Tariffs and Quota increases also make it harder for importers and exporters to do business.

5. As the inflation rate has hit the FED’s target, will concerns about inflation affect financial markets?

6. How will historically high consumer business confidence affect the markets?

· Economy will overheat if consumer confidence continues to be high. This will force fed to tighten (increase rates) in an attempt to discourage spending and level out the economy (control inflation)

Previous Exam (Use this as a direction for studying; Be aware the questions in the previous exam is different than we learn)