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AFM271
Wednesday May 9 2012
financial market: market where funds are transferred from people who have an excess
of available funds to people who have a shortage
o allows people with growth opportunities to expand
o key factor in economic growth
debt market: allows corporations and businesses to borrow in order to finance
activities
o also known as a bond market
o interest rate = the cost of borrowing
differences between financial markets and financial intermediaries:
o FM = raised through equity, collective place to buy and sell financial assets
ex: stocks, bonds
o FI = raised through debt, business that move money from individuals to FM
ex: banks, ins. companies, mutual and hedge funds
flow of funds:
direct finance: borrowers borrow
directly from lenders by selling
securities in FM
indirect finance: borrowers borrow
funds from the FM through FI
Dorene Dang
AFM271
Wednesday May 9 2012
Dorene Dang
AFM271
Wednesday May 9 2012
1) Interest-bearing
o fixed-term, non-negotiable
o requires regular interest payments that are deductible for the firm
o no ownership on the firm
o debt holders are paid off before equity holders in the event of bankruptcy
1) money market instruments: less than 1 year, purchased at a
discount, no fixed payments, extremely liquid
2) fixed income instruments: more than a year, purchased at face
value, interest payments and principle at the end
ex: bonds: issued at coupon rate, coupon frequency
o face value at maturity are also realized
2) Equity
o no fixed-term lifespan of company
o payments in the form of dividends, not mandatory by the company however
non-deductible
o represents ownership of the firm
1) common stock: ownership with voting rights), dividends issued
2) preferred stock: (same as common stock) dividends usually
become fixed at some point in time
at bankruptcy, preferred stocks are paid out at face value
before distribution to common stockholders
value of stocks = value of company
3) Derivative
o value is derived by an underlying asset
1) future: binding contract (obligations) to buy or sell at a future point
in time
features: quantity
delivery logistics (date, time, place)
2) option: premium paid by buyer or seller for them to have the right
but not obligation to buy or sell
call option: buyer has choice
put option: seller has choice
o used for:
hedging: offsetting some risk associated with a given market
commitment
insurance: reduces or eliminates downside exposure