FINM1001 flashcards

what is the primary role of financial markets?

to facilitate the purchase and sale of financial instruments including equity, debt instruments, derivatives and foreign currencies.

what are the three principal sets of players that interact in the financial markets?

• the time value of money

• arbitrage

• diversification

what does the time value of money entail

it forms the basis for all asset valuations and is broke into financial mathematics and return calculations, valuing bonds, and making investment decisions

what does diversification entail

it displays the reduction of risk done by market participants to make as much money as possible. so instead of putting in money in one company alone, market participants will put money into multiple companies.

what does arbitrage entail

this is the ability to take advantage of different prices in different markets to make the most effective purchase. it is used in the valuation of future contracts, option contracts and forward contracts.

what is a financial market

a mechanism that facilitates the purchase and sale (trade) of financial instruments including equity, debt instruments, derivatives and foreign currencies.

it:

• brings together of lenders (savers) and borrowers, aiding in the transfer of funds from people who wish to lend them to people who wish to borrow them (capital raising)

• allows the transference of funds between parties

• allows international trade between individuals, companies, and governments

what are characteristics of lenders

lenders have more than they wish to consume. therefore:

• they loan funds that are excess to their consumption to other market participants (borrowers).

• In exchange they receive a positive rate of return on these funds from the people they lend to.

what are characteristics of borrowers

borrowers have less than they want to invest. therefore:

• they borrow funds that are required to meet their current consumption or investment requirements.

• In exchange, they pay a positive rate of return on these funds to the people they lend from.

what is a financial intermediary?

this is an institution such a bank that holds funds from lenders in order to make loans to borrowers

list and describe the principal types of financial intermediaries in the Australian financial markets

• commercial banks

• building societies

• credit unions

• insurance companies

• superannuation funds

describe the flow of fund within the financial system

lenders who have surplus funds lend these funds to others (borrowers) through financial markets. this can be done on individual, company, and government level.

what are the types of financial markets

• money market

• capital market

• derivatives market

• foreign exchange markets

discuss the main differences between money markets and capital markets.

the money market is a market that facilitate short-term borrowing and lending. this is usually a time frame of less than a year. the capital market is a market is a market that facilities medium to long-term borrowing. this is usually longer than a year.

describe the money market and some instruments that are traded there

• the short-term government debt market - this includes treasury bills and treasury notes.

• the interbank market

• the bills market

• the commercial paper market

• the negotiable certificates of deposit (CD) market

describe the capital market and some instruments that are traded there

• medium to long-term debt instruments like

  • corporate debt

  • government debt

• equity - this considered at medium to long term borrowing as businesses can technically exist forever.

what is the corporate debt market

Short-term debt instruments issued by corporations are classified as forming part of the money markets, while company issued medium-to-long term instruments are traded in the capital markets.

these instruments include:

• loans

• debentures

• unsecured notes

• subordinated debt.

what is the government debt market

While these bonds have varying maturities, they are invariably in excess of 1 year, meaning they are traded in the capital markets.

these instruments include:

• budget expenditures

what is the equity market

Providers of equity finance receive a share in the ownership of the business in which they have purchased shares, providing the businesses with a source of long-term funding for use across a number of activities.

This includes both ordinary and preference shares which are sought by both public and private companies.

what is the derivatives market

• They allow you to lock in the price of an asset in advance.

• They are available over a wide range of assets including shares and debt instruments

• Examples of derivatives include forwards contracts, futures contracts and options contracts.

what does a forwards contract do

locks in the price for a good and can be a good or bad thing depending on how prices rise and fall respectively

what does a futures contract do

locks in the price for a good and can be a good or bad thing depending on how prices rise and fall respectively

what does a options contract do

allows an individual choose whether they use their locked in price or the market price

what is the foreign exchange market

Foreign exchange markets allow market participants to convert their money between currencies. Market participants can convert their money from currency A to currency B at the exchange rate.

describe the difference between the primary and the secondary market

both the money and capital market can be further split in the the primary and the secondary market.

• the primary market consists of transactions with newly issued instruments and therefore raise funds for issuers.

• the secondary market transactions represent transferring from one holder to another, therefore not raising any additional funds for the issuer.

what is an inter-company market? is it regarded as a money market or a capital market?

This is the direct lending between companies. This is considered to be in the money market.

find the future value of $5000 invested for 10 years at 10% compounded annually

formula

Compound - FV = PV (1+r)^n

Simple = FV = PV + PV*r*n

Answer = 12968.71

find the future value of $8000 invested for 7 years at 8% compounded annually

formula

Compound - FV = PV (1+r)^n

Simple = FV = PV + PV*r*n

Answer = 13710.59

find the future value of $775 invested for 12 years at 12% compounded annually

formula

Compound - FV = PV (1+r)^n

Simple = FV = PV + PV*r*n

Answer = 3019.38

find the future value of $21000 invested for 5 years at 5% compounded annually.

formula

Compound - FV = PV (1+r)^n

Simple = FV = PV + PV*r*n

Answer = 26801.91

If you deposit $10000 today into an account earning an 11% annual rate of return, in the third year how much interest would be earned? How much of the total is simple interest and how much results from compounding of interest? (future value)

formula

Compound - FV = PV (1+r)^n

Simple = FV = PV + PV*r*n

Simple Answer = 13300

Compound Answer = 13676.31

find the present value of $800 to be received 10 years from now discounted to the present at 10%

formula

simple - PV = FV/(1+R*N)

compound - PV = FV/ (1+r)^n

Simple Answer = 400

Compound Answer = 308.43

find the present value of $300 to be received five years from now discounted to the present at 5%

formula

simple - PV = FV/(1+R*N)

compound - PV = FV/ (1+r)^n

Simple Answer = 240

Compound Answer = 235.06

find the present value of $1000 to be received eight years from now discounted to the present at 3%

formula

simple - PV = FV/(1+R*N)

compound - PV = FV/ (1+r)^n

Simple Answer = 806.45

Compound Answer = 789.40

find the present value of $1000 to be received eight years from now discounted to the present at 20%.

formula

simple - PV = FV/(1+R*N)

compound - PV = FV/ (1+r)^n

Simple Answer = 384.62

Compound Answer = 232.57

what are annuities

they are a finite number of cash flows that are equal in value and are evenly spaced.

what are the three types of annuities

• ordinary annuities

• deferred annuities

• annuities due

what is an ordinary annuity

this is one where the time between now and the first cash flow is the same as the time separating the subsequent cash flow`

what is an example of an ordinary annuity

a bank loan

what us an annuity due

this is where the first cash flow occurs immediately.