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Level 10

Structure of Financial Markets


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Debt Instrument
a contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals (interest and principle payments) until a specified date (the maturity date)
Maturity (of a debt instrument)
the number of years (term) until the instrument's expiration date
equities
claims to share in the net income and assets of a corporation, such as common stock
Financial Market
mechanism that channels funds from households, firms, and governments that have saved surplus funds by spending less than their income to those that have a shortage of funds because they wish to spend more than their income
Primary Market
financial market in which new issues of a security, such as a bond or stock, are sold to initial buyers by the corporation or the government agency buying the funds (often done behind closed doors)
Secondary Market
financial market in which securities that have been previously issued can be resold (the most commonly known financial markets)
Exchanges
A type of secondary market in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades)
Over-The-Counter (OTC) Market
A type of secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices
Money Market
financial market in which only short-term debt instruments are traded
capital market
a financial market in which longer term debt and equity instruments are traded. (generally those with maturity of one year or greater)
Stockholders
those who hold stock in a corporation;they own an interest in the corporation proportional to the percentage of outstanding shares they own
Common Stock
Share of an ownership in a corporation
residual clamaint
the stockholder receives whatever remains after all other claims against the firm's assets have been satisfied
cash flows
funds flowing into the firm
dividends
payments made periodically, usually every quarter, to stockholders
Collateral
property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments **this type of debt is secured debt**
Unsecured debt
the predominant form of household debt and is widely used in business borrowing as well
restrictive covenants
long legal documents with provisions that restrict and specify certain activities that the borrower can engage in
agency theory
the analysis of how symmetric information problems effect economic behavior
free rider problem
occurs when people who do not pay for information take advantage of the information that other people have paid for
net worth (net capital)
the difference between a firm's asset and its liabilities
equity contracts
claims to a share in the profits and assets of a business
principal agent problem
when managers only own a small fraction of the firm they work for, the stockholders who own most of the firm's equity are not the same people as the managers of the firm, who…
costly state verification
monitoring the the firms activities can be expensive in terms of money and time
venture capital firm
they pool the resources of their patterns and use the funds to help budding entrepreneurs start new businesses
incentive compatible
debt contract aligns the incentives of the borrower with those of the lender
state owned banks
little incentive to allocate their capital to the most productive uses