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FINA3324 Study online at quizlet.com/_4ym6fg 1.

what do well functioning financial markets facilitate

storage and exchange of value, intertemporal matching of consumption and productivity, efficient risk sharing and separation of ownership and management

2.

why is finance seen as socially worthless

it's the most profitable industry but it doesn't design, build or sell a single tangible thing

3.

whta is the largest contributor to the australian national economy

finance sector

4.

characteristics of a product that facilitates economy activity and creates further wealth

store wealth in a way that; does not lose value over time, low cost to maintain, easily transportable, easily transferable, easily broken into smaller items of value or aggregated to larger items of value, low cost to use as a medium of exchnge (ie highly liquid) and is widely accepted

5.

how does store of value create value

creates a convenient, reliable store of welath that can be used in exchange,

6.

how has money developed over time and how has this influenced finance

went from gold (too complicated to use since it required weighing, etc) to money (easy transportation but relies on goverment to print and need to trust government) to digital (easier to track and more convenient) increases in convenience over time and reduction in the work required to establish trust has lead to substantial increases in economic transactions and thus wealth creation

7.

what is the key determinant of money

people believe in its value

8.

how does finance create value through intertemporal matching of consumption and productivity

allows you to consumer your future wealth in the future time and save your present wealth to consume in the future - allows you to live a lifestyle similar to that of much wealthier people because you can borrow againnsst your future wealth, also used for the three reasons people save (life cycle neesds, emergencies and to exploit opportunities eg investments)

9.

issues with intertemporal matching of consumption and productivity

can facilitate projects wiht negative consequences eg war, and these things can become longer and deadlier as financing increases with borrowing, financial institutions can also become highly adept at promoting their loans and encouraging people to borrow more than they can afford

10.

what are payday lenders

entities that advance short term, often very high interst loans to people who cannot access credit elsewhere

11.

how does efficient risk sharing create value

an efficient financial system brings together the skills and capital of different people, which allows them to bear the right amount of risk and return, ie when contracts are appropriately designed, the risk of loss is borne by the entities best able to bear that loss eg futures for farmers may help them increase productivity as they can focus on farming and not worry about price changes, and Ray Dalio breaking down the chicken nugget market into components to reduce costs

12.

how does separation of ownership and management create value

people generate wealth from their investments, and their standard of living depends on the rates of return that can be earned on their wealth (includes investing in child's education, etc) - when there are few opportunities to make your wealth work for you (ie separate ownership from management) your standard of living is reduced substantially

13.

what kind of wrk do finance workers do

intermediation - matching savers with spenders, analying pricing risk and designing, advising and selling products to protect against risk, monitoring and enforcing contractual obligations - they are middlemen who bring together suppliers of capital and customers of capital

14.

functions of middlemen

bridge - providing access across a barrier (eg Atlas trend who provides investors with low cost access to economic trends) certifier (guaranteeing quality) - people who give credit scores (Zhima) enforcer (monitoring and enforcing contracts) - people go and beat up people who don't pay, angadias risk bearers (bearing risk) concierge (providing information) - bloomberg insulator (taking the heat) -debt negotiators, eg trying to convince client's creditors to write off at least some of their debt

15.

what is one thing that has been argued to limit some developing countries' growth

inability to develop low cost, efficient enforcement of contracts

16.

why is finance so profitable

economics - demand for financial intermediation is high, people lock in to a preferred supplier and don't change because it's inconvenient, can't be bothered or don't know they're getting a bad deal (high information asymmetry), cost of information and economies of scale give advantage to large corporations (short term investments aren't always profitable) technology - advances in tech normally reduce demand for some intermediation work but also create other opportunities (eg excel spreadhseets lead to reduced demand for skilled drafters byt it allowed more projects to become feasible) politics - social values (many societies traditionally have not been comfortable with lenders charging interest which impedes development) and looser laws and regulations have allowed more creative finance but higher risk (Thomas Phillippon says bankers are overpaid because of deregulatoin) THRIVES ON CHANGES IN TECH AND LOOSENING OF REGULTION

17.

define risk

the probability of an outcome being different to the expected outcome

18.

if you're pricing something, what parameters would you consider?

the opportunity cost of the toll (investing money at rf), the risk (the risk premium), the expected profit, growth opportunities

19.

define risk free rate

opportunity cost of waiting and expected inflation

20.

define risk premium

extra return required by investors for accepting risk

21.

what affects the risk premium

investors' appetite for risk

22.

are all investmenst done based on expectations of future cash flows?

no, buying costly investments can also be to send a credible signal of quality (signalling that you have money) eg people choose a "good" uni because it signals they're smart, why countries spend so much on the olympics (signals their competence to put on a large scale project and showcasing the country to the world)

23.

why are people we're in a low interest rate environment, so small changes can have a large impact on prices currently so concerned about interest rate rises

24.

what is the slope of the line in the risk return diagram

risk premium

25.

what do value investors focus on

net cash flows

26.

why have stocks been performing well recently despite high risk aversion

there are very few companies in the market and the price rises have been driven predominantly by the 4 major banks, because they're deemed as safer investments

27.

consequences of an increase in risk aversion

increase the purcchase of rf investments, which increases their prices and decreases return, corporate bonds become relatively more popular (although depends on risk), equities of companies with high payout ratios and perceived as low risk become more popular and increase in price, equities of companies with low payout ratios and risky projects become less popular and prices decrease

28.

why are value investors upset about 'cheap' money

their model doesn't fit, prices have changed but net cash flows haven't

29.

what do changes in the discount rate, E[R] reflect

changes in market wide risk sentiment

30.

what do changes in net cash flows reflect

changes in company specific and industry specific factors

31.

why is finance called ketchup economics

the price of assets depends on their cashflows and risk relative to other assets, they have no way to determine the absolute value of anything, thus they only look at the ketchup market specifically compared to general economists who look at the ketchup market as part of the whole economic system

32.

why are interest rates so low around the world

confidence is low so people want to keep their money safe somewhere, feels too unsafe to invest anywhere else, people aren't worried about inflation

33.

why have bank shares been so highly priced

after the GFC, the RBA guaranteed a large portion of deposits place with the big four banks, making them close to rf and thus demand for these shares increased and so did prices (draw graph)

34.

why have some investors been taking on extra risk

a sustainable standard of living depends on the rate of return you can earn on your wealth, with interest rates so low, some people (eg retirees) have no choice but to expose themselves to risks they normally wouldn't just to maintain their standard of living

35.

are investors wise to take on extra wise?

it does speed up your accumulation of wealth, and that may not be a bad thing, it just depends on how well placed you are to withstand the almost inevitable wealth loss when you do take on extra risk, ie can you bear this extra risk`

36.

difference between risk and uncertainty

risk describes decision situations in which probabilities are available to guide choice, uncertainty describes decision situations in which information is too imprecise to be summarised by probabilities

37.

when is it possible to have high return with low risk

almost never, only happens when there are barriers to entry and even then it's a temporary phenomenon - if it persists then it is almost guaranteed that high risk accompanies it

38.

why do we rely on intermediation so much

they have more interaction with buyers and sellers and thus develop trust on both sides, they connect nodes on a network to increase the value of the network, cognitive resources are scarce nad it's difficult to sift through the abundance of information out there, which leads to people often buying attention grabbing stocks, middlemen can help with this sometimes

39.

examples of when banks failed

weimar germany when the weimar government had to print money to meet obligations outlined by the treaty of versailles, hit the middle class, those with pensions and bank savings the hardest zimbabwe - the president gave farmland to those who lacked experience in modern agriculture which lead to a systematic decline in exports, he also sent troops to the congo which lead to ever increasing paper printing to pay off debts and fund wars

40.

problems with a decentralised currency

ownership, double spending, authenticity and updated account balances

41.

what is a hash

mathematical function with 3 properties - input can be any size, output has a fixed size, efficiently computable

42.

why are hash functions used

provides some level of anonymity whilst enabling information to be completely public, duplication is also practically impossible, provides security in ownership

43.

what hash function does bitcoin use

SHA256

44.

what are ICOs

initial coin offerings - a means to raise capital and bypass regulations

45.

why are prices important

they contain more information than any investor would have

46.

define fixed income securities

they promise a defined stream of income over fixed number of periods with repayment of principal at the end

47.

what does the fixed payments of bonds imply about analysis of bonds

it's mostly about predicting changes in E[R]

48.

what does an increase in risk aversion imply for governments

it increases the cost of borrowing for governments

49.

do stocks or bonds have higher return in the long run

stocks

50.

relationship between interest rates and bond

inverse

51.

relationship between credit stress and bonds

inverse - if the issuer becomes financially stressed they may propose varying the terms of their borrowing, eg reducing coupon payments, extending maturity or reducing the face value- at worst defaulting

52.

why do people purchase bonds

earn income and as a store of value

53.

what does it mean by risk free for sovereign government bonds

guaranteed repayment in currency, not guaranteed real return

54.

why do banks issue bonds

raises capital and uses proceeds to lend at a higher rate (guarantees payments)

55.

what kinds of firms issue bonds

large ones (not cost effective otherwise)

56.

describe asset backed securities

money is lent to borrows to allowt hem to buy specific assets, loans are then sold to investors wishing to buy the income stream from the payments made by borrowers, asset is collateral

57.

how do financial intermediaries make money from asset backed securities

commission

58.

who bears the risk of asset backed securities and implications

the investors who bought the loans, which leads to information asymmetry as they on't know the full extent of the risk

59.

who prices fixed income securities and why

debt rating agencies because of the lack of information about issuers

60.

potential problem with govenrments protecting credit rating agencies

could be a conflict of interest - companies pay for securities to be rated

61.

why is the bond market important

bond market is very large so the rate of return required on them is very influencial on the overall cost of capital, yield on government bonds defines the risk free rate, bond market is opaque (difficult for investors to get information to assess the risk of bond securities making credit rating agencies very powerful)

62.

why don't small investors pay more attention to the bond market

less liquid markets (typically sold in large parcels), most sold OTC, less information available, less volatility in return (can be less interesting)

63.

hoq to invest in bonds

buy bonds issued by individuals companies or buy a bond index via active bond index or passive index

64.

how does the australilan bond market compare and implications

about the same size as equities, there are concerns that it's too small which causes overallocation to equities and forcing investors to bear more risk than is appropriate

65.

strategies to capture capital appreciation

duration strategy, yield curve strategy, security allocation, sector allocation and country allocation

66.

how does duration affect bonds

prices of bonds with longer maturities are more sensitive to changes in interest rates

67.

what is the yield curve and what does it do

plots interest rates of bonds with different maturities but same credit risk - gives us an indication of what people expect the future to be like

68.

if you're lending to someone for 2 years instead of 1, would you expect the rate to be higher or lower

usually higher because you're tying up your capital for longer which usually increases exposure to risk, but could be lower if you expect it to be easier to lend money in the future and it also avoids the transaction costs of finding a new borrower

69.

why are bond yields low

interest rates are a function of demand and supply of cash, demand for cash depends on investment opportunities, so when aggregate demand is low, companies don't invest because they fear there is insufficient demand - some current reasons are that large scale outsourcing of production and more efficient capital use has increased wealth inequality and lowered the spending power of the middle class, ageing population has reduced overall demand, secular stagnation (period of low growht over a long period of time - which could be a result of efficient economies and technology growth [less demand for people]), excess savings (less popular now)

70.

approaches to boost aggregate demand

keynesian solution (stimulate demand by spending and running budget deficits), austerity (cut back spending and balance the budget - recessions are symptoms of economies reorganising themselves), monetary response (increase money supply until investors choose to invest in risky assets)

71.

concerns with keynesian stimulus and asset pricing

govenrments can't print money forever without stimulating inflation and or raising debt and interest rates beyond the country's capacity to pay, crowds out private investment (but the large cash stocks of firms suggest that crowding out isn't valid now - they're already not investing)

72.

why did the S&P threat of cutting the US credit rating not affect the market

there is almost no chance of the US government not repaying its debt obligations - they can print as much money as they want to repay it all and the low interest rates in the US indicate that investors are not worries about not being repaid

73.

what should countries do if they're concerned with deflation

monetarist solution - quantitative easing - when the central bank credits its own account with money (prints money), then purchases government and corporate bonds from banks, giving them the excess reserves to create new money by the process of deposit multiplication from increased lending. used when interest rates are close to 0 - the aim is that riskier asset classes can also get access to capital which in turn stimulates demand

74.

risks of QE

spurring hyperinflation, banks using the additional cash to increase their capital reserves rather than lending it out if they fear increasing defaults in their current loan portfolio

75.

milton friedman's paradox of tight money and easy money

tight money is when interest rates decrease, because when risk aversion increases, people shun riskier investments and buy government bonds which means it's harder for riskier investments to get money/borrow (opposite of traditional thinking)

76.

define modern portfolio theory

building an optimal portflio, one that has the highest return for a given level of risk

77.

who developed modern portfolio theory

James Tobin and Harry markowitz

78.

why...