1. Enumerate the types of financial markets.

(6)
Primary Markets —markets in which corporations raise funds through new issues of securities.
Secondary Markets —markets that trade financial instruments once they are issued.
Money Markets —markets that trade debt securities or instruments with maturities of less than
one year.
Capital Markets —markets that trade debt and equity instruments with maturities of more than
one year.
Foreign Exchange Markets —markets in which cash flows from the sale of products or assets
denominated in a foreign currency are transacted.
Derivative Markets —markets in which derivative securities trade.
2. The first public issue of financial instruments by a firm. initial public offerings(IPOs)
3. A market that trades financial instruments once they are issued. secondary market
4. A financial security whose payoffs are linked to other, previously issued securities.
derivative security
5. Markets that do not operate in a specific fixed location—rather, transactions occur via
telephones, wire transfers, and computer trading. over-the-counter (OTC) markets
6. Enumerate money market instruments. (6)
Treasury bills —short-term obligations issued by the U.S. government.
Federal funds —short-term funds transferred between financial institutions usually for no more
than one day.
Repurchase agreements —agreements involving the sale of securities by one party to another
with a promise by the seller to repurchase the same securities from the buyer at a specified date
and price.
Commercial paper —short-term unsecured promissory notes issued by a company to raise
short-term cash.
Negotiable certificate of deposit —bank-issued time deposit that specifies an interest rate and
maturity date and is negotiable, (i.e., can be sold by the holder to another party).
Banker’s acceptance —time draft payable to a seller of goods, with payment guaranteed by a
bank.

7. Corporate stock —the fundamental ownership claim in a public corporation.

8. Mortgages —loans to individuals or businesses to purchase a home, land, or other real
property.
9. Corporate bonds —long-term bonds issued by corporations.
10. Treasury bonds —long-term bonds issued by the U.S. Treasury.
11. Bank and consumer loans —loans to commercial banks and individuals.
12. Financial institutions (e.g., commercial and savings banks, credit unions, insurance
companies, mutual funds) perform the essential function of channeling funds from those
with surplus funds (suppliers of funds) to those with shortages of funds (users of funds).
13. Enumerate the types of financial institutions (8)
Commercial banks —depository institutions whose major assets are loans and whose major
liabilities are deposits. Commercial banks’ loans are broader in range, including consumer,
commercial, and real estate loans, than are those of other depository institutions. Commercial
banks’ liabilities include more nondeposit sources of funds, such as subordinate notes and
debentures, than do those of other depository institutions.
Thrifts —depository institutions in the form of savings associations, savings banks, and credit
unions. Thrifts generally perform services similar to commercial banks, but they tend to
concentrate their loans in one segment, such as real estate loans or consumer loans.
Insurance companies —financial institutions that protect individuals and corporations
(policyholders) from adverse events. Life insurance companies provide protection in the event
of untimely death, illness, and retirement. Property casualty insurance protects against personal
injury and liability due to accidents, theft, fire, and so on.
Securities firms and investment banks —financial institutions that help firms issue securities
and engage in related activities such as securities brokerage and securities trading.
Finance companies —financial intermediaries that make loans to both individuals and
businesses. Unlike depository institutions, finance companies do not accept deposits but
instead rely on short- and long-term debt for funding.
Mutual funds —financial institutions that pool financial resources of individuals and companies
and invest those resources in diversified portfolios of assets.
Hedge funds —financial institutions that pool funds from a limited number (e.g., less than 100)
of wealthy (e.g., annual incomes of more than $200,000 or net worth exceeding $1 million)
individuals and other investors (e.g., commercial banks) and invest these funds on their behalf,
usually keeping a large proportion (commonly 20 percent) of any upside return and charging a
fee (2%) on the amount invested.
Pension funds —financial institutions that offer savings plans through which fund participants
accumulate savings during their working years before withdrawing them during their
retirement years. Funds originally invested in and accumulated in a pension fund are exempt
from current taxation.
14. A corporation sells its stock or debt directly to investors without going through a
financial institution. direct transfer
15. The ease with which an asset can be converted into cash at its fair market value. liquidity
16. Buying and selling shares on the Internet. Etrades
17. The ability of an economic agent to reduce risk by holding a number of securities in a
portfolio. Diversify
18. A theory of interest rate determination that views equilibrium interest rates in financial
markets as a result of the supply and demand for loanable funds. loanable funds theory
19. The continual increase in the price level of a basket of goods and services. Inflation
20. The risk that a security issuer will default on that security by being late on or missing an
interest or principal payment. default risk
21. The risk that a security can be sold at a predictable price with low transaction costs on
short notice. liquidity risk
22. Interest earned on an investment is reinvested compound interest
23. Interest rate used to calculate the annual cash flow the bond issuer promises to pay the
bond holder. coupon interest rate
24. Bonds that pay interest based on a stated coupon rate. The interest, or coupon, payments
per year are generally constant over the life of the bond. coupon bonds
25. Bonds that do not pay interest. zero-coupon bonds
26. A bond in which the present value of the bond is greater than its face value. premium
bond
27. A bond in which the present value of the bond is less than its face value. discount bond
 28. The central bank of the United States. Founded by Congress under the Federal Reserve
Act in 1913, the Fed’s original duties were to provide the nation with a safer, more
flexible, and more stable monetary and financial system. The Federal Reserve (the Fed)
Answer Key
1. Primary Markets
Secondary Markets
Money Markets
Capital Markets
Foreign Exchange Markets
Derivative Markets
2. initial public offerings(IPOs)
3. secondary market
4. derivative security
5. over-the-counter (OTC) markets
6. Treasury bills
Federal funds
Repurchase agreements
Commercial paper
Negotiable certificate of deposit
Banker’s acceptance
7. Corporate stock
8. Mortgages
9. Corporate bonds
10. Treasury bonds
11. Bank and consumer loans
12. Financial institutions
13. Commercial banks
Thrifts
Insurance companies
Securities firms and investment banks
Finance companies
Mutual funds
Hedge funds
Pension funds
14. direct transfer
15. liquidity
16. Etrades
17. Diversify
18. loanable funds theory
19. Inflation
20. default risk
21. liquidity risk
22. compound interest
23. coupon interest rate
24. coupon bonds
25. zero-coupon bonds
26. premium bond
27. discount bond
28. The Federal Reserve (the Fed)