Financial Markets & Instruments Flashcards

What is the primary function of financial markets?

Answer: Facilitate capital exchange

The primary function of financial markets is to facilitate the exchange of capital between those who have surplus funds (savers/investors) and those who need funds (borrowers/issuers). They provide a platform for buying and selling financial instruments like stocks and bonds, enabling efficient allocation of capital for economic growth. This process allows businesses to raise money for expansion and individuals to invest for future returns.

Which of the following is a primary market instrument?

Answer: Initial public offering (IPO)

An Initial Public Offering (IPO) is a primary market instrument because it represents the very first sale of stock by a private company to the public. In the primary market, new securities are issued and sold for the first time directly by the issuer to investors. Secondary stock sales and mutual fund units involve existing securities traded between investors, not directly from the issuing entity.

What are derivatives used for?

Answer: For hedging or speculation

Derivatives are financial instruments whose value is derived from an underlying asset, such as stocks, bonds, commodities, or currencies. They are primarily used for hedging, which involves mitigating financial risks by offsetting potential losses, or for speculation, where investors bet on the future price movements of the underlying asset to profit. Derivatives allow for complex risk management and investment strategies.

Which instrument represents a debt obligation?

Answer: Corporate bond

A corporate bond represents a debt obligation, where the issuing company borrows money from investors and promises to pay interest over a specified period, along with returning the principal amount at maturity. Unlike common or preferred stock, which represent ownership equity, a bond signifies a loan relationship. This makes it a fixed-income security, as investors receive regular interest payments.

What is liquidity in financial markets?

Answer: Ease of converting assets to cash

Liquidity refers to how quickly and easily an asset can be converted into cash without significantly affecting its market price. In financial markets, high liquidity is desirable as it allows investors to buy or sell assets efficiently, providing flexibility and reducing transaction costs.

Which market deals with previously issued securities?

Answer: Secondary market

The secondary market is where investors buy and sell securities that have already been issued by companies or governments. This market provides liquidity for existing securities, allowing investors to trade them among themselves after their initial offering in the primary market.

Which instrument gives ownership in a company?

Answer: Common stock

Common stock represents ownership shares in a corporation, giving shareholders a claim on the company's assets and earnings. Stockholders typically have voting rights on corporate matters and the potential to benefit from the company's growth through capital appreciation and dividends.

What is the purpose of a mutual fund?

Answer: Pool money for investment

A mutual fund pools money from many investors to collectively invest in a diversified portfolio of stocks, bonds, or other securities. This allows individual investors to gain access to professional management and diversification that might be difficult or costly to achieve on their own.

What is a treasury bill (T-bill)?

Answer: Short-term government security

A Treasury bill (T-bill) is a short-term debt instrument issued by the U.S. government to finance its operations. T-bills mature in one year or less and are considered one of the safest investments due to the backing of the full faith and credit of the U.S. government.