FIN 4520 - HANDOUT 2 - SOME USEFUL DEFINITIONS
Direct vs. indirect finance:
Direct involves no intermediaries. Examples include stocks and bonds.
Indirect involves an intermediary. Examples include bank loans.
Types of financial instruments:
Debt (bonds and loans): repayment promised. Must be paid before equity.
Equity (stock): ownership claim on assets and future earnings. Residual claim (paid only after all debt is paid).
Primary vs. secondary markets:
Primary market is for new issues of an instrument; the only way the issuing firm actually raises money.
Secondary market is for resale of previously issued securities. Examples include NYSE and American Stock Exchange. Stock price in secondary market affects the amount of money the firm can raise in subsequent new issues.
Money market vs. capital market:
Money market involves short-term instruments (under 1 year maturity), all debt.
Capital market involves long-term instruments (more than 1 year maturity), both debt and equity.
Two main reasons for financial intermediaries:
Transaction costs.
Asymmetric information: adverse selection (before transaction) & moral hazard (after transaction).
Financial regulation:
Three reasons: disclosure, safety & soundness, and monetary policy.
Six types of regulation: charter requirements; reporting requirements; product powers; deposit insurance; geographic restrictions; pricing restrictions.