Financial Term Definitions

Solution Preview

Define the following terms and identify their role in finance:

a. Finance - A discipline concerned with determining value and making decisions.
Finance Role - The finance function allocates resources, which includes acquiring, investing, and managing resources.

b. Efficient Market - In economic theory, an efficient market is one in which market prices adjust rapidly to reflect new information. The degree to which the market is efficient depends on the quality of information reflected in market prices.
Finance Role - In an efficient market, profitable arbitrage opportunities do not exist and traders cannot expect to consistently outperform the market unless they have lower-cost access to information that is reflected in market prices or unless they have access to information before it is reflected in market prices.

Efficient Market Hypothesis - This is a hypothesis that suggests markets adjust very quickly to new information and that it is very difficult for investors to select portfolios of securities that outperform the market. Markets in general are efficient when: (1) Prices adjust rapidly to new information; (2) There is a continuous market, in which each successive trade is made at a price close to the previous price (the faster that the price responds to new information and the smaller the differences in price changes, the more efficient the market); (3) The market can absorb large dollar amounts of securities without destabilizing the prices.

c. Primary Market - the market for the raising of new funds as opposed to the trading of securities already in existence. The first buyer of a newly issued security buys that security in the primary market. All subsequent trading of those securities is done in the secondary market.
Finance Role - When a corporation or business uses the financial markets to raise new funds, the sale of securities is said to be made in the primary market by way of a new issue. After the securities are sold to the public (institutions and individuals), they are traded in the secondary market. (1) For producers, their major purchaser of commodities; (2) to processors, the market that is the major supplier of their commodity needs; and (3) in commercial marketing channels, an important center at which spot commodities are concentrated for shipment to terminal markets.

d. Secondary Market - The market for securities that have already been issued. It is a market ...