Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Financial Economics Year 3 > 1. Financial System and Economic Growth > Flashcards

1. Financial System and Economic Growth Flashcards

1
Q

Make-up of Financial System

A

Financial assets, financial institutions, financial markets, financial services

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Classifications of Financial Markets

A
  • By Nature of Claim: Debt v Equity
  • By Maturity of Claim: Money v Capital
  • By Seasoning of Claim: Primary v Secondary
  • By Timing of Delivery: Cash Spot v Derivatives
  • By Organisational Structure: Auction v Over-thecounter
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

How do Well-Functioning Financial Systems Accelerate Economic Growth?

A
  • Allocating funds to their most productive uses.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

How do Well-Functioning Financial Systems Accelerate Economic Growth? (Low to Intermediate Levels of Financial Depth)

A
  • There is a positive relationship between the size of the financial system and economic growth.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

How do Well-Functioning Financial Systems Accelerate Economic Growth? (High Levels of Financial Depth)

A
  • More finance is associated with a higher likelihood of financial crises and lower growth.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What can a Financial System do?

A
  • Record transactions.
  • Reduce Transaction Costs e.g pooling funds.
  • Trade, transform and manage risks
  • Reduce Information costs e.g screening projects and monitoring investments.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Examples of Institutional Quality (regulation, policy) matters

A
  • Property rights protection and contracts enforcement e.g collateral, covenants, corruption.
  • Information provision (transparency): reducing asymmetric information.
  • Soundness of Financial institutions: deposit insurance, chartering process
  • Health competition: branching, restrictions on interest rates.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

How can Financial Markets promote efficient allocation of funds?

A
  • Facilitate price discovery: disseminate information.
  • Reduce transaction costs: agglomeration and standardised trading mechanisms.
  • Execute clearing and arrangements.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What are the challenges when financial markets promote efficient allocation of funds?

A

Information asymmetry with transaction costs.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What Information asymmetries are there across financial markets?

A
  • Asset sellers are better informed than buyers.
  • Borrowers know more about their own likelihood of repayment than lenders.
  • Firms know more about their costs and risks than investors or the government.
  • Agents take actions that are party unobservable. (Stakeholders).
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Adverse Selection in financial transactions

A
  • Occurs before.
  • One side has better information than the other (insurance v buyers)
  • Cost of information (screen ability and free-rider) aggravates the problem
  • Akerlof’s market for lemons theory.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

How can the Lemons problem be applied to Security markets?

A
  • Investors can’t distinguish the quality of securities (uniformly distributed) and pay only the average value.
  • Good (low risk) securities tends to be undervalued and issued less.
  • Bad ones overvalued and issued more.
  • Investors know and would not buy bad securities.
  • Market cannot function.
  • Therefore, equity is expensive to issue.
  • Only large, established firms have access to securities markets.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

When does Moral Hazard occur in a financial transaction?

A
  • One side has incentive to deviate from the commitment.
  • E.g. Borrowers v Lenders, Manager v Lenders/Shareholders, Insurance v Buyers.
  • Cost of information (verifiability of state or action and free-rider) aggravates the problem.
  • Principal-Agent Problem.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

How can Financial Intermediaries Promote Efficient Allocation of Funds?

A
  • Reduce transaction costs.
  • E.g. Economies of Scale: Trade in blocs, pooling diversification, toolboxes. E.g. Expertise: e.g. equipments and knowledge.
    E.g. Liquidity services for investors
    E.g. Achieve Economies of Scope - lower cost of information production, but conflict of interest.
  • Reduce Asymmetric Information Problems
  • E.g. Adverse Selection: screening and private information production, private loans (pecking order hypothesis)
    E.g. Moral Hazard: monitoring and restrictive contracts, venture capital.
  • Financial intermediaries allow for small players in the market.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What Asymmetric Information Problems are Related to Features of Financial Systems?

A
  • Stocks are not the most important source of external financing (Debts > Equities)
  • Marketable securities are not the primary source of financing (Low Bonds + Equities)
  • Indirect finance is still more important than direct finance (bonds+equities increase)
  • Banks are still the most important source of external funds (bank/other credits dominate)
  • Financial system is heavily regulated (unincentivise)
  • Large, well established firms have easier access to securities markets financing.
  • Collateral is prevalent in debt contracts (secured v unsecured debt)
  • Debt contracts have substantial restrictive covenants.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What are the characteristics of financial markets and institutions?

A

They involve moving huge quantities of money, affect the profits of business and affect the types of goods and services produced in an economy.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Financial Markets Definition

A

Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

Bond Definition

A

A debt security that promises to make payments periodically for a specified period of time.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

Stock definition

A

A security that is a claim on the earnings and assets of a corporation.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

Role of Financial Intermediaries

A
  • Act as middlemen, borrowing funds from those who have saved and lending these funds to others.
  • Play an important role in determining the quantity of money in the economy.
  • Help promote a more efficient and dynamic economy.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

Securities Definition

A

Securities are assets for the person who buys them, but liabilities for the individual/firm that sells them.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Money Market Definition

A

The market in which short-term debt instruments are traded.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

Liquidity Services Definition

A

Banks providing depositors with checking accounts that enable them to pay their bills easily.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

Economies of Scale in Financial Intermediaries

A

They can substantially reduce transaction costs per dollar of transactions because their large size.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Adverse Selection Example

A

When a potential borrower are most likely to default are the ones most actively seeking a loan.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

Moral Hazard Example

A

When a borrower engages in activities that make it less likely that the loan will be repaid.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

Conflict of Interest Definition

A

When one party in a financial contract has incentives to act in its own interest rather than in the interests of the other party.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

Economies of Scope Definition

A

A financial institution that can achieve cost saving by engaging in multiple activities.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

Lenders actions in Adverse Selection Problem

A
  • May make a disproportionate amount of loans to bad credit risks.
  • May refuse loans to individuals with low net worth.
  • Reluctant to make loans that are not secured by collateral.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

Characteristics of a Bank

A
  • Has the ability to profit from the information it produces.
  • Avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market.
  • Becomes an expert in determining good firms from bad firms.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

Moral Hazard is a problem associated with debt and equity contracts arising from…

A
  • Borrowers incentive to undertake highly risky investments.
  • Owners inability to ensure that managers will act in the owners interest.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

Examples of Financial Institutions

A

Banks, insurance companies, finance companies

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

SVB Mid Quarter Q1 23 Strategy Update

A
  • Securities Portfolio Sale and Capital Raising: The group sold its available-for-sale securities to restructure its balance sheet. Additionally, plans were made to sell common and convertible preferred stocks.
  • High Uninsured Deposits: A large portion of SVB’s deposits were uninsured, making them more sensitive to shifts in depositor confidence.
  • Client Base Concentration: A significant percentage of SVB’s deposits came from technology and life science/healthcare sectors, leading to increased risk due to the lack of diversification.
  • Asset-Liability Mismatch: Investments in held-to-maturity securities, using excess post-pandemic funds, led to a mismatch as deposit outflows increased unexpectedly.
  • Bank Closure Due to Rapid Withdrawals: Following the restructuring announcement, rapid depositor withdrawals occurred, leading to regulatory closure and FDIC receivership.
  • Venture Capital Slowdown and Interest Rate Impact: A decline in venture capital activities and rising interest rates significantly affected the bank’s financial stability, with increased borrowing and reduced deposits.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

SVB Shutdown FT

A
  • SVB Shutdown: Silicon Valley Bank was shut down by U.S. regulators on March 10, 2023.
  • Bank’s Size: It was the 16th-largest bank in the U.S., primarily serving tech startups.
  • Liquidity and Insolvency Issues: The closure was due to inadequate liquidity and insolvency.
  • FDIC as Receiver: The Federal Deposit Insurance Corporation (FDIC) was appointed as receiver.
  • Depositor Access to Funds: Insured depositors were assured access to their funds by March 13, 2023.
  • Share Price Drop: SVB’s shares fell 66% in premarket trade before trading was halted.
  • Tech Community Impact: The shutdown raised concerns in the tech sector, particularly among startups.
    Assets and Deposits: As of December 31, 2022, SVB had about $209 billion in assets and $175.4 billion in deposits.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

AT1 Bonds

A
  • Credit Suisse’s AT1 bonds, valued at over $17 billion, were written down to zero by the Swiss regulator as part of a rescue merger with UBS.
  • AT1 bonds, also known as contingent convertibles or CoCo bonds, are designed to absorb shocks if a bank’s capital falls below a certain level, and can be converted into equity or written off.
  • These bonds are considered the riskiest type of bank-issued bond and typically offer higher returns.
  • In the Credit Suisse case, the Swiss regulator’s decision allowed shareholders to receive compensation, but left AT1 bondholders with nothing, contrary to the usual hierarchy where bondholders are paid before shareholders.
  • This decision has caused a drop in the value of other European banks’ AT1 bonds and raised concerns about the future of the AT1 bond market, making investors wary of purchasing such bonds.
34
Q

What do activities in financial markets directly impact?

A
  • Individuals wealth
  • Behaviour of businesses
  • Efficiency of economy
35
Q

What are the three main financial markets?

A
  • Bond market: where interest rates are determined
  • Stock market: has a major effect on people’s wealth and on firm’s investment decisions.
  • Foreign Exchange Market: fluctuations in FX rate have major consequences on economy in question.
36
Q

Why do banks and other FIs play crucial role in improving the efficiency of the economy?

A
  • They channel funds from people who may not put them to productive use to people who can do so (financial intermediary)
37
Q

What does money and monetary policy have an influence on?

A
  • Inflation, business cycles and interest rates.
38
Q

Definition of a Security

A
  • A claim on the issuer’s future income or assets.
39
Q

Definition of an Asset

A
  • Any financial claim or piece of property that is subject to ownership.
40
Q

Definition of a Bond

A
  • A debt security that promises to make periodic payments for a specific amount of time.
41
Q

Interest Rate Definition

A
  • The cost of borrowing or the price paid for the rental of funds.
42
Q

Definition of a Stock

A
  • Represents a share of ownership in a corporation
43
Q

Definition of a Financial Intermediaries

A
  • Institutions that borrow funds from people who have saved and in turn make loans to people who need funds.
  • FIs that acquire funds by issuing liabilities and use the funds to acquire assets by purchasing securities or making loans.
44
Q

Definition of Aggregate Output

A
  • Measure of this is GDP
  • The market value of all final goods and services produced in a country during the course of the year.
45
Q

Definition of Aggregate Income

A
  • Total income of factors of production (land, labour, capital) from producing goods and services in the economy during year.
  • Best thought to equal Aggregate Output
46
Q

Basic Function of Financial Markets

A
  • To channel funds from savers who have an excess of funds to spenders who have a shortage of funds.
  • Achieved by either direct or indirect finance
47
Q

Direct Finance

A
  • Borrowers borrow funds directly from lenders by selling them securities.
48
Q

Indirect Finance

A
  • Involves a financial intermediary that stands between the lender-savers and borrow-spenders and helps channel funds from one to the other.
49
Q

How does indirect finance impact the economy and society?

A
  • Improves the economic welfare in society.
  • Allow funds to move from people who have no productive investment opportunities to those who have these opportunities, thus financial markets contribute to economic efficiency.
50
Q

What can financial markets be classified as?

A
  • Debt and Equity Markets
  • Primary and Secondary Markets
  • Exchanges and OTC Markets
  • Money and Capital Markets
51
Q

What are the principal money market instruments?

A
  • Debt instruments with maturities of less than a year.
  • US Treasury Bills, Negotiable bank certificates of deposit, commercial paper, repurchase agreements, federal funds.
52
Q

What are the principal capital market instruments?

A
  • Debt and equity instruments with maturities greater than one year.
  • Stocks, mortgages, corporate bonds, US govt securities, state and local govt bonds and consumer and bank commercial loans.
53
Q

How do F Intermediaries play an important role in the financial system?

A
  • Reduce transaction costs.
  • Allow risk sharing
  • Solve problems created by adverse selection and moral hazard.
  • Thus increasing economic efficiency
54
Q

Evaluation to the point of F intermediaries play important role in financial system

A
  • Economies of scope created can lead to a conflict of interest causing less efficiency.
55
Q

What are the three principal categories for financial intermediaries?

A
  • Banks, contractual savings institutions, investment intermediaries
56
Q

Who fall into banks?

A
  • Commercial banks, saving and loan associations, mutual savings banks, credit unions.
57
Q

Who fall into contractual savings institutions?

A
  • Life insurance companies, fire and casualty insurance companies, pension funds
58
Q

Who fall into investment intermediaries?

A
  • Finance companies, mutual funds, money market mutual funds, hedge funds and investment banks.
59
Q

Why do governments regulate financial markets and financial intermediaries?

A
  • Increase information available to investors and to ensure soundness of financial system.
60
Q

What regulation is In place to help tackle thus?

A
  • Disclosure of information to the public.
  • Restrictions on who can set up a financial intermediary
  • Restrictions on what assets financial intermediaries can hold
  • Provision of deposit insurance
  • Limits on competition
  • Restrictions on interest rates
61
Q

What are banks’ primary liabilities?

A
  • Source of funds
  • Deposits
62
Q

What are banks’ primary assets?

A
  • Uses of funds
  • Business and consumer loans, mortgages, government securities, municipal bonds.
63
Q

What are contractual savings institutions primary liabilities?

A
  • Premiums from policies
64
Q

What are contractual savings institutions primary assets?

A

Corporate bonds and mortgages, municipal bonds, stock, government securities

65
Q

What are investment intermediaries primary liabilities?

A
  • Commercial paper, stocks, bonds, shares, partnership participation
66
Q

What are investment intermediaries primary assets?

A
  • Consumer and business loans, stocks, bonds, money market instruments, loans, FX
67
Q

Conflict of Interest

A

A moral hazard problem which occurs when someone has multiple objectives which may conflict each other.

68
Q

Moral Hazard Definition

A
  • Problem created by asymmetric information after the transaction has occurred.
  • Risk that the borrower may engage in hidden activities that are undesirable from a lenders perspective. Therefore loan less likely to be paid back.
69
Q

Adverse Selection Definition

A
  • Problem created by asymmetric information before the transaction occurs.
  • When potential borrowers who are most likely to produce an undesirable outcome actively seek a loan and thus more likely to be selected.
70
Q

Diversification Definition

A
  • Investing in a portfolio of assets whose returns of not always move together, with result that overall risk is lower than for individual assets.
  • Explains risk sharing
  • Risk averse, risk loving
71
Q

Transaction Costs

A
  • The time and money spent in carrying out financial transactions.
72
Q

Capital Defintion

A
  • Wealth, either financial or physical, employed to produce more wealth.
73
Q

Primary Market

A
  • Where new issues of a security, such as bond or stock, are sold to initial buyers by corp or govt borrowing the funds.
74
Q

Secondary Market

A
  • Where securities can be resold.
  • FTSE 100, NYSE
75
Q

How can adverse selection be solved?

A
  • Private production and sale of information.
  • Govt regs to increase information.
  • Financial intermediation
  • Collateral and net worth
76
Q

How can moral hazard in equity contracts be solved?

A
  • Can be seen as the principal agent problem.
  • Production of information: monitoring
  • Govt regs to increase information
  • FI
  • Debt Contracts
77
Q

How can moral hazard be solved in debt contracts?

A
  • Collateral and net worth
  • FI
  • Monitoring and enforcement of restrictive covenants
78
Q

Enron 2001 Issue

A
  • Engaged in transactions, keeping debt and financial contracts off its balance sheet to hide financial difficulty.
  • Govt regulation can lessen information asymmetry but not eliminate it.
  • Adverse Selection Problem: secured $1.5b of funding.
79
Q

How do Transaction Costs impact direct involvement in financial markets?

A
  • They freeze many small savers and borrowers out of the market.
80
Q

How can F intermediaries take advantage in reducing TC’s?

A
  • Economies of scale and are better able to develop expertise, leading to lower TC’s and enabling savers and borrowers to benefits from the existence of financial markets.
81
Q

Free-Rider Problem in Adverse Selection

A
  • Occurs when people who do not pay for the information take advantage of information that other people have paid for.
  • Explains why FIs, particularly banks, play a more important role in financing activities of businesses than do security markets.
82
Q

Moral Hazard/Principal-Agent Problem in Equity Contracts

A
  • Occurs because managers (agents) have less incentive to maximise profits than stockholders (principals).
  • Explains why debt contracts are more prevalent in FMs
83
Q

Tyranny of Collateral

A
  • Explains why poor countries can’t access financial markets.
  • People in developing countries are bound by corruption and lack of collateral and therefore cannot start businesses or afford to take out a mortgage for a house.

Financial Economics Year 3 (9 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions