Ch 2

Question 1

direct finance

Answer 1

borrowers borrow funds directly form lenders in financial markets by selling them securities.

Question 2

Function of financial markets

Answer 2

Promotes economic efficiency by producing an efficient allocation of capital, which increases production.
- directly improve the well-being of the consumers by allowing them to time purchases better.

Question 3

Structure of Financial markets

Answer 3

Debt and equity Markets:
- debt instruments (maturity)
- equities (dividends)
Primary and secondary markets:
- investment banks underwrite securities in primary markets
- brokers and dealers work in secondary markets.

Question 4

Exchanges and over-the-counter (OTC) markets:

Answer 4

• Exchanges : NYSE, Chicago board of Trade

- OTC Markets: Foreign exchange, federal funds

Question 5

Money and capital markets:

Answer 5

• Money markets deal in short-term debt instruments

- Capital markets deal in longer-term debt and equity instruments.

Question 6

Foreign Bonds

Answer 6

Sold in a foreign country and denominated in that country’s currency

Question 7

Eurobond

Answer 7

Bond denominated in a currency OTHER than that of the country in which it is sold.

Question 8

Eurocurrencies:

Answer 8

Foreign currencies deposited in banks outside the home country
- Eurodollars: US dollars deposited in foreign banks outside the US or in foreign branches of US banks.

Question 9

World Stock Markets

Answer 9

Also help finance the federal gov.

Question 10

Financial intermediaries: indirect finance

Answer 10

• Lower transaction costs ( time and money spent in carrying out financial transactions)
• economies of scale
• liquidity services.
  Reduce the exposure of investor to risk
• risk sharing ( asset transformation)
• diversification

Question 11

Adverse selection:

Answer 11

(before the transaction): try to avoid selecting the risky borrower by gathering information about them.

Question 12

Moral Hazard

Answer 12

(after the transaction) ensure borrower will not engage in activities that will prevent him/her to repay the loan.
- sign a contract

Question 13

conclusion:

Answer 13

Financial intermediaries allow “small: savers and borrowers to benefit from the existence of financial markets.

Question 14

Regulation of the financial system

Answer 14

Increase the information available to investors:

• reduce adverse selection and moral hazard problems
• reduce insider trading (SEC)