Chapter 18 Flashcards
in practice how much of firms equity and debt finances their investments? what about banks?
30 - 40 equity
60 - 70 debt
differs betwen countries and industry
banks have around 10% equity
what is the link when firms finance a share of their investments by retained earnings? what is this mechanism called?
current profit and investment - financial accelerator
what happens if expectations about future production and profits increase?
share prices should increase
what is tobins q?
investment is a function of Tobins q, the market value of capital stock relative to the replacement value of the capital stock
why is direct lending from households to firms or other households usually not possible?
due to lack of trust and information and maturity mismatch
what is deposit insurance?
meant to protect deposit holders and bank runs
how did central banks and governments manage to prevent a general collapse of the financial system 2008-2009?
supporting banks with liquidity in the form of short and medium term lending, guarantees for loans taken by banks to help them roll over short term debt
what is a main element of the Basel III agreement?
capital requirements increased
what should the central bank do when a financial crisis arises? what 2 factors limit the power of monetary policy?
should reduce interest rates
1. increased uncertainty - leads to rising margins between the repo rate
2. interest rate set by CB may hit the zero lower bound
what does the law of large numbers mean?
means that the share of credit losses in the loan portfolio can be estimated rather well and the bank’s equity acts as a buffer that absorbs unusually large losses on loans. also means that withdrawals and new deposits tend to cancel out and banks have some liquid assets eg. gov bonds which can be sold at short notice
what is a bank run? how can this cause a financial crisis?
triggered when a bank has made or feared to make large losses. financial institutions have claims on each other and people fear they have made similar losses
what are capital requirements?
require banks to have a certain amount of equity relative to assets so theres a buffer to absorb losses
how do firms finance their real and financial investments?
with debt and equity
what is equity?
arises from money invested by shareholders and retained earnings being reinvested - it absorbs shocks
what fixed repayment are debt holders promised? in what case would they get less than promised?
the loan + interest
only in case of bankruptcy
are shareholders promised the same? why?
not promised fixed return
they bear the risk
what makes a debt more risky? what do lenders do to require firms to have?
the higher the share of investment financed by debt
lenders require firms to have a substantial share financed by equity so there is a sufficient buffer that can absorb losses without the company becoming insolvent
