Chapter 2 Flashcards
What are functions of financial intermediaries?
Lower transaction costs through economies of scale and liquidity services.
Reduce risk through risk sharing (asset transformation) and diversification
Reduces information costs of screening and monitoring borrowers - adverse selection and moral hazard
What is adverse selection and moral hazard?
Adverse selection (before transaction) more likely to select risky borrower
Moral hazard (after transaction) - less likely borrower repays loan
What are functions of financial markets?
Channel funds from economic agents that have saved surplus funds
(lender-savers) to those that have a shortage of funds (borrower-investors-
spenders).
Promote economic efficiency by producing an efficient allocation of
capital, increasing production.
Directly improve the well-being of consumers by allowing them to plan the
timing of consumption better.
What is direct finance?
borrowers borrow funds directly from lenders in financial markets by selling them securities.
What is indirect finance?
financial intermediary stands between lenders and
borrowers.
what is an asset?
something of value that is owned
what is a liability?
something of value that is owed
debt and equity markets?
financial claims are bought and sold for immediate cash payment
What are debt instruments?
contractual agreements by borrowers to make regular payments to the holders
(principal payment and interest) until maturity date.
Maturity is the number of years to expiration date of the debt.
What is equity?
claims to share the net income (dividends) and assets of a business
what are derivative markets?
financial claims are based on underlying assets.
These are bought and sold for payment at a future date.
What is the difference between primary and secondary markets?
primary markets trade in newly issued securities
secondary markets trade in existing securities
Describe brokers and dealers?
Brokers: agents matching buyers with sellers of
securities (buy/sell for their clients).
Dealers: link buyers and sellers by buying/selling
securities at stated prices (buy/sell on their own
account).
what is the maturity in money and capital markets?
money markets deal in short term (<1 year) debt instruments
capital markets deal in longer term (>1 year) debt and equity
Money market instruments:
Government bonds (Treasury bills)
Bank certificates of deposit
Commercial paper
Repurchase agreements (Repo)
Eurodollars
Banker’s acceptances
capital market instruments:
Government securities and bonds (long-term)
Corporate stocks
Corporate bonds
Mortgages and mortgage-backed securities
Bank commercial loans
What are the primary assets and liabilities of commercial banks?
liabilities: deposits
assets: business and consumer loans, mortgages, US government securities, and municipal bonds
What are primary assets and liabilities of savings and loan associations?
liabilities: deposits
assets: mortgages
What are primary assets and liabilities of mutual savings banks?
liabilities: deposits
assets: mortgages
What are primary assets and liabilities of credit unions?
liabilities: deposits
assets: consumer loans
What are primary assets and liabilities of Finance companies?
liabilities: commercial paper, stocks, bonds
assets: Consumer and business loans
What are primary assets and liabilities of mutual funds?
liabilities: shares
assets: stocks, bonds
What are primary assets and liabilities of money market mutual funds and hedge funds?
money market mutual funds
liabilities: shares
assets: money market instruments
hedge funds
liabilities: partnership participation
assets: stocks, bonds, loans, foreign currencies, and many other assets
What are the contractual savings institutions and list their liabilities and assets?
Life insurance companies
liabilities: premiums from policies
asset: corporate bonds and mortgages
fire and casualty insurance companies
liabilities: premiums from policies
assets: municipal bonds, corporate bonds and stock, and US government securities
pension funds, government retirement funds:
liabilities: Employer and employee contributions
assets: corporate bonds and stocks
Reasons to regulate the financial system?
To increase information available to investors
to ensure soundness of financial intermediaries
