Chapter 2: Financial markets and institutions Flashcards
Where does the financing for corporations come from? (LO2-1)
The ultimate source of financing is individuals’ savings. The savings may flow through financial markets and intermediaries. The intermediaries include mutual funds, pension funds, and financial institutions, such as banks and insurance companies.
Why do non-financial corporations need modern financial markets and institutions? (LO2-1)
Corporations need access to financing in order to innovate and grow. A modern financial system offers different types of financing, depending on a corporation’s age and the nature of its business. A high-tech start-up will seek venture capital financing, for example. A mature firm will rely more on bond markets.
What if a corporation finances investment by retaining and reinvesting cash generated from its operations? (LO2-1)
In that case, the corporation is saving on behalf of its shareholders.
What are the key advantages of mutual funds and pension funds? (LO2-2)
Mutual and pension funds allow investors to diversify in professionally managed portfolios. Pension funds offer an additional tax advantage because the returns on pension investments are not taxed until withdrawn from the plan.
What are the functions of financial markets? (LO2-3)
Financial markets help channel savings to corporate investment, and they help match up borrowers and lenders. They provide liquidity and diversification opportunities for investors. Trading in financial markets provides a wealth of useful information for the financial manager.
Do financial institutions have different functions? (LO2-3)
Financial institutions carry out a number of similar functions to financial markets but in different ways. They channel savings to corporate investment, and they serve as financial intermediaries between borrowers and lenders. Banks also provide liquidity for depositors and, of course, play a special role in the economy’s payment systems. Insurance companies allow policyholders to pool risks.
What happens when financial markets and institutions no longer function well? (LO2-4)
The financial crisis of 2007–2009 provided a dramatic illustration. The huge expansion in subprime mortgage lending in the United States led to a collapse of the banking system. The government was forced into costly bailouts of banks and other financial institutions. As the credit markets seized up, the country suffered a deep recession. In much of Europe, the financial crisis did not end in 2009. As governments struggled to reduce their debt mountains and to strengthen their banking systems, many countries suffered sharp falls in economic activity and severe unemployment.
