Chapter 8

Question 1

What is the function of financial markets?

Answer 1

The function of financial markets is to channel funds from economic players that have surplus funds to those that have a shortage

Question 2

What kind of roles do players adopt within the economy

Answer 2

Efficient allocation of capital
Allows consumers to time their purchases

Question 3

What is direct finance?

Answer 3

It is when one borrows funds directly from lenders

Question 4

What does direct finance usually involve?

Answer 4

It involves selling a liability (an IOU or a debt)

Question 5

What are bonds?

Answer 5

A bond is a contract between a borrower and a lender

Question 6

What does a bond involve?

Answer 6

It involves regular payments until maturity

Question 7

What is equity?

Answer 7

Equity is the value of shares within a corporation

Question 8

What are equity holders?

Answer 8

They are residual claimants

Question 9

What is a primary market?

Answer 9

It is a market where new security issues are sold to initial buyers
They are not well known to the public and includes the participation of investment banks who guarantee prices

Question 10

What is a secondary market?

Answer 10

It is a market where previously issued securities are bought and sold

Question 11

Who are the primary players in a secondary market?

Answer 11

Brokers and Dealers

Question 12

What do Brokers do?

Answer 12

They match buyers and sellers in each other

Question 13

What do Dealers do?

Answer 13

They offer to buy and sell securities at stated prices

Question 14

What are the two main ways in which we can organize a primary market?

Answer 14

Through exchanges or by creating a over-the-counter market

Question 15

What are the characteristics of an exchange market?

Answer 15

Buyers and sellers meet in one central location

Question 16

What are the characteristics of an over-the-counter market?

Answer 16

Dealers have inventory, ready to buy/sell at stated prices

Question 17

What do money and capital markets do?

Answer 17

They distinguish markets by maturity of the securities

Question 18

What are money markets?

Answer 18

They are markets where only short-term debt instruments are traded

Question 19

Why do banks and corporations use money markets?

Answer 19

They use money markets in order to reach interest on temporary surplus funds

Question 20

What are capital markets?

Answer 20

They are markets for longer-term debts

Question 21

Which market is more liquid; money markets or capital markets?

Answer 21

Money markets

Question 22

List the 5 money market instruments

Answer 22

Government of Canada Treasury Bills
Certificates of Deposit
Commercial Paper
Repurchase Agreements
Overnight Funds

Question 23

List the 8 capital market instruments

Answer 23

Stocks
Mortgages and mortgage-backed securities
Corporate bonds
Government of Canada bonds
Canada Savings bonds
Provincial and municipal government bonds
Government agency securities
Consumer and bank commercial loans

Question 24

What are foreign bonds?

Answer 24

They are bonds sold in a foreign country denominated in that country’s currency

Question 25

What is a eurobond?

Answer 25

They are bonds sold in a foreign country, denominated in that country’s currency, specifically in europe

Question 26

What are eurocurrencies?

Answer 26

They are a variant of a eurobond where foreign currencies are deposited in banks outside the home country

Question 27

What are eurodollars?

Answer 27

They are US dollars deposited in foreign banks outside the US or in foreign branches of US banks

Question 28

What is financial intermediation?

Answer 28

It is indirect financing using financial intermediates
Primary route is to move funds from lenders to borrowers

Question 29

What are the three main roles of financial intermediaries?

Answer 29

Lowers transaction costs
Improves risk sharing
Helps solve asymmetric information problems

Question 30

How does financial intermediation lower transaction costs?

Answer 30

Through economies of scale and liquidity services

Question 31

How does financial intermediation improve risk sharing?

Answer 31

Allows for asset transformation and diversification

Question 32

How does financial intermediation help asymmetric information problems?

Answer 32

Adverse Selection: Potential borrows who are more likely to default will most actively seek out loans
Moral Hazard: Borrowers might engage in activities that are undesirable from a lender’s point of view
Financial intermediates can screen and monitor

Question 33

What are the 3 types of financial intermediaries?

Answer 33

Depository Institutions
Contractual Savings Institutions
Investment Intermediaries

Question 34

What are depository institutions?

Answer 34

Chartered Banks, Trusts and Mortgage Loan Companies, Credit Unions and Caisses Populaires

Question 35

What are contractual savings institutions?

Answer 35

Life Insurance Companies, Property and Casual Insurance Companies, Pension Funds and Retirement Funds

Question 36

What are investment intermediaries?

Answer 36

Finance Companies, Mutual Funds, Money Market Mutual Funds, Hedge Funds, Investment Banks

Question 37

What are the primary reasons for regulation?

Answer 37

Increase information available to investors
Ensure soundness of financial intermediaries

Question 38

How does an increase in information available to investors aid in regulation?

Answer 38

Reduces adverse selection and moral hazard problems
Increases efficiency of financial markets

Question 39

How does the ensured soundness of financial intermediaries aid in regulation?

Answer 39

Restrictions on entry and competition, reporting requirements, and restrictions on assets and activities
Deposit insurance