Exam Style Questions To Think About

Question 1

Discuss the main theories for the existence of financial intermediaries. What are the costs and benefits of having them?

Answer 1

Sure, here are condensed notes suitable for Brainscape:

1. Financial Intermediation Theory:
   
   • Purpose: Bridging gap between savers and borrowers.
   • Benefits: Efficient capital allocation, reduced information asymmetry, and transaction cost reduction.
   • Costs: Intermediation costs and agency costs due to conflicts of interest.
2. Transaction Cost Theory:
   
   • Purpose: Reduce transaction costs through economies of scale and specialization.
   • Benefits: Convenience, efficiency, and economies of scale.
   • Costs: Concentration risk and reduced competition.
3. Risk Management Theory:
   
   • Purpose: Manage and diversify risk in the economy.
   • Benefits: Risk diversification and risk-sharing mechanisms.
   • Costs: Moral hazard and systemic risk due to interconnectedness.
4. Asymmetric Information Theory:
   
   • Purpose: Overcome information asymmetry in financial markets.
   • Benefits: Improved market efficiency and access to credit.
   • Costs: Adverse selection and moral hazard.

Question 2

Explain the transformation functions of banks?

Answer 2

1. Maturity Transformation: Banks engage in maturity transformation by offering short-term liabilities, such as deposits, while investing in longer-term assets, such as loans and securities. This allows banks to match the maturity preferences of depositors with the funding needs of borrowers who require longer-term financing.
2. Risk Transformation: Banks also transform the risk characteristics of assets and liabilities. They aggregate funds from multiple depositors and lend them out to borrowers, diversifying risk across a portfolio of assets. By spreading risk, banks reduce the exposure of individual depositors to the credit risk associated with specific borrowers.
3. Liquidity Transformation: Banks provide liquidity to depositors by offering on-demand access to funds through checking and savings accounts, while investing in less liquid assets, such as loans and mortgages. This liquidity transformation allows banks to channel funds into longer-term investments while meeting the short-term liquidity needs of depositors.
4. Size Transformation: Banks act as financial intermediaries that aggregate small deposits from a large number of savers and transform them into larger loans or investments. This enables banks to mobilize savings efficiently and allocate them to borrowers who require larger amounts of financing for various purposes, such as business expansion, investment projects, or consumer loans.

Question 3

Discuss peer to peer lending

Answer 3

The role of peer to peer lending:

• increased access to credit
• alternative investment opportunities: lenders can invest directly into loans or loan portfolios earning higher returns compared to traditional savings accounts.

Types of loans:

• Personal Loans
• Business Loans
• Debt consolidation

Advantages of peer to peer lending

• Potentially lower interest rates
• Faster funding than banks
• lenders have greater flexibility over their investments

Disadvantages:

• higher credit risk
• regulation isn’t robust investor protection may not be a good as regular FI.
• P2P investments may not be liquid.

Question 4

Discuss the main limitations of bank financial ratios.

Answer 4

1. Lack of Context: Ratios lack broader operational and external context.
2. Historical Bias: Based on past data, may not reflect current or future conditions accurately.
3. Industry Variability: Difficult to compare across banks due to differing practices and risks.
4. Manipulation Risk: Susceptible to manipulation through accounting practices or financial engineering.