Financial markets and Financial Institutions Flashcards
What is the financial system?
A mechanism through which loanable funds reach borrowers, consisting of financial markets, financial institutions, financial assets, instruments, economic agents, governments, and central banks.
What is the role of financial markets?
They facilitate capital transactions between economic agents with surplus funds and those needing to raise capital.
What are financial institutions?
Entities within or outside financial markets that mediate between savers and borrowers.
What are deposit-taking financial institutions?
Institutions empowered to accept and hold public deposits, traditionally granting loans.
What are non-deposit-taking financial institutions?
Institutions not funded by deposits, like investment banks, insurance companies, and pension funds.
Institutions not funded by deposits, like investment banks, insurance companies, and pension funds.
Define uncertainty in financial terms.
Situations where the outcome of an activity is unknown, measurable using probability theory. Examples: Brexit, COVID-19.
What is the risk-return dilemma?
The trade-off where lower risk implies lower returns, and higher risk implies higher potential returns.
What is asymmetric information in finance?
A situation where borrowers have more information about the investment’s true nature than lenders, potentially hiding or misusing funds.
What is adverse selection?
When a lender finances bad projects due to an inability to distinguish them from good ones.
What is moral hazard?
When borrowers misuse funds or act irresponsibly after agreeing to a financial contract.
Describe the “No Financial Intermediation Theory”.
Proposes that financial intermediaries add no value as households can achieve Pareto optimal allocations directly through financial markets.
What are transaction costs in finance?
Coordination costs involve connecting buyers and sellers, while motivation costs arise from ensuring adherence to transaction terms.
How do financial intermediaries act as liquidity providers?
By offering insurance against liquidity needs and transforming liquid liabilities (deposits) into illiquid assets (loans).
What causes a bank run?
Customer panic over perceived insolvency, leading to mass withdrawals and potential bankruptcy.
What is the traditional financial intermediation theory?
It emphasizes the role of intermediaries in reducing transaction costs, mitigating adverse selection and moral hazard, and providing liquidity and credit allocation.
What is the modern theory of financial intermediation?
Focuses on risk transformation and management, addressing challenges through new products and diversification.
What did the Gramm-Leach-Bliley Act (1999) change?
It repealed the Glass-Steagall Act, allowing commercial banks to engage in investment banking, insurance, and security firm activities.
