Lesson 1

Question 1

It is a
densely interconnected network
of all financial intermediaries,
financial markets and
regulators and their relations
with respect to the flow of
funds to and from households,
governments, business firms,
and foreigners, as well as the
financial infrastructure.

Answer 1

Financial System

Question 2

the importance of financial markets

Answer 2

Facilitates economic activity and growth
❖ Transforms household savings into funds available for investment by
firms. It diverts savings to productive uses, it helps to increase
output of the economy.

Question 3

• It occurs if a sector in need of
  funds borrows from another
  sector via a financial market.
• borrowers
  and savers exchange money
  and financial instruments
  directly.

Answer 3

direct finance

Question 4

a
financial intermediary obtains
funds from savers and uses
these savings to make loans to
a sector in need of finance.
• Borrowers borrow indirectly
from lenders via financial
intermediaries by issuing
financial instruments which
are claims on the borrower’s
future income or assets.

Answer 4

indirect Finance

Question 5

which facilitate the flow of funds
in order to finance investments by corporations, governments and
individuals

Answer 5

financial markets (direct finance)

Question 6

who are the key
players in the financial markets as they perform the function
of intermediation and thus determine the flow of funds

Answer 6

• financial institutions (indirect method of finance)

Question 7

who perform the role of monitoring and
regulating the participants in the financial system

Answer 7

• financial regulators

Question 8

act as the middleman for joining two unrelated
parties in investing and growth. Most frequently, this process is
completed through a financial institution.

Answer 8

Financial intermediaries

Question 9

Financial institutions can be divided into two types

Answer 9

depository
non depository

Question 10

consists of traditional banks, credit unions, and
savings and loan depositories. They accept deposit and make
loans acting as intermediaries in matching lenders and borrowers.

Answer 10

Depository

Question 11

are made up of financial advisors and brokers,
insurance companies, life insurance companies, mutual funds,
and pension funds.

Answer 11

Non-depository

Question 12

WHY DO FINANCIAL INTERMEDIARIES EXIST?
Financial Intermediaries are engaged in process of indirect finance and
exist because of:

Answer 12

• Lenders and borrowers have conflicting needs
• Transaction costs;
• Asymmetric of information; and
• To allow risk sharing

Question 13

Most lenders prefer lending short-term
Most borrowers prefer borrowing long-term
That is why most intermediation is done indirectly, where
intermediaries understand and reconcile the different needs of
lenders and borrowers.

Answer 13

CONFLICTING NEEDS

Question 14

Financial intermediaries can substantially reduce transaction costs
because they have developed expertise in lowering them, and
because their large size allows them to take advantage of economies
of scale, the reduction in transaction costs per peso of transactions
as the size (scale) of transactions increases

Answer 14

TRANSACTION COSTS

Question 15

refers to a situation where one party to a
market transaction has much more information about a product or
service than the other. This lead to the problems of moral hazard
and adverse selection.

Answer 15

ASYMMETRY OF INFORMATION

Question 16

tendency of one party to a contract to alter his/her
behavior in ways that are costly to the other party

Answer 16

Moral hazard

Question 17

information known by the first party to a
contract is unknown to the second and, as a result, the second party
incurs major costs.

Answer 17

Adverse selection

Question 18

are usually equip with a better credit risk
screening than individuals. This help in reducing losses due to wrong
investment decision making.
- have developed expertise in monitoring the
parties they lend to, thus reducing losses due to moral hazard.

Answer 18

ASYMMETRY OF INFORMATION
Financial intermediaries

Question 19

Financial intermediaries create and sell assets with low risk
characteristics and then use the funds to purchase other assets that
may have far more risk. This process of risk sharing is called asset-
liability transformation.

Answer 19

RISK SHARING

Question 20

Another way of risk sharing provided by financial intermediaries is
through diversification. Financial intermediaries invest in a
collection of assets whose return do not always move together, with
the result that overall risk is lower than for individual assets.

Answer 20

RISK SHARING

Question 21

Refers to channels or places where funds and financial instruments
such as stocks, bonds and other securities are exchanged between
willing individuals or entities.

Answer 21

FINANCIAL MARKETS

Question 22

• This is the sector of the financial market where financial instruments that
will mature or be redeemed in one year or less from issuance date are
traded.
• Consists of buyers and sellers who purchase and sell short-term
securities, such as certificates of deposit, commercial paper, and
treasury bills. These securities are traded as a means of short-term
borrowing and lending.

Answer 22

MONEY MARKETS

Question 23

• This is the sector in the financial market where financial instruments
issued by government and corporations that will mature beyond one
year from issuance date are traded.
• It is a financial market where buyers and sellers trade long-term
securities, such as stocks and bonds.

Answer 23

CAPITAL MARKETS

Question 24

• This is where fund demanders
like corporation or government
agencies raise funds through
new issuances (first-hand or
original issuance) of financial
instruments (bonds or stocks).

Answer 24

PRIMARY MARKET

Question 25

• This is where securities issued
in the primary market are
subsequently traded (resold
and repurchased – second
hand).
• Trading Previously Issued
Securities
• No New Funds for Issuer
• Provides Liquidity for Seller

Answer 25

SECONDARY MARKET

Question 26

If the transaction is perfected within the same national boundary this is
called Domestic Market otherwise it is International or Foreign Market.

Answer 26

FINANCIAL MARKETS AS TO ORIGINATION