Overview of financial system

Question 1

What is a financial system

Answer 1

represents all markets, institutions,
laws, regulations & techniques through which financial
assets are created & traded, interest rates determined &
financial services produced & delivered around the world.

Question 2

What is a sercurity

Answer 2

Financial asset that is tradable e.g. a share of a company,

debt instruments e.g. company bond or debenture

Question 3

1) what is a primary market

Answer 3

A primary market issues new securities on an exchange for companies, governments and other groups to obtain financing through debt-based or equity-based securities

Question 4

1a) what is direct finance

Answer 4

Is when funds flow from savers to lenders

Question 5

1a) what are the advantages of direct finance

Answer 5

avoids cost of intermediation
• Borrowers access different financial markets & financial
instruments

Question 6

1a) what are the disadvantages

Answer 6

matching of preferences & asymmetric information
• Often illiquidity of secondary market
• search & transaction costs high –timing problems
• assessment of risk (e.g. default) not easy

Question 7

What is asymmetric info

Answer 7

occurs when one party to an economic transaction possesses greater material knowledge than the other party

Question 8

1b) what is indirect finance

Answer 8

funds flow with help of investment banks, security brokers &
dealers who aid in sale of direct claims against borrowers (but
no new assets are created by investment bank

Question 9

1b) differemce between broker & dealer markets

Answer 9

Broker: agents for investors who match buyer & sellers (for
a fee - don’t own the assets)

Dealer: people who link buyers & sellers by buying &
selling at stated prices (market makers= make a market)

Question 10

1c) what is Intermediated finance

Answer 10

Flow of funds through financial intermediary

Question 11

1c) advantages of intermediated finance

Answer 11

-asset transformation–wide range of financial products
-maturity transformation- deposits of short periods to
longer period loans
-credit risk diversification (or transformation)
- economies of scale due to size & business volume

Question 12

1c) Main advantage of intermediated finace

Answer 12

Overall, intermediation = usual way to finance businesses as

adverse selection & moral hazard are reduced (asymmetric info)

Question 13

2) what is a secondary market

Answer 13

Secondary markets are used to trade existing securities

Question 14

3) what is a wholesale market

Answer 14

Wholesale markets involve large transactions
( usually $100,000) between institutional investors &
borrowers or large investors

Question 15

3) What is retail market

Answer 15

Retail markets generally involve the transactions of
households & small business sectors using financial
intermediaries

Question 16

What have financial intermediaries created expertise in?

Answer 16

-Lowering transaction costs & taking advantage of
economies of scale
-in monitoring
the parties they lend to (by gathering info about potential
borrowers) & so manage their risk

Question 17

definition of Financial Institutions

Answer 17

permit the flow of funds between borrowers & lenders by assisting financial transactions

Question 18

examples of Depository Financial Institutions

Answer 18

• Banks
  – Building Societies
  – Credit Unions

Question 19

functions of Depository Financial Institutions

Answer 19

Attract savings from depositors (deposits = bank liabilities) &
investors to provide loans (= bank assets) to borrowers
• Create NEW financial assets (loans) as part of transaction
• These new assets (Loans) provide benefits (income from
interest payments & repayment of principal) but risks (e.g.
default by borrower & interest rate)

Question 20

definition of Contractual Institutions & Non-depository

Answer 20

The sources of funds (liabilities) of these institutions are
contracts that generate periodic cash flows & are then used
to purchase both primary & secondary market securities

Question 21

example of contractual institutions

Answer 21

Insurance companies

Question 22

example of non-depository institutions

Answer 22

– Superannuation (Pension)Funds NZ Superannuation
Fund: Home
– Finance companies UDC Finance Limited
– Investment banks (Money market Corporations)
– Managed funds (Unit Trusts)