The Financial System Flashcards
What is a bond?
- Is a security issued by a corporation or government that promises to pay the buyer predetermined amounts of money at certain times in the future
- also called debt securities.
- called a fixed-income security
what name have the Bonds with maturities of less than a year?
- It is called commercial paper
What is a stock ?
- It is an ownership share in a corporation - or equity
- Corporation issue bonds: to raise funds for investment
Why is riskier to buy a stock?
- The earnings from a company’s stock are a share of profits, and profits are unpredictable.
Consequently, buy- ing stocks is usually riskier than buying bonds - People buy stocks despite the risk because stocks often produce higher returns.
Difference between the control that give the bonds and the stocks?
- stock is an ownership share, stockholders have ultimate control over a corporation
- bondholders have no control over a corporation; a bond is simply a corporation’s promise of future payments to the bond’s buyer.
What is savers ?
- people that accumulate wealth by spending less than they earn
who are investor ?
- people who expand the productive capacity of businesses by buying and/or hiring
Common misperception in the word “invest” when buying stocks and bonds ?
- purchasing securities is a form of saving.
- investment is when someone hire and/or buy product to create sometime
First role of the finance sector ? and second ?
- To be an intermediary
- help people to share risks (with shareholders) - This strategy means giving up a chance for high profits, but it is less risky.
What is diversification ?
- the distribution of wealth among many assets, such as securities issued by different firms and governments
- Divide the risk by buying assets in many corporations
- Diversification lets savers earn healthy returns from securities while minimizing the risk of financial disaster.
What is mutual funds ?
- financial institutions that holds a diversified set of securities and sells shares to savers
What is asymmetric information ?
- situation in which one participant in an economic transaction has more information than the other participant
types of asymmetric information ?
- adverse selection
- moral hazard
what is adverse selection? (asymmetric information)
- A situation where one menber of a transaction (buyer or seller) have more information and It may lead to an adverse desicion prior the transaction
- the problem that the people or firms that are most eager to make a transaction are the least desirable to parties on the other side of the transaction
What is moral hazard ? (asymmetric information)
the risk that one party to a transaction will act in a way that harms the other party (after transaction)
what is a bank ?
- A bank is one kind of financial institution.
- also called a financial intermediary
difference between adverse selection and moral hazard?
- The main difference between the two:
Is that adverse selection occurs when there’s lack of symmetric information prior to a transaction/deal between borrower/buyer and lender/seller.
Whereas moral hazard occurs when there is asymmetric information between parties after the transaction has taken place.
two main characteristic of banks ?
financial institution that:
- accepts deposits
- makes private loans
what is private loan ?
- Loan negotiated between one borrower and one lender (not intermediaries)
what is indirect finance ?
- savers deposit money in banks that then lend to investors
what is direct finance ?
- savers provide funds to investors by buying securities in financial markets
what is a covenant ?
- provision in a loan contract that restricts the borrower’s behaviour
how banks reduce adverse selection? (asymmetric information)
Reducing Adverse Selection:
- by screening potential borrowers, therefore, allowing funds flow to the most productive investment.
- by gathering information with higher changes of success than an individual non-expert inn the field.
how banks reduce Moral Hazard ?(asymmetric information)
- By using Covenants
What is economic growth ? (finance)
- increases in productivity and living standards; growth in real GDP
what is Real gross domestic product (real GDP)?
- the measure of an economy’s total output of goods and services
Basic macro theories assume: (savings rate)
- that saving flows automatically to investors with productive projects
- In fact, the right investors get funds only if the economy has a strong financial system that functions well
- An economy can save a lot and still remain poor if saving is not channeled to its best uses.
What happens when a country have a inefficient financial system ?
- When a financial system cannot work properly, investors have trouble financing their projects and economic growth slows.
what come first growth or financial development ?
According to the author:
-“This suggests that financial development comes first and causes growth, rather than vice versa.” - base on World Bank’s research that addresses the question of causality.
What is unit banking?
- federal law allowed a bank to operate in only one state
- Some states went further and restricted each bank to a single branch
- A bank’s customers could make deposits or seek loans at only one location
what the Proponents of unit banking believed?
- that multiple branches would allow banks to become too large and powerful
- Large banks might drive smaller banks out of business and exploit customers.
- Unit banking was most com- mon in the Midwest, the home of the Populist political movement of the nineteenth century. Populists were angry at banks for seizing property from farmers who defaulted on loans.
Why most economist most economists think unit banking was a mistake?
- Economies of scale (it didn’t allow)
- Risk diversification
- Monopolists
why most economist think that economies of scale is good? (unit banking counter-argument)
- They can operate more efficiently than small banks because they can offer services at a lower cost per customer
- Unit banking increased banks’ costs by keeping them small.
why most economist think that Risk diversification was a problem in a unit banking system ?
- a bank operated in only one town. If the town’s economy did poorly, many borrowers defaulted on loans.
- The bank lost money and might be forced out of business.
- Having branches in different towns reduce the risk of default
why most economist think unit banking system allow monopolies ?
- many small towns had only one bank
- Customers had nowhere else to go if the bank charged high interest rates on their loans or provided poor service
- In states that allowed multiple branches, banks from throughout the state could enter a town and increase competition.
what is Microfinance ?
- small loans that allow poor people to start businesses - or micro-lending
- fill the gap in developing countries’ banking systems by providing small loans to poor people
- The idea was pioneered by Muhammad Yunus, an economics professor in Bangladesh,
Why there is contradictory opinion about Microfinance and Commercial banks?
- Many supporters of microfinance welcome the involvement of commercial banks because it increases the availability of micro loans
- Others allege hat for profit lenders charge excessive interest rates and deny loans to the poorest of the poor even Muhammad Yunus has criticized “Compartamos” (commercialize), saying it is “raking in money off poor people desperate for cash.”*
what is Central planned economy or command economy?
- system in which the government decides what goods and services are produced, who receives them, and what investment projects are undertaken
What went wrong with the Soviet Union? (common factors pointed by economist historians)
an important factor was a misallocation of investment:
- Planners did not allocate resources in a proper way
- Overemphasized short-run increases in productivity.
- Managers focused on meeting current quotas rather than increasing long-run productivity
- The power of government bureaucrats reduced efficiency. Plant managers were rewarded for following orders, not for thinking of innovative ways to raise output and lobbying
what is a financial crisis?
- major disruption of the financial system, typically involving sharp drops in asset prices and failures of financial institutions
What is Nominal GDP ?
- the total value of all final goods and services produced in an economy in a given period
What is Aggregate price level ?
- an average of the prices of all goods and services
What is Inflation rate ?
- percentage change in the aggregate price level over a period of time
Real GDP formula:
Real GDP = nominal GDP/ Aggregate price level
Asymetric Information in financial markets: graph

The flow of funds from savers to investors: graph
