Tutorial 1

Question 1

What is the definition difference between direct and indirect finance?

Answer 1

direct: lender to borrower
indirect: lender to intermediary to borrower

Question 2

Why does indirect finance exist?

Answer 2

1. reduce transaction costs
2. spread risk through many smaller deposits OR reduce risk by using larger pools of money to diversify
3. more resources to screen borrowers or check their history, filter out bad lenders

Question 3

What are the 3 ways of segmenting the financial market?

Answer 3

1. debt and equity:
   - Debt: lend from others w a promise to pay them back
   - Equity: let others own a part of your company, they get paid after debts
2. primary and secondary: new securities vs existing securities
3. money vs capital: short-term (<1 year) maturity debt vs long-term maturity debt and equity

Question 4

What are examples of financial intermediaries?

Answer 4

depository, contractual savings (insurance), investment companies

Question 5

Is the government considered a financial intermediary?

Answer 5

Transaction costs: does not facilitate exchange between lender and borrower

Risk-sharing/reduction of risk: government does not reduce the risk of investments, though it has a risk-free bond

asymmetric information: does not have the additional information needed to scan out bad lenders, facilitates policymaking to necessitate such practices

i.e. No

Question 6

What are the different types of financial market instruments?

Answer 6

treasury bills, corporate stocks, residential mortgages

Question 7

Do T-bills belong in the money or capital market?

Answer 7

money because it’s a short term debt

Question 8

What is the quintessential definition of money?

Answer 8

stock concept, generally accepted as payment for G&S

• medium of exchange (does not require double coincidence of wants)
• store of value (save purchasing power over time)
• unit of value (used to measure value in the economy)

Question 9

Is credit considered money?

Answer 9

credit is a future obligation to payback based on a purchase today

underlying credit is a currency which is to resolve the double coincidence of wants, it is not used to measure value

No

Question 10

How to distinguish M2 from M1?

Answer 10

M2 = M1 + less liquid assets

Question 11

Are bank deposits considered to be in M1?

Answer 11

No, because they can only be liquidated subject to bank demand and supply (availability) of money